Aim Power Consulting’s top ten Long Term Service Agreement (LTSA) tips.
By Bill Ray and Craig Nicholson
It is common for power plant owners to consider partnering with a service provider by entering into a Long Term Service Agreement (LTSA) as part of their operation and maintenance strategy. Previously, we have discussed why asset owners would consider such an agreement as well as the make up of LTSAs. Furthermore, we reviewed how LTSAs have held up to the vicissitudes of a changing power market as well as their viability going forward.
Specifically, this blog highlights our top ten tips if considering entering or renegotiating an LTSA as part of your overall maintenance strategy.
1. Plan and set a strategy
LTSAs by definition are long term and are relatively complicated agreements. For this reason, appropriate planning prior to set a winning strategy is essential. The goal is to determine a clear set of needs and wants for profitable and executable LTSA over the term. Advanced planning can save on costly mistakes and mitigate hidden costs that may survive for decades to come.
2. Consider the Competition
The service provider landscape has transformed over the last 15 years and continues to do so. Moreover, it is ripe with various vendors and options. Considering alternative acceptable options provides a point of leverage in any LTSA negotiation. With such leverage, the owner increases the probability of an improved outcome.
3. Clear scoping of covered equipment
Scope of LTSAs can be complex and should begin with defining the covered equipment. This determines the scope boundary of the contract as well as exclusivity rights and boundaries of warranty provisions. Owners should be aware of what they are ‘locking’ into as well as what scope will fall outside the agreement.
“Considering alternative acceptable options provides a point of leverage in any LTSA negotiation.“
4. Planned vs Unplanned
Identification of fixed scope in the form of scheduled maintenance and additional billing such as extra work and unscheduled maintenance should be clearly understood and defined. Simply put, planned is paid for, everything else is extra. A common oversight is the cost of unplanned maintenance during scheduled maintenance in the form of findings or emergent work on ‘inspect only’ components.
5. Think with the end in mind.
The natural end of a contract is defined by numerous triggers such as a maintenance event, a fixed date or cumulative engine operating hours. Owners should ensure that a contract ends on an event to get full value for prepaid maintenance.
Buyer beware – the service provider typically holds exclusive rights for the covered equipment. Moreover, this may include additional billing items. That is to say a service provider may restrict an owner’s options with regards to emergent repairs or optional scope such as rotor repair or replacement. This may limit competitiveness, quality or timing of implementation.
You have warranty right? Not all parts and services have the same warranty coverage. For example, covered and non covered parts have drastically different warranties. Additionally, warranty coverage may not cover the service to access and replace the part (in/out costs), which could far exceed the cost of replacing the initial failed part.
8. Collateral damage vs warranty
Let’s say during operation, a rotating part liberates in the turbine section. That part subsequently damages adjacent static and rotating parts. Even though the parts are under warranty, the service provider may only be obligated to provide replacement of the initial failed part. In this case, adjacent damaged parts are collateral damage and are not covered under warranty. Warranty and collateral damage coverage are not the same. It is prudent to understand warranty boundaries and the limits of collateral damage coverage.
9. Annual/aggregate caps
Great, you negotiate many benefits such as unplanned, warranty & collateral damage coverage as well as performance guarantees with liquidated damages. Although individual caps are sufficient, such coverage is governed by an annual cap which may severely restrict realization of such benefits. Service providers commonly utilize overlapping deductibles, limits and aggregate caps as a risk mitigation strategy.
Seems like a small thing and may only be a sentence or two in a contract; however, this can lead to significant costs down the road. Escalation clauses can be eliminated, capped, indexed or a combination thereof. The goal for an owner is to ensure an LTSA stays competitive over the term and does not drift out of market due to compounding escalation.
Seller’s upper hand
Power plant owners can reduce cost and risk when considering such common provisions found in LTSAs. However, service providers have a distinct advantage in that they are constantly negotiating agreements and honing their expertise. They have a holistic market view and take best practices from one negotiation to another, maximizing profits while minimizing risk. On the other hand, power plant owners may negotiate an agreement once every several years, if at all. LTSA negotiation expertise at the initial phase of the commercial process will, at a minimum, level the playing field to improve the outcome of the negotiated agreement. Further, such support can significantly improve the future competitiveness of the underlying power assets for years to come.