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HOW TO ADVISE LATAM CLIENTS CONSIDERING UTILISING A CHINESE EPC OR OEM’S

We interviewed an engineer with over 25 years of industry experience in the power sector, and an experienced power market underwriter who has been at the forefront of research into the matter within his own company. Both parties wanted to remain anonymous so that they could speak freely about the issues. For the purpose of this article, we will refer to them as Subject 1 (S1) and Subject 2 (S2).

Chinese manufacturers have been penetrating the Latin American and Asian markets successfully for some time and we have reached a point where there is some Chinese manufacturer involvement at most new power generation projects in Latin America. As a largely non-emissions traded market, Latin America was the perfect market for China to export to, having developed some experience manufacturing boiler and steam turbine technology. With Chinese manufacturers such as Harbin, Shanghai Electric and Dongfang able to produce dated designs under licence at commercially attractive prices, international companies have been happy for them to produce under license whilst they concentrate their own manufacturing resource on producing technology at the higher end of the thermal efficiency scale. As we will see, producing under license can create a minefield of exposures and disclosure issues for the market.

Policy shifts in China and India have led to a dramatic reduction in the demand for new coal units, however the manufacturing capability remains in China and the willingness to export this technology has grown with the fall in domestic demand. This has played a part in increased Chinese boiler and steam turbine technology entering the international market.

Some of the experience for international insurers has not been positive on account of several high profile losses in Latin America; a market where the conditions lend themselves to flexible coal units which can be ramped up and down to fill in the supply gaps and diversify the asset base. The recent advancement of the joint venture between Ansalado and Shanghai Electric, is just one of a number of joint ventures which will facilitate intellectual capital moving to the Chinese market. Whilst these partnerships are primarily set up to service the domestic Chinese market, in the view of our subjects it is only a matter of time before Chinese manufactured gas turbines are commonplace in the international market. With that in mind, we discussed the issues with our two guest interviewees.

Introduction

A LONDON MARKET PERSPECTIVE

Following the proliferation of Chinese manufactured equipment entering international power generation markets, Alesco Risk Management Services (‘Alesco’) invited two experienced London market practitioners to discuss the potential issues, opportunities and measures of caution that should be taken when engaging with, and insuring, Chinese manufactured equipment. The purpose of this article is to provide network partners of Alesco, who are likely to come into contact with clients with Chinese exposures, an informative London market perspective on Chinese equipment, as well as provide some ideas about how to advise clients who are considering utilising Chinese EPC contractors or OEMs . We have focused primarily on the Latin American market because that is where our interviewee’s - and Alesco’s - own experience lies, with regard to Chinese OEMs.

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QUALITY ASSURANCE AND QUALITY CONTROL (QA/QC)

Quality assurance and quality control (QA/QC) was a key issue in the opinion of both of our subjects. They agreed that the lack of knowledge of Chinese QA/QC procedures was a concern.

“The concern would be that if a unit was produced in a GE factory in US, we know the QA/QC procedures. They do get bad batches, it does happen. They might recall a set of blades before they have losses. Given some of the quality issues we have seen on some less complex components coming out of China, you would worry about them producing units of the right quality and if they didn’t, would they pick up the defects before they send them out. So you need to see a few of these machines in China in service and running clean to give you confidence that they’ve got the QA/QC right.”- S1

“All it takes is for the QA/QC to be slightly less thorough and the incident rate could go up quite a lot. We can do Chinese manufacturers a disservice by assuming that it’s going to be poor - and we shouldn’t, but it does come from previous poor experience.” S1

There was a suggestion that difference in QA/QC is in part due to differences in internationally accepted standards for manufacturing and Chinese Institute standards.

“We’ve seen it across both the manufacturing and the installation / build, installation specs and the quality of the build. QA/QC is not as thorough in China, there are certain local standards like the Chinese Institute standards. I’d say they have the same materials in the main components but they may cut corners on the less critical parts because it complies with Chinese standards but may deviate with international standards”- S2

LOW DATA BANK / ABILITY TO DIFFERENTIATE

Whilst knowledge and experience clearly will improve in time, and as the data bank increases, concerns are founded from experience to date. Clearly manufacturers should be judged on their own merit and not bundled together, however both subjects indicated that differentiating between manufacturers is currently very difficult.

“We tend to group them (the Chinese manufacturers) together because we haven’t the data yet to say this is the market share by manufacturer and these are the losses, so it’s very much anecdotal at this stage. We have not differentiated between them yet.”- S1

Subject 2 supported this statement however did indicate that some larger insurers are starting to differentiate between the Chinese manufacturers.

“We are starting to differentiate between the core manufacturers; Dongfang have been around for a long time so we have a lot more information to understand where their experience and expertise lies. The key question in rotating equipment is ‘does that manufacturer have the expertise to deliver reliable technology for conventional thermal plants? Do they have the expertise to then install, operate and maintain it?’ A lot of the time they may have one element of it but not across the whole spectrum. I’d say Dongfang and Harbin have demonstrated enough experience and expertise on the boiler side where we are getting more comfortable.” -S2

BRANDING AND LICENSING ISSUES

Producing equipment under license creates a potential disclosure issue for underwriters. Both of our subjects referenced examples where underwriting reports reference only the licensor as the OEM, rather than the actual manufacturer:

“I know of an example in Latin America.

We are told the plant is using entirely Siemens technology from Germany, until when you go there and realise that the STGs are actually Chinese with huge Siemens logo on and a very small Shanghai Electric logo on. This was not in the report. Siemens went out to the factory at Shanghai Electric, they commissioned them, and they’ve got a big Siemens badge on them, but they’re most definitely made in China.”-S1

“The generator might be Chinese but all you see in the 50 page report is the generator spec and that the GT was shipped from Germany so then you’re thinking it’s all German equipment. Suddenly it comes out that this was built in China and there were some issues with the quality control.”-S2

Whilst both subjects acknowledged that the critical components would be made from the same materials under license, there was evidence that less critical components were not made in accordance with original design specifications, which affected the credibility of the units being produced in China, under license.

“We’ve seen plants in Europe where the steel pipework has been signed off in China as being steel, but it was not the specified grade. So they’ve lost some credibility in that respect due to that.” -S1

TRANSFORMERS & GENERATORS

Whilst in theory it should be easier to find out the origin of the rotating equipment and critical items, many generators who have purchased German or US equipment are going to the Chinese market to source spares or replacement parts due to the cost and occasionally favourable lead times. Desk reports rarely acknowledge the origin of transformers, ancillary equipment and electrical protection systems. Whilst transformers are sometimes viewed as a “black box” the early data suggests that Chinese manufactured transformers are less reliable in the first year than their American and European counterparts.

1 - Engineering, Procurement, Construction (EPC)2 - Original Equipment Manufacturer (OEM)

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“There is data to suggest that in testing and commissioning and in the first few years of operation that Chinese transformers are not as reliable as internationally manufactured transformers. If you can pin down who the manufacturer is, and where they manufactured the unit and whether they have units operating internationally, and how many hours etc, then you’re gaining a bit of comfort.”- S2

There was a suggestion that the infrastructure of the Chinese domestic market could be a factor affecting the reliability of Chinese equipment when sold overseas.

“One other thing we have seen is quite specific; the Chinese market is 50 hertz. When you design technology, especially generators etc to produce at 50htz, you have to change the design to go to markets which are 60htz. You’ve seen in Saudi Arabia where they’ve had to adapt standard designs to go into a new market. We’ve seen issues there because maybe they just don’t have the experience to manufacture for that market.” -S2

LEAD TIMES

Full disclosure of information is clearly important in order to give comfort to insurers over the perceived negatives discussed. There are clearly, however, some future potential benefits for clients and insurers to be gained from engagement with Chinese manufacturers, not least lead times:

“There are generally shorter lead times in China on transformers and critical items etc. Transformers can be turned around more quickly in China, they probably do not have spares sitting there but they can produce quicker than 12 months. It’s not common for GE or Siemens to have a spare sitting around. So we are only comparing the manufacturing time.”-S1

“No doubt they (Chinese OEMs) can produce it quicker, there are examples where they have continued issues and then they have to send the unit back, so the timing advantage is lost. But there will be examples where a transformer lead time goes down from 18 months to 6-9 months” -S2

As intellectual capital transfers and experience is gained, it is plausible that lower lead times for critical items could benefit clients and insurers in the future.

As S1 noted, whilst the general feeling in the London market toward Chinese EPC contractors and OEMs is negative, there are clear advantages for the future if the process is managed carefully.

“I spent a lot of time with a particular client and the project manager for the construction. He said a lot of people advised him not to go with a Chinese EPC contractor; however he indicated he would happily go Chinese EPC again, it’s just how you manage it. You need to make sure you have good people out there, local Chinese companies, good intermediaries and reps supporting you in the factories, looking for quality. You need good Chinese people you trust to do business in China.” - S1

SOFT FACTORS

From our discussions, it is clear that soft factors, primarily language barriers is a risk area which need particular focus when engaging with a Chinese EPC or OEM.

“It’s a very serious issue because they provide the operating manuals in Chinese and in English and I’ve seen them in English and it’s not particularly good. If the English documents are poor then the translation from them cannot be good.”- S1

“One project you’re referring to - there was a lot of Chinese people, then a lot of Spanish speakers and a small number of people speaking English and trying to translate. However the translation only takes place between a few people. The key is you have to standardise procedures clearly in 3 languages and very simply. One issue is that signage is initially done in Chinese and then it takes months if not years to change this and translate into English or local language. I agree with that comment.” S2

It is clear how substandard translation can lead to loss, furthermore these soft factors appear to be the low hanging fruit which if addressed could improve loss experience and enhance the OEM reputation.

“People are scared of the Chinese tech because there were some bad losses in the market. But it’s about the whole picture; plant, process, people.”- S1

ALESCO’S RECOMMENDATIONS AND CONSIDERATIONS

It is our view that whilst the client is always best placed to provide their Standard Operating Procedures (SOPs), brokers and consultants should provide early advice and case studies to highlight the potential issues which can arise if soft factors such as language and translation services are not taken seriously enough. As a market we have more experience and data on the wider spectrum of claims than individual clients, and we can add value as consultants by utilising prior experience.

“I think the way (for a broker) to help clients is when you go out to site, have someone who can speak the local

languages and help them through the process, emphasise that issues can occur down the line due to communication. It’s difficult to speak about specific projects but it’s important early in the project to set some ground rules about communication and ranslations.” S2

Another consideration should be the handover time from EPC contractor to O&M team. We would recommend having the O&M team on site for 9 - 12 months before operational handover because the language barriers and translations will add months to process and as discussed above, it is critical to have a thorough and widespread understanding of the operating procedures.

If you have clients engaging with Chinese manufacturers to source spares or critical items, we would advise that an independent third party conduct a thorough QA/QC review or audit of the manufacturing site. We are of the opinion that it is important to have a good understanding of the production site and their procedures regarding QA/QC. We recommend seeking out high quality local Chinese intermediaries and representatives who are well placed to assess the market and advise on QA/QC procedures. This also extends to third party production locations, if they have sub contracted any of the production process. This is especially important for production sites of generators and transformers which are extremely vulnerable to climatic factors such as humidity levels during the production process.

This is perhaps even more important if you are operating in a country with a less stable grid system where you may rely on your ancillary systems to safely phase up and down a unit which has tripped. If your ancillary systems and electrical protection systems are being provided by a manufacturer which you have little experience with it is even more critical that you have a thorough understanding and trust in the production source.

Alesco frequently place insurances for clients who have selected Chinese EPC contractors and OEMs. We have built a vast experience in the global insurance markets’ appetite and information requirements to deal with these specific issues to ensure the smooth delivery of proven risk transfer products. If you require any further information or wish to engage with us further about the issues discussed then we invite you to do so.

Author: Ian Anson

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Insurance brokers across the world working with clients spanning the full spectrum of the energy industry recognise that the London market still offers vital expertise and capacity for large and complex energy risks. That’s why having a specialist, London market broker that you can partner with is essential. Alesco’s Energy division has one of the largest teams in London which has continued to grow despite the volatility in the energy industry. We continue to attract broking talent, which in turn means more companies are making the switch to work with us. We pride ourselves on doing things differently; using senior brokers on all accounts, regardless of size or premium paid, using the outputs of our Energy Risk Consulting team to differentiate our clients’ risks in the market, and keeping our claims specialists as an integrated part of our offering.