Long Term Service Agreements – What’s Under The Hood

This is Part 2 in a four-part series of mini blogs concerning Long Term Service Agreements in the power industry.

Consultant in the power industry

By Bill Ray and Craig Nicholson

The typical long-term service agreement (LTSA) of a power turbine is composed of two elements: the scope and the commercial terms.  Commercial terms can be further subdivided into those supporting the scope and those supporting the contract. For the purpose of discussion, this paper will focus on the scope and their supporting commercial terms.  The contract terms — such as limit of liability, insurance, indemnification and intellectual property — while material are not part of this discussion.

Simply stated, an LTSA is a multi-year agreement with scope, price and terms.  The spectrum of an LTSA can range from a price list agreement in which the asset owner selects when and what scope is applied from a preset list of prices to a full scope agreement in which the LTSA provider is responsible for determining when and what scope is required.  The agreements carry many names and differ in nomenclature by provider. Typically speaking, the most common names for asset owner-controlled LTSAs are long term maintenance agreement (LTMA), major maintenance program (MMP), master service agreement (MSA) or parts agreements, while an LTSA provider-controlled agreement keeps the LTSA designation.  This paper will focus on the provider-controlled agreements or LTSA.

LTSAs are customizable but they all have a basic structure:

  1. A clear scope boundary and definition of applicable equipment
  2. A means to efficiently conduct business over the term
  3. A framework for commercial treatment of parts and services performed in the contract
  4. The ability to add significant scope and life extension
  5. Risk sharing and continuous improvement
  6. A division of responsibility between the asset owner and LTSA provider
  7. An escalation provision

This discussion will focus on items 1-5.

The typical long-term service agreement (LTSA) of a power turbine is composed of two elements: the scope and the commercial terms”

The scope development for an LTSA begins with defining the covered equipment.  The covered equipment becomes the scope boundary of the contract. The LTSA provider, unless by exception in the agreement, is given exclusive rights to provide parts and services to the covered equipment.  The provision of parts and services is addressed through a combination of fixed scope, defined and priced into the contract, and additional billing valued and paid at the time of service. The price basis for additional billing for the non-fixed price scope is defined in the agreement and can be derived from a variety of methods such as discount to list price or rate sheet, set price defined in the agreement or firm priced at time of need.

 The fixed scope portion of the agreement comprises the commitment of the contract. If no additional scope arose during the term of the agreement, this would be the full value of the contract. Within the covered equipment, the fixed scope work can be broad or narrow. For example, the covered equipment can be the gas turbine, steam turbine and associated generators, with the fixed scope only applied to the (1) gas turbine plus inspection services on the steam turbine and generators (2) all the covered equipment or (3) any coverage agreeable between the parties.  Similarly, the covered equipment may vary. For example, the covered equipment may be the gas turbine and its associated generator, with the steam turbine and its generator being excluded from the agreement. For both steam turbines and generators, the parts and repair needs vary; and it is common to address these needs through the additional billing component in the agreement.

The commercial simplicity of an LTSA contract allows the parties to eliminate repetitive bidding, negotiation and award, and to proceed straight to project execution.  Increasing the amount of equipment in the LTSA eliminates much of the need to qualify vendors, create bid specifications, negotiate terms, mobilize suppliers, project manage multiple suppliers working in adjacent spaces or prioritize resources (such as cranes or lay down space).  If the asset owner does not have the resources or capability for commercial and project management, increasing the amount of equipment in the LTSA is a great alternative. However, the LTSA provider may not be the best-in-class or low-cost provider for all the scope within covered equipment exclusivity.  

In summary, the asset owner must select his contracting strategy: either to minimize the covered equipment and maintain the in-house ability to self-perform (or bid and source) the required scope; or to increase the amount of covered equipment but create a request for proposal incorporating additional billing work for comparison among bidders.  Once the contract is in place, the ability of the asset owner to shop is severely diminished.

Another key element in an LTSA is the framework for the division of services between those form priced in the contract and those paid separately at the time occurrence.  The division of “work” is typically categorized as planned, unplanned and extra work. Planned work is typically the defined and expected maintenance sequence of the covered equipment and is in the fixed scope (price) portion of the agreement.  Both unplanned and extra work require additional payment outside of the fixed price of the agreement. Unplanned work may be identified through discovery during an outage or by an event requiring unscheduled maintenance ranging from premature wear of a component requiring early replacement to a catastrophic, in-operation failure with associated equipment damage.  

Asset owners can protect themselves from the additional contract expense of unplanned work by requiring extended coverage or warranties to specific parts or services beyond standard warranty terms.  The degree, coverage definition and remedy for unplanned work is complex, to say the least. On one extreme, there is the firm scope of the LTSA with all unplanned work being additional billing (no unplanned coverage).  The other extreme is that all unplanned work is covered at no additional cost to the asset owner (full unplanned coverage). In between is a defined list of services and parts that are subject to unplanned work coverage.  The degree of coverage is also variable and can be full value, applicable after a deductible or applicable up to cap. A thorough knowledge and balance of technical risks coupled with asset owner cash flow risk is required to select the optimal unplanned work coverage.  

 In summary, unplanned coverage greatly mitigates additional contract cost and holds the LTSA provider accountable for work product beyond traditional warranties, but is highly variable based on which parts and services are covered, the degree of the remedy and commercial aggressiveness during the negotiation.  Extra work is most often defined as elective or beyond the scope of the agreement such as enhancements, upgrades or scope outside of the contract. Extra work is typically performed from predetermined prices with escalation, discounts from current published price or at a quoted price based on the scope.

 

“Unplanned work may be identified through discovery during an outage or by an event requiring unscheduled maintenance 

Given the term of the contract and age of the asset, it is possible that major components may reach obsolescence, need replacement due to unexpected technical issues or desirable enhancements may be developed.  With proper planning and forethought, many of these items can be addressed in the contract through inclusion in the fixed scope, extra or unplanned work. For example, a control or excitation system nearing end of life when the agreement is put to bid should have provisions to replace the control system as an extra work item should it become inoperable.

Once again, including these items during the competitive bid process assures a competitive price when they are required in the future.  Likewise, accounting for unknown technical issues through a form of unplanned coverage can help mitigate risk. Alternatively, if the desire is to source anticipated scope items from a best-in-class provider, this option needs to be explicitly identified in the agreement.  For example, if the generator rotor will reach its anticipated end of life during the agreement term and the asset owner wishes to bid the scope competitively when required, this option must be declared in the agreement, or the scope will fall to the LTSA provider under the exclusivity of provision of covered equipment.  

As a long-term agreement, the LTSA should encourage and promote teaming.  The asset owner has selected an LTSA provider to work exclusively over the next decade through good times and bad.  The LTSA provider is expected not only to perform the contracted service, but to improve year over year. In addition, the LTSA maintenance and technical support teams must work in tandem with plant operations personnel as if they were one company.

Team behavior is typically measured and graded with financial bonuses and penalties tied to plant or maintenance performance indicators, or in extreme cases, contract termination.  Selection of the performance indicators should be both near term as well as the future. A lot can change over 10-plus years, so it’s critical to build performance indicators that will remain relevant over the term.  There are limits on the size of bonuses or penalties parties are willing to share, so be selective and strategic. Typical metrics are outage duration, heat rate, parts delivery to schedule and reliability/availability, but could include metrics such as saves (technical advice that avoided shutdowns), maximum asset performance during periods of high grid demand or peak profitability, turbine/generator auxiliary reliability, upgrades or enhancements, or return of outage personnel/leadership.

The scope and structure of an LTSA has many variables.  In the end, there is a limited amount of price that can be paid by the asset owner or concessions made by the LTSA provider.  Asset owner capabilities, risk tolerance, budget, strategic objectives and a sound technical asset assessment need to be mapped and prioritized to establish a bid specification.  LTSA providers should be evaluated based on their ability to conform to the specification, willingness to team and demonstrated past performance.

Part 3 in the mini-blog series addresses LTSA viability.

For additional discussion

bill.ray@aimpowerconsulting.com

craig.nicholson@aimpowerconsuting.com

www.aimpowerconsulting.com

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