Evolution of Procurement Risk Management in Large-Scale EPC Projects in the Power Industry ― The Need to Build Risk Management for Equipment Procurement in the Era of Rising Demand and Decarbonization | Insights

About the Author

Shiro Komatsu

Principal
Akinori Sakurai

Senior Manager
Kosuke Nishimura

Manager

1. The Power Industry Facing Unprecedented Procurement Risks

The power industry is currently facing an investment boom of unprecedented scale.

As indicated in the Seventh Strategic Energy Plan and other policies, under the trend of decarbonization, new growth investments such as renewable energy generation, next-generation thermal power, and the modernization of transmission and distribution networks are rapidly advancing.

On the other hand, power demand is increasing on the infrastructure side, driven by the expansion of data centers associated with digital transformation and the promotion of electrification in the context of Green Transformation. As a result, the entire industry is being forced to address a so-called “trilemma” of simultaneously achieving three requirements: affordability, stability, and environmental compatibility.

As investments expand into new areas unlike anything seen before, traditional procurement schemes are increasingly unable to sufficiently control risks.

In addition, structural changes are occurring on the supplier side. Withdrawals and overseas relocation by heavy electrical equipment manufacturers are occurring in succession, and geopolitical risks in the supply chain remain elevated.

Triggered by COVID-19 and the situation in Ukraine, supply constraints and cost increases are becoming normalized, accelerating the materialization of risks at the procurement stage.

As a result, coordination regarding risk sharing and the allocation of responsibilities is becoming increasingly stringent between contracting parties, as well as between prime contractors and subcontractors.

These risks are not merely procurement issues; they can lead to the deterioration of profitability for individual investment projects, delays in investment recovery and even the need to reassess business plans themselves. In practice, cases where deficiencies in setting conditions or ambiguity in risk allocation lead to additional costs and disputes, significantly affecting management decisions, are becoming evident.

2. Integrated Risk Response Across Business Owner, Procurement, and Legal Is Required

For example, in large-scale EPC projects, there are many structural risk issues that cannot be fully absorbed by adjusting conditions at the time of transaction alone.

It is necessary not only to organize individual elements such as responses to force majeure and price fluctuations but also to comprehensively establish mechanisms from identifying risks at the project design stage through to post-order monitoring systems.

However, in reality, there are many cases where risk management remains dependent on individuals and is unstructured, and axes for organizing risks, decision-making criteria, and response processes are not systematized.

Coordination among business owner departments, procurement departments and legal departments remains formalistic, and there are situations where negotiations and adjustments of transaction conditions proceed without early visualization of critical risks.

Three typical challenges in such situations are as follows:

Challenge 1: Unclear Risks to Be Considered
Internal standards for organizing risks by project characteristics are not established, and key discussion points in consultations with management are ambiguous.
Challenge 2: Absence of a Decision-Making Framework
Responsibility allocation regarding which risks should be decided by the business owner department, procurement department, or management is not organized.
Challenge 3: Lack of Standards for Terms Negotiation
Applying standards based on conventional ordering practices as-is results in increased individual adjustments and reliance on personal judgment.

If these challenges are left unaddressed, they may lead to rigid condition setting and a chain reaction of risk transfer, ultimately undermining project profitability and reliability. For example, it is not uncommon for projects to proceed to construction with ambiguous handling of price fluctuation risks, resulting in unexpected cost burdens during periods of rising labor rates and prices. Many such cases could have been mitigated or avoided if risks had been structurally organized and agreed upon in advance.

3. Risk Management Initiated from the “Quotation and Terms Negotiation Process” That Procurement Should Lead

Going forward, the contracting entity should focus on establishing a structured approach to risk management that spans the entire transaction.

Procurement departments are entering a phase where they move beyond being merely responsible for price negotiations to assuming the role of “designers of the terms negotiation process.” In other words, the procurement function is being redefined from a simple purchasing activity to part of a management function that controls investment risks.

In large-scale EPC projects, each revision of transaction terms and each contract clause adjustment has ripple effects on subsequent design changes, delivery schedules, and cost management. Therefore, by controlling the procurement process, it becomes possible to establish the “framework” of risk management.

However, there are certain hurdles to this systematization.

In the process of clarifying risks, it is necessary to delve into specification finalization and schedule management within business owner departments, and it becomes necessary to introduce certain standards and perspectives even into areas that have traditionally been handled on a case-by-case basis because they could not be finalized at the ordering stage.

As a result, it is unavoidable that the burden of internal coordination, including with business owner departments, will temporarily arise and increase.

Nevertheless, while initial efforts may require a certain level of effort when viewed as individual projects at the startup stage, establishing standard processes through collaboration among procurement, business owner, and legal functions represents the first step toward moving away from individual-dependent risk responses and reducing the burden over the medium to long term.

4. The Keys to Success Are “Risk Diagnosis Based on Field Operations” and “Establishing Standards”

The first step in risk response is to comprehensively organize risks related to procurement and project execution of large-scale projects and to clarify the company’s own “risk perspectives and response standards.”

Many publicly available risk checklists remain generic, so further refinement is necessary to appropriately assess the impact of risks and determine responses based on the specific circumstances of each company. For example, many general checklists have been prepared with a bias toward contractor protection based on past procurement environments. However, establishing standards from the perspective of the contracting entity requires redesign that takes into account factors such as the positioning of counterparties in the business, past trouble cases, and business advantages and disadvantages.

In particular, in recent years, there has been an increase in issues that cannot be fully addressed by conventional assumptions, such as the scope of application for price fluctuations and the expansion of definitions of force majeure. For these themes, it is effective to continuously update “company standards” by incorporating external knowledge while referring to the latest cases.

Furthermore, risk response cannot be completed with procurement knowledge alone. It is essential to understand EPC practices and technical perspectives and to comprehensively grasp elements such as specifications, schedules, and payment conditions.

In this regard, the presence of personnel who can anticipate risks that may arise during project execution and understand response policies significantly influences the success or failure of on-site implementation.

To effectively promote such risk diagnosis and standard development:

Visualization of risk structures aligned with EPC practices
Design of decision-making processes that span procurement, business owner, and legal departments
Translation into concrete terms negotiation and practical operations

It is important to design these three elements as an integrated whole.

5. Conclusion

In the future, the power industry is expected to face challenges such as launching businesses and making investments that have never been experienced before. Beyond one-time cost reductions, more comprehensive risk management is required that spans from procurement through to post-operation.

The key point lies in “designing appropriate risk sharing rather than merely transferring risks.”

By ensuring that internal related departments, as well as contracting parties, share a common understanding of risks and build relationships that enable collaborative responses when risks materialize, it becomes possible to enhance the stability and sustainability of the overall business.

For companies venturing into unknown areas, identifying procurement risks and negotiating terms are not merely administrative procedures but management tools for controlling business risks.

ABeam Consulting supports the stable execution of large-scale investments in the power industry through a cross-functional perspective spanning procurement, EPC and project management, as well as an approach to risk diagnosis and standard design rooted in practical operations.

Disclaimer
This insight is intended to provide general business insights and information on procurement risk management and does not constitute legal advice regarding specific cases or contract conditions.
Even in our support track records on which this article is based, responses regarding contract content and legal judgments are carried out based on the decisions of the client company’s legal department or external experts such as attorneys, and ABeam Consulting does not engage in activities that would constitute unauthorized practice of law.
When making contractual decisions or addressing legal risks, please consult your company’s legal department or qualified legal professionals.

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