Contracting for decommissioning: what to consider

Decommissioning is arguably the least appealing phase of the project life cycle. The revenues from operations are over and the owner is facing what is likely a very large clean-up bill. Nevertheless, it is a priority. Decommissioning liabilities are increasingly becoming the focus of regulators and environmental groups and there is significant pressure on proponents to ensure the safe restoration of a site with good environmental outcomes promptly once operations have ceased.

Decommissioning is complex work. The risk profile for decommissioning scopes is different to that for construction scopes and this should feed through to the contractual terms. Here are a few considerations from our recent experience with contracting for decommissioning work.  

Decommissioned materials – ownership and risk

The product of a decommissioning contract is generally a remediated site and the recovery of the decommissioned materials. Decommissioned materials are not generally a feature of an ordinary construction contract and will need to be addressed specifically. 

Sometimes the decommissioned materials will have value (for example, as scrap metal or plant that can be refurbished and re-used). More commonly, the decommissioned materials may be waste. Most decommissioning scopes will include materials in both categories. Accordingly, ownership and risk in the decommissioned materials will need to be considered on a case by case basis. 

If there is value in the materials, ownership may pass to the contractor as part of the payment for the works. If ownership remains with the project owner, risk in the items and responsibility for damage caused during decommissioning will need to be addressed. 

Even if there is no value in the decommissioned materials and they are to be disposed of, it may be most appropriate for ownership to pass to the contractor if they are responsible for disposal as part of their scope. If the project owner retains ownership, they may be concerned about liability for waste that is dropped or mismanaged by the contractor once it leaves the site.  

Disposal methods

Even if the contractor owns the waste and is ultimately responsible for disposal, the scope is likely to require particular methods of disposal. Regulators will frequently seek commitments from proponents in relation to recycling and waste management. In these circumstances project owners will want comfort, possibly in the form of a certificate, that any waste has been disposed of as agreed. 

Latent conditions 

There is a considerable amount of risk involved in removing aging assets. The underlying composition and condition of the assets is often unknown so the particular requirements and cost of removal can be difficult for contractors to price. In these circumstances it may be sensible and ultimately more cost effective for owners to leave these risks outside of the pricing by including a regime to manage the cost and time impact of latent conditions.

Pollution

The unknown composition and condition of the assets will also make it difficult for contractors to evaluate the risk of pollution emanating from those assets on removal. Often under a construction contract the contractor will be responsible for any pollution or contamination it causes. However, contractors may be more reluctant to accept this position for a decommissioning scope. In any event, causation may be less clear when the pollution or contamination emanates from the owner’s property. 

Ultimately this risk should be covered by insurance and relevant in terms of responsibility for payment of the deductible. However, insurance for pollution risk may be more challenging to obtain. 

Delay

Delay is a key risk to be managed under a construction contract, usually by the inclusion of a liquidated damages regime. However, a typical liquidated damages regime can be expected to have pricing implications. While in most circumstances owners will see value in these pricing implications at the inception of a project, it is a different value proposition for a decommissioning scope which has no revenues dependent on completion of the works. 

Delay to a decommissioning scope may still give rise to increased costs or regulatory risk (for example if the owner is obliged to complete decommissioning works by a specific date). However, owners are likely to look for more cost effective ways to manage this risk, for example through the structuring of milestone payments. Alternatively, liquidated damages may still be utilised but set at a lower rate than we would ordinarily expect to see in the market for construction work. 

Defects

For a decommissioning scope, the are no defects in the works that will give rise to suspension of operations or loss of revenue for the owner. The risks associated with defects in the works is something that will need to be assessed having regard to the particular decommissioning scope. For example, a defects liability period may only be necessary where property is being made safe to remain in situ. If the scope is for full removal, it is likely that any defects will be readily identifiable on completion of the works. 

Security for performance 

The typical requirements included in construction contracts for provision of bank guarantees to secure performance may be unnecessary, and ultimately not good value, for a decommissioning scope. Owners should consider their requirements for performance security having regard to the risks associated with delay and defects in the works. 

Regulatory risks

Decommissioning works will require regulatory approvals just like other works and there can be a considerable amount of back and forth between the owner and the regulator to agree acceptable end states. It is recommended that approvals are sought early so that there is more flexibility in the schedule and delay risk can be mitigated. 

Regulatory risks are also relevant in terms of the owner’s obligations in relation to decommissioning and remediation of the site.  

Pricing considerations 

On many projects, the assets to be decommissioned may be decades old, passed through multiple owners and designed and constructed without removal in mind. Accordingly, it may not be possible to properly understand the composition and condition of those assets, and therefore the scope of the decommissioning works, until the work is in progress. 

Pricing without a clear understanding of the scope and risks of the works is likely to lead to an inflated lump sum price. A cost-plus model may be more appropriate in this case, with a regime included to incentivise the contractor to minimise costs.