Why have an LTSA?
This is Part 1 in a four-part series of mini blogs concerning Long Term Service Agreements in the power industry.
By Bill Ray and Craig Nicholson
Long Term Service Agreements (LTSAs) are ubiquitous in the world of servicing gas-fired power plants. What began as a means to achieve a lower price from a near sole source list of qualified cutting-edge technology providers, has evolved into a competitive solution across multiple suppliers. A well negotiated agreement is beneficial to the asset owner, providing cost savings from these advantages:
- Preferred pricing achieved through the bulk purchase of parts and services over the term of the agreement
- Commercial and supply chain simplicity from a one-time buy versus a repetitive bid process
- Risk sharing and favorable commercial terms typically negotiated into the contract
- Indirect cost savings such as technical expertise, outage planning, logistics and inventory administered and supplied by the LTSA provider
- Benefits of continuous improvement from the year-over-year continuity and team effort of the LTSA provider and owner
- Potential cash flow benefits from inventory and payment terms
Another LTSA benefit allows owners with limited technical or commercial resources or a minimal geographic presence to maintain complex equipment cost effectively. When coupled with an operations and maintenance (O&M) agreement, the owner outsources much of the project overhead, resulting in a cost-effective, lean, low-overhead asset with predictable, defined variable cost. For some owners, a transferable LTSA and O&M agreement provides flexibility to trade or divest the underlying asset as market conditions change with little impact to its own core organization.
LTSAs are applicable to both existing equipment (Installed Base) and new projects. Virtually all new, advanced-class gas turbine projects require the equipment suppliers to provide an equipment price plus LTSA. The equipment, along with other project metrics, are evaluated on a combination of capital cost, performance guarantees, operating expenses, cash flow and expected maintenance cost. The resulting computation is usually reconciled to a net present value over the project evaluation period and allows a competitive rack and stack and baseline pro-forma expectation from which to select the most cost-effective equipment/service package.
“LTSAs are applicable to both existing equipment (Installed Base) and new projects“
As the installed base assets have matured, the number of LTSA providers has also grown, resulting in greater competition among providers. As this competition increased, the basic owner value elements have magnified. Competition yields the obvious pressure on price plus a willingness of providers to accept greater scope and risk. In addition to more favorable coverage on the prime mover, providers are willing to expand their contract coverage beyond the gas turbine itself. Coverage may include other principal components such as the generator and steam turbine or include auxiliary items such as balance of plant, further reducing owners’ commercial and indirect costs.
With the increase in coverage, the owner can increase risk sharing and commercial term coverage. While competition has greatly affected owners’ options to expand scope, shift risk and drive a competitive process, it should be noted that not all suppliers are equal and have matching capabilities; and an “all in” contract may not be cost effective. For an installed base owner with years of operating experience, building an experience-based bid specification from what is working well, what can be improved, and which tasks the owner is willing to self-perform or at least administer, should result in an improved, need-based LTSA. With the willingness to go through the commercial process and negotiate, the door is open to achieve a viable, customized and cost-effective service solution.
A large, soft benefit of an LTSA is the partnership developed between owners and suppliers. While “partnership” is an overused term, the contract relationship in the LTSA will likely exceed 10 years. Within that time, such variables as fuel prices, asset profitability, technology, key personnel and plant dispatch profile are all likely to change. An LTSA provider should be aligned with the owner and continually bring value and evolve with changes to the original operating assumptions.
In its most minimal context, an LTSA is no more than a firm-price package of parts, services and repairs occurring over the course of the agreement term with no expectation beyond delivery of the contract scope. However, when properly executed, the LTSA provider — just as one would expect of an employee or team member should increase competence and grow year over year. Continuous improvement efforts should drive outage duration down, quality up, reduce unexpected or unplanned expense, anticipate upcoming maintenance needs, produce outcomes to match KPIs and provide a pool of trained, repeat personnel with succession planning for key personnel. The asset owner makes a long-term commitment with the LTSA provider to act as an extension of the owner’s maintenance staff. The LTSA provider must accept the challenge, delivering ever-increasing quality of work and keeping pace with external pressures affecting the viability of the owner’s asset. It is common to link plant goals with supplier performance contractually through guarantees and incentives — driving to the proverbial “win-win.”
Not all the benefits of LTSAs reside with the asset owners. The LTSA providers also benefit from the commercial simplicity and ability to drive productivity into a known backlog of work. There is also benefit in workflow planning in repair shops, factories and supply chain. Like all businesses, LTSA providers are under pressure to grow their top and bottom lines. LTSA opportunities offer one-time chances to secure significant portions of work. Succeed and there are years of benefit, while losing means an opportunity gap for years to come. The LTSA providers are therefore interested and motivated to be competitive.
LTSAs have proven, along with stable natural gas prices, to be the cornerstone of high technology gas turbine success.
Part 2 in the mini-blog series addresses LTSA content.
For additional discussion: