530SW1577
Resource Recovery Plant Implementation
Guides for Municipal Officials
RISKS AND CONTRACTS
This guide (SW-157.7) was compiled
by Robert E. Rando!
-~ -T T
U.S. Environmental Protection Agency
1976
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An environmental protection publication (SW-157.7) in the solid
waste management series. Mention of commercial products does not
constitute endorsement by the U.S. Government. Editing and technical
content of this report were approved by the Resource Recovery Division
of the Office of Solid Waste Management Programs.
Single copies of this publication are available from Solid Waste
Management Information, U.S. Environmental Protection Agency, Cincinnati,
Ohio 45268.
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PREFACE
This volume is intended to aid states, municipalities, and private
industry in their efforts to achieve fair and equitable agreements for
the implementation of resource recovery systems. The document is
organized into five chapters:
t The first chapter, "Resource Recovery Risks and Contracts:
Introduction," describes the purpose of this volume as
providing guidance to efforts in resource recovery by
sharing information and insights from three pioneering
projects.
The second chapter, "Risks In Resource Recovery," describes
the nature of risks and risk management, and their
implications to contracting for a resource recovery
project.
The third chapter, "The Effect of Risks on Contractual
Relationships: Some Case Study Experience," discusses the
diversity of contractual relationships that may be created
to implement resource recovery. Case studies of Milwaukee,
Bridgeport, and Nashville show how perceptions of risk and
the willingness to assume, manage, or share risks result in
different contractual relationships.
The fourth chapter, "Resource Recovery Risk Allocations,"
summarizes some of the specific ways in which risks were
allocated among the participants in the Milwaukee, Bridgeport,
and Nashville projects. The chapter concludes with a listing
of certain types of contract provisions which appear to have
general applicability for managing, allocating, or sharing
the risks associated with a resource recovery project.
The fifth chapter, "Contracting For A Resource Recovery
Project: Insights From Three Pioneering Projects," provides
some observations on how the acquisition approach to resource
recovery influences the specific terms and conditions that
are negotiated and recorded in a legally binding contract.
The sixth chapter, "Conclusions," points out that risks are
highly manageable and contracts can be successfully and
expeditiously negotiated provided that there is early
recognition in the implementation process of the key issues
which must be negotiated and recorded in a contract.
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ACKNOWLEDGMENTS
The information on resource recovery risks and their treatment in
the recovery projects of Milwaukee, Bridgeport, and Nashville could not
have been developed without the valuable advice and unrestrained
cooperation of some of the individuals who have been involved in the
projects.
Particular appreciation for their contributions is extended to:
t Donald Kummerfeld
The First Boston Corporation
Dorsey Lynch
The First Boston Corporation
f John Carhuff
The First Boston Corporation
t Richard Chase
Connecticut Resources Recovery Authority
t Donald Roethig
Department of Public Works
City of Milwaukee
Raymond Kaplan
Department of Public Works
City of Milwaukee
James Schiere
Department of City Development
City of Milwaukee
t Carlyle (Bud) Fay
Wisconsin Electric Power Company
t Lucian Bielicki
Americology Division
American Can Company
t Carl Avers
Formerly with the
Nashville Thermal Transfer Corporation
Ed Laposka
Nashville Thermal Transfer Corporation
t Robert Buckman
Nashville Thermal Transfer Corporation
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t Peter Heidenreich
Department of Public Works
City of Nashville
t Robert Eadler
Metropolitan Planning Commission
Metropolitan Government of Nashville and Davidson County
t Robert Stamps
Equitable Securities Corporation
Nashville
t Ogden Stokes
Griffith and Stokes, Attorneys at Law
Nashville
The EPA project director for this guide has been Robert Randol.
He has been assisted by a project team from Development Sciences Inc.
(of East Sandwich, Massachusetts) composed of:
James Barker (Project Director)
John Culp (Deputy Project Director)
Rita Ballou
Charles Flinkstrom
Morton Gorden
Janet Kinahan
Philip Mulvey
Ora Smith (Consultant)
Messrs. Kummerfeld, Lynch, and Carhuff (Consultants)
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CONTENTS
Paae
PREFACE
ACKNOWLEDGMENTS
CHAPTER I RESOURCE RECOVERY RISKS AND CONTRACTS:
INTRODUCTION
CHAPTER II RISKS IN RESOURCE RECOVERY
Risks Management
Examples of Resource Recovery Risks
CHAPTER III THE EFFECT OF RISKS ON CONTRACTUAL RELATIONSHIPS:
SOME CASE STUDY EXPERIENCE
CHAPTER IV RESOURCE RECOVERY RISK ALLOCATIONS
CHAPTER V CONTRACTING FOR A RESOURCE RECOVERY SYSTEM:
INSIGHTS FROM THREE PIONEERING PROJECTS
Institutional and Organizational Factors
Financing
Project Economics
The Contractual Process
CHAPTER VI CONCLUSIONS
IV
3
3
5
14
24
33
33
35
38
42
51
vii
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EXHIBITS
EXHIBIT 1. CATEGORIES OF RESOURCE RECOVERY RISKS
EXHIBIT 2. SYNOPSIS OF RESOURCE RECOVERY CASE STUDY ELEMENTS 18
EXHIBIT 3. SUMMARY OF MILWAUKEE CONTRACTUAL RELATIONSHIPS 21
EXHIBIT 4. SUMMARY OF BRIDGEPORT CONTRACTUAL RELATIONSHIPS 22
EXHIBIT 5. SUMMARY OF NASHVILLE CONTRACTUAL RELATIONSHIPS 23
EXHIBIT 6. MECHANISMS FOR ALLOCATING RESOURCE RECOVERY RISKS 29
viii
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CHAPTER I
RESOURCE RECOVERY
RISKS AND CONTRACTS: INTRODUCTION
Other volumes in this series of guides on the implementation of
resource recovery projects have focused attention on the many technical,
financial, and institutional considerations which require serious
attention before a recovery project can be launched. This volume
addresses a function which rests between planning for a system and
groundbreaking for a recovery facility. It addresses the management
of risk and the development of contracts among organizations whose
participation is critical to the initiation and successful operation
of the project. Such contracts can cover, among other things:
0 The purchase of a facility
The construction and operation of a facility
The acquisition of solid waste for processing
t The sale of products
Resource recovery contracts are written agreements which document
the substance of negotiations among participating parties. They also
record the outcome of attempts of all parties to seek equitable allocation
of the project's risks. Preparing for, and carrying out, negotiations of
recovery system contracts tests the soundness of the entire system planning
and acquisition process. It also tests the ability of different organizations
(which have different constituencies) to develop a sound basis for entering
into agreements.
The contractual process is demanding, final, and far-reaching in its
implications. Contract negotiators may commit their constituencies to
responsibilities which extend far into the future.
Although the contractual process culminates the system implementation
process, project success requires that contract formulation issues be
addressed early to forestall activities that might sidetrack start-up
of a system. The design of the contractual processincluding the
sequencing of events and timing of decisionsmust reflect the styles of
the key organizations, and must lead efficiently to negotiated agreements
which stand the test of time and the scrutiny of financial and legal counsel.
The contractual process must identify the risks associated with a
project and allocate these risks to those parties who are best able to
manage them. The contractual process must also develop legal instruments
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which accurately reflect the agreements reached among the participants in
the project, and which protect the parties from possible future misinter-
pretations. Finally, the contractual process must not jeopardize the good
faith and trust developed among the participants during negotiations and
system selection.
Case studies of the recovery projects underway in Milwaukee, Bridgeport
(Connecticut), and Nashville have underlined the intense creative efforts
required to establish contractual relationships which support the needs of
all participants. Hopefully, the lessons learned, and the legal and
institutional mechanisms developed during each case, will help the
implementors of new projects to avoid pitfalls and to select mechanisms
which are most appropriate to their situations. It is in this spirit of
sharing the experiences and contributions of those who converted the
Milwaukee, Bridgeport, and Nashville projects from plans to commitments
that this document is written.
The sequence of events that precede the signing of contracts for a
resource recovery system reflects how the project is organized and how
its managers decide to proceed toward implementation. In resource recovery,
as in other programs of public and private interest, progress during a
project often is attributable to the perseverence and hard work of a few
individualsthe "prime movers" of the project. The Milwaukee, Bridgeport,
and Nashville projects were fortunate to have had such individuals pressing
for closure and action-taking.
In the examination of the three cases, it has become clear that very
different postures toward legal and institutional agreements can be taken
which still result in successful conclusion of the contractual process.
Future negotiators will have to make similar fundamental choices such as
who shall bear the risks of unexpected failure and reap the benefits of
unexpected success.
The participants in the Milwaukee, Bridgeport, and Nashville projects
ultimately determined what legal and institutional formulae were best for
their respective cities. However, amid the diversity of these three
experiences, there are methods and processes which have general applicability.
Before elaborating on the three cases, it is important to identify some of
the risks which these and other projects must face. The next chapter
outlines the more important risks in resource recovery.
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CHAPTER II
RISKS IN RESOURCE RECOVERY
Decision makers earn their reputations, and compensation, by taking
action in the face of uncertainty. They know that there exists some
probability, great or small, that the ultimate result of the action could
be undesirable.
For example, an automobile manufacturer may decide to invest in the
development of a new engine even though it recognizes that: (1) production
of the engine may not prove to be technically feasible; or (2) consumers
may not buy automobiles which are powered by it even if the engine operates
beyond expectations. Still the manufacturer may decide to accept these
technical and market risks if there is a reasonable opportunity to improve
his competitive position in the marketplace.
People and organizations take risks because they want the positive
outcome of their actions and can probably live with the negative outcome.
Insurance companies, and individuals who buy tickets in a state lottery,
are classic examples of risk-takers. The insurance company wants the
premium but not the claim; the individual wants his ticket to be drawn.
To a point, each is prepared to suffer the consequences of the undesirable
outcome. Where the "point" is depends on the financial base of the
decision makers as well as their ability to cover their bets.
Thus, risk is the possibility that an action may produce an undesirable
outcome. This outcome has a value (often negative), a probability of
occurrence, and a consequence to the action-taker. If risk is avoided by
not taking the action, the potential benefits of the action are also foregone.
Risk Management
Risk in a resource recovery project is managed in two waysthrough
reduction and allocation. Risk can be reduced by working to prevent or
ameliorate those events which might lead to an undesirable outcome. An
insurance company, for example, can require the installation of a sprinkler
system to prevent the destruction of a building by fire.
However, total project risk can never be reduced to zero. The
remaining risks and their potential effects must be allocated between the
project participants in some fashion. One common approach is to allocate
reduceable risks to the party most able to control them. Another approach
is to have more than one party share the large and irreduceable risks, so
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that the impact of possible undesirable outcomes can be spread so as not
to critically hurt any single party. For example, an insurance company
may sell part of a policy it writes to other insurance companies.
Of course, a risk cannot be reduced or allocated effectively unless
the primary decision-makers understand what they are dealing with. For
example, a director of a project in which more than one organization is
participating, before deciding on how to handle a risk, needs to know
the answers to certain questions:
What is the source of the risk? What event, series of
events, or actions on the part of various organizations
or bodies, might lead toward a situation which could be
undesirable for the project or for an individual participant
in the project?
t What is the consequence of the risk? If the undesirable
situation does occur, how will the project be affected?
Which participants in the project will be hurt the most,
and by how much? Will they be able to survive the situation?
What is the probability that the undesirable situation will
occur? Are each of the events and actions leading up to the
situation really possible, or even likely to occur? Are there
ways to prevent their occurrence? How do the consequences of
the situation compare to its likelihood of occurrence, e.g.,
is a very serious situation also very unlikely? How important
is avoidance of the direct consequences of the situation,
regardless of its likelihood?
t Which of the project participants is best able to reduce the
risk? Who is most experienced in preventing this type of
situation from occurring, or in ameliorating its consequences
should it occur? What compensation is appropriate for assuming
the responsibility for reducing and accepting the risk?
What mechanisms can be used for the sharing or allocation of
the risk among project participants? Which mechanism best
suits the needs of the participants? Which mechanism is most
consistent with the various participants' abilities to manage
the risk?
Do resource recovery project directors need to be concerned about
risk? Yes, but their concern should be focused on identifying the risks
faced by their projects, and then on building into the project sound
methods for reducing and allocating each of them. Some resource recovery
projects are most appropriately compared to new business ventures which
depend on unproven technologies, which rely on a raw material of variable
quality and questionable supply security, and which plan to produce goods
that, a priori, have no proven market. This may sound risky, and it is,
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but not so risky that public and private organizations operating in good
faith cannot establish equitable means for dealing with the uncertainties
so that the larger interests of their constituencies are served by
utilizing a heretofore neglected resource. The payoff, in other words,
is worth the risk. What, then, are the risks in resource recovery?
Examples of Resource Recovery Risks
Because of the newness of resource recovery as a function of public
administration and as a business activity of private industry, and because
of the uncertainties associated with recovery technology, costs, and
markets, any particular project faces a large number of risks. The most
important risks are those which affect:
Waste Stream: The quantity and quality of waste for processing.
Facility Construction and Operation: The cost of constructing and
operating the system.
t Marketing: The revenues from the sale of recovered products.
Disposal: The ability to dispose of solid waste and recovery
residuals in an environmentally acceptable manner.
Experience to date indicates that the situations and risks which most
concern participants in recovery projects are those which most seriously
impact one or more of the above four categories. This is true because all
but a few of the major risks bear directly on project economics and system
reliability. Thus, project directors should pay particular attention to
managing, allocating, or sharing the risks of:
Changes in waste tonnage and waste composition. These changes
can seriously affect the potential revenue stream from the sale
of recovered products.
Increases in the investment required to bring a recovery system
on-line. These increases may cause dump fees to escalate to
unreasonable levels or may have major financial impacts on the
facility owner.
Escalation of dump fees caused by inefficient operations,
inflation of operating and maintenance costs, or inappropriate
bases for changing the fees (e.g., cost indices which do not
represent the true cost of operating a recovery facility).
Unreliable system performance (e.g.. excessive downtime and/or
inconsistent output quality). This can have major impacts on
the ability to market output, and can result in the need to
landfill the solid waste.
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Catastrophic events, such as storms, sabotage, or labor strikes.
These uncontrollable events can partially or totally destroy a
facility, or can cause serious interruptions in operations.
t Cancellation or nonrenewal of contracts for the purchase of
recovered products. This could jeopardize the economic viability
of the project and thus cause major increases in dump fees or
major financial losses by the operator.
Exhibit 1 presents a more complete list of risks which parties
contracting for resource recovery should at least be aware of. The risks
are categorized according to the recovery system element which they impact
(e.g., waste stream, facility construction, facility operations, marketing,
or disposal).
This lengthy list of risks is not presented to discourage parties from
entering into resource recovery projects, although that may be its first
impact. Rather, it is designed to prepare participants for some of the
uncertainties surrounding resource recovery. These uncertainties are often
learned slowly, with difficulty, and at a great expense to the project
implementation process. At some point in the implementation process, the
project's risks, and their allocation, will become major issues for
negotiation among participants. These issues require resolution before
fair and equitable contracts can be developed.
Decisions about how to deal with the uncertainties associated with
each element of a resource recovery project help determine the project
organization and the broad assignment of responsibilities for managing or
participating in the management of various risks. These decisions also
lead toward definitions of the specific conditions under which the various
parties assume liability for the risks. The next chapter discusses how
attitudes about the source, consequence, probability toward the occurrence,
management, and sharing of risks influence the basic structure of contractual
relationships among participants in a recovery project.
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CHAPTER III
THE EFFECT OF RISKS ON CONTRACTUAL
RELATIONSHIPS: SOME CASE STUDY EXPERIENCE
The previous chapter pointed out the situations and risks which can
most seriously impact upon a resource recovery project.
Naturally, each individual project has different amounts of risk
associated with it, depending upon type of technology, local markets,
control of the waste stream, cost uncertainties, and so on. Also, different
cities and companies will have different perceptions about the relative
importance of various risk areas, as well as about the probability that
certain events will occur. In turn, their perceptions will affect both
the specific allocation of risks among the various parties involved in a
project and the structure of the contractual relationships.
This chapter provides examples of the diversity of contractual
relationships which may be created to implement resource recovery, and
deals with the broad assignment of responsibilities for the five general
areas of risk listed in the previous chapter.
Considerable variations exist in resource recovery contracts because
of differences in the parties' willingness to assume risk and in their
ability to manage the various types of risk if they eventuate. These
differences, as noted, depend largely on the particular organizational
and institutional characteristics of the agencies engaged in resource recovery
projects. To illustrate, case studies were undertaken in Milwaukee,
Bridgeport, and Nashville. As a result, there is a better understanding
of how assignment of responsibilities varies in different circumstances.
Accordingly, these cases provide some guidance to others contemplating a
resource recovery project.
The resource recovery projects of Milwaukee, Bridgeport, and Nashville
were chosen because, among them, they included:
Different institutional forms;
t Different financing mechanisms;
Different kinds of technological applications to resource recovery;
t Different local market conditions;
Different contracting and bidding processes;
t Existence of signed contracts, if not actual construction and
operation.
14
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The main features of these three resource recovery projects are summarized
in Exhibit 2.
In Milwaukee, the City's Department of Public Works (DPW) had three
interrelated concerns regarding the implementation of a resource recovery
facility:
The need to dispose of the City's solid waste (including
nonrecoverable wastes and residues from recovery operations)
at all times, irrespective of whether or not the resource
recovery facility was capable of long-term operation.
The desire to avoid increases in the operating budget for
disposal and to avoid capital costs involving technologies
that, over time, either might not work or might become obsolete.
The existence of state-mandated competitive bidding procedures
which would delay the construction process if the City undertook
responsibility for construction of a facility. More importantly,
these procedures could seriously jeopardize the DPW's ability to
efficiently operate the system because competitive bidding and
associated city budgeting procedures could seriously delay
procurement of replacement equipment should it be required.
The Common Council (buttressed by studies of both the Department
of City Development and the Office of the Comptroller) was concerned about
risks associated with municipal financing: revenues from recycled
materials could not be determined before experience at the local level
was available; and considerable risks were associated with a technology
that had not been proven in the long run. Consideration was given to
utilize state authorized, but untried, "public improvement bonds" which
would have avoided bondholder risk. However, upon advice of bond counsel
along with indications of a potential law suit, this form of public financing
was dropped from consideration.
As a result of these considerations, the Americology Division of
American Can Company agreed to own and finance construction of the resource
recovery system, to process all of the City's solid waste, and to be
responsible for operating the system and marketing recovered materials and
fuel. Recovered solid fuel will be sold to Wisconsin Electric Power
Company (WEPCO). Recovered metals and glass will be sold to other divisions
of American Can. The City retains the right to buy the facility from
American Can at any point during the fifth to tenth years of operation.
In addition, the City will receive a small share of the revenues derived
from the sale of the fuel as a partial offset to the guaranteed dump fee
which it will pay to American Can.
The contractual relationships displayed in Exhibit 3 show how
Milwaukee's perceptions regarding various risk issues affected the broad
assignment of responsibilities between it and American Can.
15
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In Bridgeport, the Connecticut Resources Recovery Authority (CRRA)
has acted as an initiator and as a facilitator of the resource recovery
project. By law each CRRA project must be financially self-sufficient,
although the state is committed to cover the worst case of meeting debt
service should revenues prove to be inadequate. CRRA will finance
(through revenue bonds) and own the Bridgeport resource recovery system,
and also will own both the municipal solid wastes accepted into its system
and all recovered products. The facilities, similar in design to those in
Milwaukee, will be built and operated by Occidental Research Corporation
(OXY).
Because of its peculiar institutional form, CRRA has had to identify
all risks which would affect the project's ability to be financially
self-sufficient and has had to shift those risks as much as possible to
the other participantsthe nine participating municipalities and OXY. The
municipalities and OXY, in turn, have negotiated limits on their liabilities
and rewards for their exposure to the project's risks.
The municipalities will participate in project revenues, are guaranteed
that their dump fees are fixed (subject only to inflationary increases),
and have an upper limit on their liability for increases in processing
costs caused by forces outside the control of any of the participants.
OXY accepted limited liability for risks associated with the design,
construction, and operation of the project, and for marketing the nonfuel
products. In addition, they demanded a reasonable profit for the managerial,
scientific, and technical services provided to CRRA.
Exhibit 4 displays the complex allocation of responsibilities
resulting from the diverse concerns of the contracting parties in order
to limit exposure to risks. Bridgeport provides a good example of a
publicly owned and financed recovery project which is privately operated
and in which the particular contractual relationships reflect the needs of
the sponsor (CRRA) to transfer most risks to those participants who are
best able to manage them.
In Nashville, the decision to construct a centralized system for
supplying downtown buildings with steam and chilled water was made prior
to the decision to use solid waste as the source of fuel for the facility.
The system involves conversion of unsegregated wastes to steam and chilled
water in waterwall incinerators and chillers, as well as a distribution
system to municipal, state, and private office buildings.
A private, not for profit corporationthe Nashville Thermal Transfer
Corporation (Thermal)--was created to finance, own, construct, and
operate the project and to market the energy. As in the other two recovery
projects, Thermal must depend upon revenues from the sale of products to
maintain its financial integrity and to meet debt service requirements.
However, unlike Milwaukee and Bridgeport, Thermal operates like a utility
16
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in that it allocates its full cost of operations to its customers according
to their consumption of steam and chilled water. Thus, it has attempted
to pass on all operating risks to its customers and all catastrophic risks,
including failure of operations, to its bondholders.
Because of the heavy public involvement in the creation of Thermal,
in participation on its board of directors, and as its steam customers,
the metropolitan government in the Nashville area (Metro) guaranteed
delivery of waste to the Thermal facility at no dump fee.
As can be seen in Exhibit 5, the contractual relationships in
Nashville are a good deal more traditional and less specific than in the
other two projects.
This brief description of the Milwaukee, Bridgeport, and Nashville
projects shows how the major assignment of responsibilities for resource
recovery risks flows from the diversity of contexts and perceptions
operating in any given locale. While each new recovery project will be
unique in its own complexities, participants should have many options to
choose from among the diverse methods already in existence for organizing
a project and for broadly assigning responsibilities.
Equally important is the specific substance of the broad assignments
of roles and responsibilities contained in a legal document. It is the
contract which spells out the limits of liability and the conditions
under which the numerous risks associated with resource recovery will be
borne by each of the parties.
The next chapter briefly describes the specific allocations of risks
associated with the broad contractual relationships outlined for each of
the three cases.
17
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23
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CHAPTER IV
RESOURCE RECOVERY RISK ALLOCATIONS
The previous chapter showed the diversity of broad contractual
relations resulting from the different concerns and perceptions of risks
in Milwaukee, Bridgeport, and Nashville. This chapter summarizes some
of the specific ways in which risks were allocated among the actors
involved in these three projects. Based upon the case analyses, the
conclusion can be drawn that certain types of specific allocations have
general applicability to any resource recovery project.
For purposes of comparison and brevity, the participants in each case
have been typified as the sponsor of a resource recovery system, the
construction contractor for the system, the supplier of waste, the
processor/marketer of waste and recovered products, and the buyer of
recovered resources. (In some cases, the sponsor of a recovery system
may also be the supplier and processor/marketer of the waste and recovered
products.) Each participant has primary goals and a willingness to assume
and manage certain kinds of risks. For example, a processor's goals could
be to secure long-term delivery to the system of all processable municipal
solid wastes and to charge the full cost of operating the recovery facility.
He would not be willing to assume responsibility for the delivery of waste
to his facility, however, since he has no control over its collection.
While, in general, the processor would be willing to accept responsibility
for the operations of the recovery facility, he can be expected to insist
upon limiting the risks associated with his responsibilities. Circumstances
such as changes in the quantity of waste available for processing can be due
to events that the processor cannot reasonably prevent or control. In those
instances, the processor wants to be relieved of some of his obligations.
Tradeoffs are required among the participants in order for each to
achieve his goals and to protect against those risks that he cannot
effectively manage. Establishing these tradeoffs is what contract
negotiations are about. The contract itself is the legal record of the
terms and conditions, i.e., the risk allocations, agreed to by each
participant. In some cases, especially where inherent risk is high,
participants may never be able to agree upon a contract.
A summary of negotiated risk allocations made in Milwaukee, Bridgeport,
and Nashville is shown in Exhibit 6. The exhibit does not reveal the
risk-mitigating forces at work in each of the cases; nor does it describe
the nuances of agreed-upon risk allocations and their detailed contexts.
The reader is urged to study the companion Technical Appendix to Resource
Recovery Plant Implementation: Guides for Municipal Officials - Risks and
Contracts, which contains a detailed analysis of the contractual agreements
involved in the three case studies and provides more details on the events
of each case that led up to the contracts.
24
-------
Examination of Exhibit 6 and the more detailed analysis contained in
the Technical Appendix indicates that certain types of contract provisions
can be applied generally to managing, allocating, or sharing the risks
associated with a resource recovery project. For purposes of exposition,
it is useful to group these various provisions according to how they
enable each of the five participants to meet his primary goals.
The sponsor's goal is to implement a recovery facility that will
operate according to specification for a known price by a particular time.
In order to protect against risks that would affect his ability to achieve
his goals, he might require from the construction contractor:
Fixed price construction contracts;
t Guaranteed delivery dates for a fully operational facility;
Independent testing and evaluation of the facility operation
prior to delivery and acceptance of the facility;
Performance bonds or other collectible liability protection in
case the construction contractor is unable to meet the delivery
date or to deliver a facility that operates according to
specifications;
Liability protection provided by the design engineer to compensate
the purchaser for any faulty design or specifications.
The construction contractor's goal is to construct the facility
according to specifications within a realistic and reasonable time period
at a price that permits him a reasonable profit. To protect against those
risks that could affect his ability to achieve this goal, he might require
from the sponsor:
Periodic payments for work in progress;
A fixed fee;
Relief from his obligations to meet the delivery date where
situations occur outside of his control, such as a work stoppage
at equipment suppliers;
Right to terminate work without liability where the sponsor fails
to meet payment schedules or fails to secure necessary legal or
permit approvals.
The supplier's goal is to secure the long-term disposal of solid waste,
and materials recovery from it, at a reasonable cost. In order to protect
against those risks that could affect his ability to achieve this goal, he
might require from the processor/marketer:
25
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A long-term (15-30 year) contract for the disposal and processing
of solid waste;
t Disposal of all solid wastes delivered to the processor;
f Acquisition of an environmentally approved disposal site or sites
capable of meeting disposal needs on a long-term basis;
t Fixed dump fees, with adjustments only for inflation;
f Minimum days and daily hours for operation of the facility
for acceptance of delivered waste;
Rights to require other periods of operation in cases of
emergency;
Maximum storage capacity for delivered wastes;
Minimum recovery efficiencies for various products, e.g., metals,
glass, and fuel or energy;
Participation in revenues from the sale of recovered products;
Guaranteed revenues or fair market value from the sale of
recovered products;
Performance bonding or other collectible liability protection for
unreasonable amounts of facility downtime;
Assumption by the processor of all maintenance, operating, and
capital replacement costs of the facility;
Insurance provided by the processor against damages to the
facility;
t Right of termination for nonperformance by the processor.
The processor/marketer's goals are to receive sufficient quantities
of processable waste from the supplier, to charge the full cost of operations
and marketing, and to realize a reasonable profit. In order to protect
against those risks that could affect his ability to achieve these
objectives, the processor/marketer might require from the supplier:
t Long-term contracts for the delivery of waste;
Guaranteed annual tonnages to be delivered;
Guaranteed payment of dump fees whether or not delivery is made;
Establishment of dump fees that cover all operating and maintenance
costs, local property taxes on all facilities and equipment, and a
reasonable profit;
26
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t Automatic annual adjustment in dump fees due to inflation;
Rights to adjust dump fees or participation in revenues from the
sale of recovered products in the event that there are significant
changes in the composition of delivered wastes which affect either
the cost of operations or the ability to live up to the terms of
the marketing agreements;
Rights to adjust dump fees in the event that increases in operating
and maintenance costs exceed the annual rate of inflation due to
events outside of the processor's reasonable control;
Deduction of the cost of marketing (may or may not include
transportation costs) from revenues from the sale of recovered
products prior to establishment of the dollar amount to be shared
with other participants.
Similarly, the processor/marketer, in order to protect against undesirable
risks, might require from the buyer:
Long-term contracts for the purchase of products (marketing
contracts for materials tend to be of shorter duration, e.g.,
five years, than those for fuel);
t Guarantees of annual minimum amounts of recovered fuel or
products that a customer will accept;
Pricing of recovered fuel based upon the price per Btu of the
fuel that it supplements.
The goal of the buyer of recovered products is to obtain a quality
product that will not interfere with his normal production operations.
He will require of the processor/marketer:
t Guarantees that products meet specifications;
Reimbursement, in the case of buyers of recovered fuel, for any
incremental capital and operating costs associated with its use;
Rights of termination (in the case of buyers of recovered fuel)
at any time if there is a likelihood that the burning of
supplemental fuel has caused or would cause damage to the utility
boilers, or if the plant utilizing recovered fuel is shut down
because it is substantially more expensive to operate relative to
other plants in the utility's system (the concept of economic
dispatch);
Assumption of the delivery cost of the materials or fuel.
27
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All contracting parties want to be relieved of their obligations
without liability or with firm limits on their liability whenever they
are prevented from fulfilling the provisions of a contract as a result
of events beyond their control. Such uncontrollable events are referred
to as force majeure. What constitutes force majeure may vary from
situation to situation, depending upon negotiations. However, at a
minimum it would include acts of God, war, civil disorders and riots.
Not only does the definition of force majeure vary, but the limits of
liability do as well. In Bridgeport, for example, because force majeure
is broadly defined, the nine participating municipalities wanted a firm
limit set on how high the dump fee could rise as a result of this risk.
The result was that under no circumstances would the dump fee be higher
than 190 percent of the fee charged in the year preceding the one in which
a force majeure occurred.
The types of risk allocations used in the Milwaukee, Bridgeport, and
Nashville projects may be generally applicable to the acquisition and
implementation of other resource recovery systems. These three cases
also provided useful insights concerning the entire process involved in
obtaining an operational project. These insights are discussed in the
next chapter.
28
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32
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CHAPTER V
CONTRACTING FOR A RESOURCE RECOVERY SYSTEM:
INSIGHTS FROM THREE PIONEERING PROJECTS
Up to this point, attention has been focused on how the attitudes of
recovery project participants toward risk affect the allocations of the
project's risk to the various contracting parties. The intent in this
chapter is to record some aspects of the implementation process which
informed and involved individuals feel are salient to the issue of
contracting for resource recovery systems. This chapter shifts the focus
to how the entire implementation approach, stretching from original
recognition of a need for a resource recovery system to final system
implementation and operation, influences the substance of risk allocations
discussed earlier.
Amid the diversity of the Milwaukee, Bridgeport, and Nashville
experiences, there are useful insights which might be applied elsewhere.
These early veterans of resource recovery offered a number of thoughts
for the next wave of negotiations. These thoughts, combined with the
observation of the case analysts, help to synthesize the experiences of
the three projects into useful information. The observations from the
three projects tend to fall into four topical areas:
Institutional and Organizational Factors
Financing
t Project Economics
t Contractual Process
Institutional and Organizational Factors
The particular institutional and/or organizational arrangements which
characterize each of the three cases result in part from decisions about
the particular method of procurement to be utilized. In turn, decisions
on the procurement method influence the form and scope of contracts which
involve the municipality or the project sponsor. Procurement is
accomplished either on a nonnegotiated (competitive bid) or negotiated
(competitive or sole source) basis. There are three basic procurement
approaches: conventional, turnkey, and full service.* Nashville is an
For a full discussion of the various procurement methods see: Office of
Solid Waste Management Programs, U. S. Environmental Protection Agency,
Resource Recovery Plant Implementation: Guides for Municipal Officials -
Procurement and Interim Report, Washington, D. C., 1975.
33
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example of the conventional acquisition approach with nonnegotiated
procurement. Both Milwaukee and Bridgeport utilized the full service
approach but with contrasting ownership options. Milwaukee, as noted
previously, will have private ownership by American Can. Bridgeport
expects to have public ownership by CRRA. However, Bridgeport
preserved the option of private ownership throughout the acquisition
process with the understanding that each proposal would have to be
reexamined if such an option became a serious consideration.
The three recovery projects illustrate that:
FULL SERVICE
WITH
PRIVATE OWNERSHIP
The full service with private ownership
approach as used in Milwaukee, requires only
a single contract between the City and the
successful proposer because the system supplier,
not the municipality, will own, operate and
finance the systom and will provide a service
solid waste disposal and resources recovery--
not a facility or system to the municipality.
Full service with public ownership, as in
Bridgeport, involves contracts for the design,
construction, and operation of the resource
recovery system and, in many cases, contracts
with the purchasers of recovered products
because the system supplier provides not only
a service but also a facility to the municipality.
FULL SERVICE
WITH
PUBLIC OWNERSHIP
The full service approach with ownership by a
State or regional public authority requires more
detailed and complex contractual relationships
because responsibility for the system and control
over the waste is divided. For example, the
State of Connecticut and its municipalities
created the Connecticut Resources Recovery
Authority, an independent state authority. CRRA,
lacking access to the solid waste stream, had to
negotiate a contract with municipalities in the
region where the system was to be located.
Further, CRRA needed to develop contracts with
the system supplier and additional agreements
covering emergency landfill, residue disposal,
sale of recovered products, and transfer station
construction and operation. All of these contracts
were required because CRRA lacked direct control
over the essential elements of the system.
Both types of full service procurement approaches
described above normally utilize a negotiated
procurement method consisting of competitive
proposals by potential system suppliers.
34
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t The conventional approach, as in Nashville,
which typically uses nonnegotiated competitive
bids, requires only a construction contract or
CONVENTIONAL contracts since overall responsibility for and
control over the resource recovery system
rests with the municipality, not the system
supplier. Complex contractual relationships
also result, however, when the municipality
decides to implement the project through an
entity other than itself. For example, the
Metropolitan Government in Nashville created a
nonprofit corporation (Nashville Thermal
Transfer Corporation), to implement its project.
In order to establish the economic feasibility
of its system, Thermal negotiated a complex
steam and chilled water purchase contract with
the metropolitan and State governments and various
other users of steam and chilled water.
Financing
Within the broad form of the contract or contracts necessitated by a
particular procurement method, various contract issues, such as project
economics, performance standards and guarantees, risk sharing, and
financing, exist and must be negotiated. Financing issues must be
resolved in order to determine the substance, and, in some cases, the
form of the definitive contract or contracts.
Decisions concerning the specifics of financing derive from those
concerning the procurement method to be employed. Sometimes two
procurement-financing approaches are concurrently undertaken in order to
determine whether private financing might be available. This was the
situation in both Milwaukee and Bridgeport. However, the final decision
on an approach should be made prior to actual contract negotiations in
order to avoid delays, and perhaps major renegotiations.
Several general conclusions emerge from experiences in the three
projects:
It is unlikely that the private sector will be
the dominant source of financing for resource
POTENTIAL recovery projects over the next decade. This
FOR PRIVATE conclusion is qualified by the overall cost
FINANCING and liabilities of a particular project as
well as the financial strength of individual
companies. Obviously, it was easier for
Americology to justify to its management the
financing of the Milwaukee plant which was under
$20 million than it would have been if the
project had cost $60 million.
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LIMITS
OF
LIABILITY
The private sector would like to assign upper
limits of its financial liability for operation
and construction of a project. In Bridgeport,
OXY negotiated vigorously for restricting
its liability to the first $15 million of
losses. In Milwaukee, the City Council agreed
to dump fee negotiation clauses if Americology
experienced significant losses through
unexpected cost increases.
DECISION
ON
FINANCING
Alternative methods of project financing, and
their consequences, should be well understood
prior to inviting private industry to bid on
the project. The method of financing should be
decided upon prior to initiating contract
negotiations. For example, Milwaukee entered
final negotiations and actually reached
agreement on a contract draft with the issue
of public vs. private financing unresolved.
The city estimates that this lack of resolution
possibly delayed their project over 60 days.
SELECTION OF
AMORTIZATION
PERIOD
The number of years sought for amortizing the
financing of a recovery project requires a
delicate and difficult balancing among several
factors. Primary among these factors are
consideration of the effect of the amortization
period on the dump fee, relationship to the
useful life of the major equipment and facility
components, rate of technological obsolence,
and uncertainties related to the revenue stream
over time from the sale of recovered materials
and fuel or energy. The total cost of the
project also influences the choice of time
period selected for amortization. While no
firm rule can be established, it appears that
the amortization period should be for as short a
time period as is economically practical. In
Milwaukee, American Can is financing the project
on the basis of 15 years of operation. This
means that the project will cease operations
prior to the time for replacement of many major
equipment items. For example, the engineering
estimates of useful life of major components,
e.g., shredder housing and shaft; the Dins, belts,
rollers, chains of the receiving conveyors;
air classifiers; cyclones; bag nouse; etc.,
ranges between 10 and 20 years. Bridgeport,
on the other hand, with a facility similar to
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that for Milwaukee, will amortize the bond
issue over 22.5 years. And Nashville, with
a waterwall incinerator and the need for
precipitators, has a 30 year amortization
period.
FULL FINANCING
OF
SYSTEM CONCEPT
It is important that the initial financing
cover the full cost of the project. Nashville
illustrates the problems which can result
from inadequate capitalization. The preliminary
engineering cost estimates for the design of
the project was approximately $24 million.
However, revenues from the project's products
(remember, there was not a dump fee) supported
only a project costing $16.5 million. Therefore,
cost-cutting decisions were implemented.
Thermal, now, is forced to purchase additional
equipment, such as the needed electrostatic
precipitators. Installation of extra equipment
after a plant is constructed is substantially
more expensive. Also, the perception of
Thermal's credit worthiness has been tarnished
and the incremental financing will prove to be
more costly.
GUARANTEED PRICE
FOR PROJECT
CONSTRUCTION
Adequate public financing is dependent upon
establishing a fixed price for the construction
of the recovery project during the contract
negotiations. Failure to do so can result in
unacceptable cost overruns, and in at best,
substantial, perhaps terminal, delays in the
construction of a project. Bridgeport is a
good illustration of the latter point. CRRA's
construction contract with OXY provides for a
cost plus fixed-fee arrangement. Construction
costs in excess of those estimates contained
in the contract are to be borne by OXY up to
a maximum "net loss before taxes" of $15
million. OXY is entitled to be reimbursed
for financing the added construction costs from
all project revenues in excess of those which
it has guaranteed to pay to the municipalities.
Normally 75-90 percent of these excess revenues
would be disbursed to the participating
municipalities. However, should the additional
construction costs exceed the $15 million limit
OXY has the right to terminate the construction
contract. Subsequent to the signing of the
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contracts, OXY developed more detailed cost
estimates. These estimates exceeded, by at
least $10 million, the total amount of the
bond issue CRRA pledged in its contracts with
GUARANTEED PRICE the municipalities. OXY balked at financing
FOR PROJECT the $10 million, and CRRA's Board of Directors
CONSTRUCTION saw a spector of OXY terminating with the
(continued) project only partially built. The result of
not having a guaranteed fixed price is that the
construction will be delayed by at least six
months. New contracts also may have to be
negotiated with a different company, not only
for construction, but operations and marketing
as well, which could further delay the start
of construction.
Project Economics
The specific risk allocations reflected in the terms and conditions
of a contract, as well as project financing, are tremendously influenced
by the economics of the project. Uncertainties regarding estimates of
operating, maintenance, and replacement costs determine both the
willingness on the part of the processor to assume these costs and the
conditions under which all or part of the costs will be borne by him.
Often there is insufficient prior operating and maintenance data available
to permit establishment of completely dependable cost estimates,
particularly over the long life span of recovery projects. In addition to
the above costs, there are debt service costs. These are directly related
to the total capital costs of the project, the interest rate, and the
amortization period.
The various costs must be paid for from project revenues. There are
two major sources of revenues:
The dump fees charged for accepting and processing municipal
solid waste;
Revenues from the sale of recovered paper, metals, glass, and
fuel or energy.
There are real limits to the dump fee that can be charged. While
municipalities have shown a willingness to pay dump fees for a resource
recovery project which are often higher than current costs of landfill ing,
they also have demonstrated that they want the dump fee set at a fixed
price over the life of the project, subject only to adjustments for
inflation. Because dump fees cover only a portion of the total annual
cost of a project, the revenues from marketing recovered resources are
critical to project economics.
The key component of marketing revenues is the income derived from
the sale of fuel or energy. In Bridgeport, for example, the sale of fuel
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to United Illuminating will account for 80 percent of the marketing
revenues, while in Nashville the sale of steam and chilled water accounts
for the entire revenue source, since at the moment there are no dump fees.
Thus, early establishment of the market for fuel or energy is essential
to the financing, construction, and operation of a recovery project.
The use of recovered fuel as a supplement to the primary fuel used
in utility boilers has had successful but limited demonstration. Whether
recovered fuel can be burned successfully over a long period of time in
either oil-or coal-fired boilers is still an unknown, and whether it can
be successfully burned at all in oil-fired burners remains to be
demonstrated. While there has been a willingness on the part of some
utilities to buy recovered fuel, utilities have not universally accepted
the concept. Furthermore, there is insufficient operating experience
demonstrating that the quality of supplemental fuel can be maintained at
a guaranteed level or that a schedule of deliveries can be met consistently.
Thus, a considerable marketing effort still is required in order to secure
long-term contracts for the purchase of fuel.
Materials derived from mixed wastes are essentially new products in
the marketplaceas such, there are certain obstacles that must be
overcome before these new materials achieve significant market penetration
and acceptance. The first marketing obstacle is that recovered materials
must compete with well entrenched virgin and secondary materials
distribution systems. Second, there exist some market biases against
secondary materialsparticularly those derived from mixed municipal
wastes. Third, the market for secondary materials has been traditionally
volatile, with prices and demand fluctuating wildly depending on conditions
outside of the control of the secondary materials distributor. Finally,
it has not yet been demonstrated that the quality of recovered materials
can be maintained at a guaranteed level or that a schedule of deliveries
can be met consistently.
To further complicate an already difficult marketing problem, recovery
projects generally seek long-term (5-30 year) contracts for their outputs
so that the conditions of their financing, and the commitments to
municipalities, can be met. Because of the crucial aspect of product
revenues in the success of a recovery project, it is not surprising that
some municipalities have turned to private industry for its skills in
dealing with the marketing and distribution problems.
The experiences in Milwaukee, Bridgeport, and Nashville provide some
insights into some marketing issues that impinge upon project economics:
Early establishment of the local market for
fuel or energy is crucial to establishing
realistic project economics and the viability
i nrAi MARKFT °^ Pr°Ject financing. A thorough knowledge
CONDITIONS of 1oca1 market conditions for both recovered
materials and fuel is essential to determine
performance specifications for a resource
recovery system. Specification should be
determined prior to design and construction
of a facility. If marketing specifications
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LOCAL MARKET
CONDITIONS
(continued)
are set after design and construction, additional
capital expense, increased operating costs, or
lower product prices may be incurred. In addition, a
system that produces a full "slate" of products
may not be immediately practicable, but a design
that provides for modular add-ons can allow
flexibility for system expansion when and if
market conditions make it economically feasible.
This may be true particularly for the recovery
of glass and nonferrous metals.
Examples of market condition issues include:
- In Nashville, because of heavy public
commitment, Thermal had thirty-year
contracts for the purchase of steam and
chilled water from county, city, and State
agencies. This established a guaranteed
market at an early date. This also
allowed Thermal to obtain good bond ratings
and to know final performance specifications
prior to design of the system.
- In Bridgeport, on the other hand, CRRA in
the early fall of 1975 had only a memorandum
of understanding with United Illuminating
for the purchase of shredded fuel. This
provides for only preliminary specifications
final specifications are to be established--
and a commitment to purchase fuel on a
long-term basis only if the R & D phase is
successful. Thus, the lack of an actual
contract for the purchase of fuel might
influence the timing and marketing terms of
a bond offering and also the final technical
design of the plant.
MARKETING
FUEL TO
ELECTRIC
UTILITIES
Marketers of fuel to an electric utility must
recognize that there are waste-based uncertainties
and costs which the utility will require to be
borne totally by either the municipality or the
private contractor. In general:
- No extra costscapital, operating and
maintenanceassociated with the burning of
supplemental fuel will be borne by a utility
since they are not in business to solve the
solid waste problem. [The proposed Union
Electric (St. Louis) project is an exception
to this.]
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MARKETING
FUEL TO
ELECTRIC
UTILITIES
(continued)
- A period of research and development, the
cost of which might be borne by the marketer,
is necessary in order to determine the
technical feasibility of burning supplemental
fuel in boilers designed to burn coal, oil,
or natural gas.
- Anything associated with the burning of fuel
which at any time during the life of the
project threatens the reliability of the
utility's system could be immediate cause for
the cessation of burning the fuel.
- The concept of economic dispatch in the utility
field is of paramount consideration and can
result in a shut-down or reduced loading of
the facilities selected for burning of the fuel.
In the Bridgeport project, CRRA provided incentives
to United Illuminating to burn fuel through:
- CRRA payment of all capital costs to modify
United Illuminating's oil burners so that they
can burn fuel produced by the recovery system.
- CRRA payment of the utility's incremental
operating and maintenance costs associated
with burning the fuel.
- Price and volume discounts, on a sliding scale,
for the purchase of fuel whenever the cost of
oil exceeds $1.50 per million Btu and/or when
the volume purchased exceeds guaranteed minimums.
MARKETING
OF STEAM
Solid waste-based public centralized heating
and cooling service can substantially reduce
overall energy requirements and capital costs
associated with the installation of self-contained
heating and cooling systems in many individual
buildings. Steam is also a product with which
the market is much more familiar than refuse-
based energy products.
The problems with steam recovery are that it can
be implemented only in areas where a facility
can be located in close proximity to its
customers and that it requires that an additional
(back-up) boiler, with its incremented capital
costs, be designed and constructed.
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Customers for products derived from solid
waste will require that the products meet
certain specifications. They may require
PRODUCT that the recoverer guarantee shipment sizes
SPECIFICATIONS and frequencies. In the case of steam,
customers may insist that the recoverer make
provisions for a standby capability to produce
steam from traditional fuels.
Changes in the supply of wastes to be processed
and marketed may adversely affect the ability
to meet materials and fuel performance
specifications, to maintain delivery of guaranteed
minimum volumes, and/or to maintain the agreed-upon
price for a given quality of product. Changes in
waste composition also could result in increased
operating costs related to meeting performance
specifications or could require additional capital
outlays.
The Contractual Process
The contractual process is an integral part of the overall resource
recovery implementation process. For the purposes of this section, the
contractual process is defined as encompassing all acts, events, and
occurrences from the original conceptualization or formulation of a
contractual format for a resource recovery system through the execution
and award of a final contract or contracts between the municipality and
the system supplier. The eventual form and substance of such contracts
will depend upon the final mix of the essential ingredients that make up
any resource recovery projectwaste, site, markets, technology, process,
financing, and procurement method.
The contractual process should not be confused as being separate
and distinct from the implementation process. The primary purpose of
the contractual process is to consolidate and record in a legal document
all prior decisions and agreements that have taken place or have been
developed. In essence, the contractual process is the culmination of the
process by which a company is chosen to build and possibly operate a
facility. The contract finalizes the arrangements and establishes the
ground rules for plant construction and operation. It is also the point
in the implementation process where the emphasis shifts from study and
selection to actual design and construction.
Confusion exists between the implementation and contractual processes
because several proposed implementations, unfortunately, have fallen apart
during the contracting process following an apparently successful selection
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of a company by a municipality. Those failures have improperly created
the impression that the contractual process is separate and sometimes
more difficult and formidable than the original feasibility and company
selection process. To the contrary, most problems have surfaced because
of inadequate effort in the initial stages of implementation. This has
resulted in insufficient problem definition, poor specification of a
desired system concept, and a general lack of knowledge of the financial,
technical, and organizational implications of a particular implementation
approach. A common example of this is the poorly designed request for
proposal (RFP) that fails to communicate to potential system suppliers
the types of responsibilities (liabilities) the private sector is expected
to assume. These misunderstandings or unresolved issues only become
apparent in the system selection and contractual process, where they can
lead to aborted solicitations or overly long negotiations as the problems
separating the contracting parties are defined and resolved.
The successful implementation of a resource recovery system by
local governments is a tremendous challenge. Preparing for, and carrying
out negotiations tests the soundness of the program concept and the ability
of different organizations to work together to resolve their differences
and develop a basis upon which to enter into a contract which may last
upwards of thirty years.
Some important observations and conclusions about the impact of the
implementation process upon the contractual process are:
The contractual process is an integral part and subprocess
of the overall implementation process. It consolidates and
records the various and diverse elements of a resource
recovery project in a comprehensive and cohesive agreement.
As a result, it tests the soundness of all prior decisions,
agreements, and understandings.
An effective and efficient system acquisition strategy consists
of detailed research and planning, knowledgeable consideration
of key issues, and selection of an acquisition approach and
procurement method tailored to fit the requirements of the
project and system concept. Thus, it produces an RFP that
communicates the municipality's requirements to potential
system suppliers in a clear and unambiguous fashion thereby
reducing the potential for misunderstandings that might create
problems during the contract negotiations.
The acquisition approach and procurement method selected for a
particular resource recovery system will dictate the form and,
in large part, the substance of the contract if they have been
based upon knowledgeable planning decisions relating to risks,
ownership, operation, funding, markets, technology, and economics.
t An effective RFP will produce comparable proposals and expedite
identification, negotiation and resolution of open issues.
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Forceful and knowledgeable management of the implementation
process is absolutely essential to the development of a
workable basis for sound contractual agreement.
Once the municipality has properly organized the implementation
process so that it will produce the required data for the contractual
process, its focus can shift to the actual functioning of the contractual
process. In order to illustrate the points mentioned above and to
provide some observations about the contractual process as it moves towards
and through contract negotiations, the following insights from participants
in the Milwaukee, Bridgeport, and Nashville projects are provided:
Resource recovery is not yet on "off-the-shelf"
procurement. Consequently, contractors must
be able to combine engineering and R & D skills
during the design and construction of a facility.
A too tightly specified competitive bid approach
may preclude this flexibility and require that
the sponsor carry a major burden of risk of system
malfunction.
The City of Milwaukee was able to overcome the
statutory requirements for competitive bidding
by an opinion of the City's law office that
the securing of services for a resource recovery
system was similar to that for other professional
and technical services. This opinion was
subsequently supported through a public hearing
by the Common Council to document that there
was scientific and technical expertise associated
with the bids received for the resource recovery
system. In Bridgeport, the legal requirement
that portions of the construction work be
competitively bid created uncertainty in that
CRRA was unable to finalize a particular system
supplier's cost estimate until it determined
what portion needed to be competitively bid and
what the expected cost of such work might be.
As a result, the system suppliers shifted the
risk created by this uncertainty surrounding
the competitive bid requirement back to CRRA.
COMPETITIVE
BIDDING
CONSULTING
ENGINEER
The availability of consulting engineering
services throughout the entire process of
planning for, and implementing, a resource
recovery system is essential. The consulting
engineer can, for example, provide a
municipality with unbiased advice on the
technical and economic feasibility of proposed
systems. In Milwaukee, Bridgeport, and Nashville,
outside consulting engineers were hired to assist
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the staffs of the organizations responsible
for implementing the recovery projects. In
Bridgeport, the consulting engineer is playing
a critical role in documenting CRRA's required
financial self-sufficiency determination.
SYSTEM
PERFORMANCE
SPECS
Early determination of the performance
requirements of the resource recovery system
is essential to providing meaningful guidelines
to prospective bidders and to the proper
evaluation of proposals. The technology
employed for meeting these performance
requirements need not necessarily be specified
this may be better left to the bidder to determine.
It may also be appropriate to establish a plan
for a modular system in which certain functions
(e.g., recovery of glass or aluminum) are added
after the basic system has been proven. Potential
contractors should be allowed to argue for the
implementation of a full system at the outset,
but only as an option to their base proposal.
ARCHITECTURAL
AND
ENGINEERING
CONTRACTS
Where architectural and engineering (A & E)
service contracts are used to develop designs
for recovery systems so that systems components
can be procured from competent vendors, it
may be advisable to include in such contracts
provisions for at least limited liability of
the contractor for the operating feasibility
and performance of the facility design.
PRE-
QUALIFICATION
OF BIDDERS
Various municipalities have wasted time and
money and incurred substantial delays by
failing to establish clear and cogent criteria
by which to qualify proposers--CRRA and
Bridgeport prequalified one bidder on the basis
of their technical competence, but later had
to require that they joint venture with another firm
in order to establish the financial capability
to assume the required risks. If a company
undertakes the expense and effort to submit
a proposal and thereafter the municipality
discovers that such firm should not have been
qualified to bid, it becomes very difficult,
politically and practically, for the
municipality to eliminate that company from
the competition.
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t In order to clearly communicate to prospective
system suppliers its position on key issues, such
as ownership, operational responsibility, financing,
markets, etc., the municipality could prepare a
draft contract, or at least the anticipated major
provisions of the contract, and include it as part
of the bid documents or RFP submitted to prospective
system suppliers. The municipality should require
that each proposer respond to the draft contract on
DRAFT a section by section basis. This approach has
CONTRACTS certain advantaages:
- It forces public officials to think through the
key issues prior to proposal solicitation and to
define a preliminary position concerning areas
such as risk, operational responsibility,
performance standards, and economics.
- It provides the proposers with explicit guidelines
upon which to base their proposals and examine
their potential return and risks.
- It improves the chances that proposals will be
comparable and that each proposer specifically
understands the requirements of the municipality.
- It assures that senior management in the proposer's
organization (financial, legal and administrative)
have reviewed and approved their proposal since a
draft contract clearly establishes the
responsibilities that the proposer will be
required to accept if the municipality selects
its proposal.
- Detailed responses to draft contracts clearly
identifies open issues and disagreements, which
aids in the analysis of complex proposals and
establishes the starting point for final
negotiations with potential system suppliers.
Draft contracts or statements of major contract
provisions also have certain disadvantages:
- Technically and financially qualified firms may
decide not to respond because the RFP appears
too restrictive and inflexible or will increase
the cost of submitting a proposal beyond a
reasonable level.
- It may discourage creative responses that might
be in the best interest of the municipality.
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DRAFT
CONTRACTS
(continued)
It may create the improper impression that
agreement to a draft contract, either explicit
or implicit, by a proposer constitutes a
knowledgeable and conscious acceptance of the
municipality's requirements, particularly if
marketing representatives of the proposer conduct
the analysis of the draft contract without the
consultation of corporate counsel.
Corporate counsel, who may be unfamiliar with the
project's background, may not fully understand
the financial consequences of the obligations
which the municipality requires of the proposer,
and, therefore, a basic misunderstanding will
arise within the context of apparent approval and
agreement between the parties.
Firms may agree to contractual provisions in the
context of proposal evaluation, but later rescind
such agreement during contract negotiations. The
RFP and draft contract should clearly state those
provisions which are absolutely required and non-
negotiable.
TIME REQUIRED
FOR
NEGOTIATIONS
t The contract is the culmination of a long and
difficult process. The time required for the
negotiation phase of this process largely depends
on two conditions: (a) the basis for sound contractual
negotiations developed during the acquisition process;
and (b) the legal complexity of the project (i.e.,
the number of contracts and their level of detail).
Simplicity, without sacrificing legal protection and
the organizational goals of the project, should be
sought by negotiators. For example:
- In Milwaukee, it took almost three years to
conclude the entire planning-contracting process,
but the City/American Can negotiating teams came
to agreement after only 72 (consecutive) days of
negotiations. They had decided in good faith to
agree, and worked very hard to develop a contract
so as to be able to get on with the task of
implementing the project.
- In Bridgeport, completion of negotiations between
CRRA and all other parties took between 13 and 14
months. These negotiations were complicated by
many events and considerations, including problems
in securing a source for the shredded fuel, and
difficulty in fixing the limits of OXY's liability;
all of which should have clearly been established
prior to the commencement of contract negotiations.
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TIME REQUIRED
FOR
NEGOTIATIONS
(continued)
The Bridgeport contracting process was also
protracted because of the complexity and the
number of agreements. The contracts between
CRRA and the various parties occurred sequentially-
thus requiring that commitments to the nine
municipalities affected the terms and conditions
in OXY contracts for facility operation and
marketing. Negotiations with United Illuminating
for purchase of recovered fuel, in turn, had to
be consistent with all prior agreements.
DELAYS
IN
NEGOTIATIONS
Not only do protracted contract negotiations lead
to cost inflation; they can cause recovery project
managers to run the risk of changes in political
climate or public officials which could jeopardize
the implementation of the project on the terms and
conditions agreed to.
REDUCING
NEGOTIATING
TIME
t It is possible to reduce the time spent to complete
contract negotiations by proper planning and
management of the acquisition process and by being
sure that the negotiators can respond quickly and
authoritatively to proposals. For example, for
negotiations between the public and private sectors:
- The municipality should designate one person as
the chief negotiator and coordinator of contract
negotiations for the municipality.
- The private negotiating team should be comprised
of executives who represent senior management and
are able to obtain a quick response from top
managementgenerally this should include a
representative of financial management, corporation
counsel, and an operations-oriented person.
- The public negotiating team should include
representatives of the various departments of
the municipal government that will be affected
by the project, the consulting engineer, and
other technical consultants, as required, such
as bond counsel, and the financial consultant.
Most importantly, the municipality should have
the benefit of legal counsel that is fully versed
in tax, corporate, financing, and government law.
- The public negotiating team must establish procedures
that will ensure the timely consideration by the
authorized government body of counterproposals made
and developments during contract negotiations.
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REDUCING
NEGOTIATING
TIME
(continued)
Where a municipality is involved in a resource
recovery project, it is desirable to have
operational solid waste personnel represented
on the municipality's negotiating team. There
are many practical factors involved in the
operation of a resource recovery system which
should be considered in the contract which only
these people can understand and appreciate.
Both negotiating teams must have mutual respect
for one another, and a strong desire to get the
negotiations over with in order to get on with
the important business of building and operating
a resource recovery system.
SEQUENTIAL
NEGOTIATIONS
A procedure whereby qualified bidders are
negotiated with sequentially (i.e., in decending
order of preference), should negotiations fail
with the top bidder, is desirable because:
- It keeps the pressure upon both parties to
complete negotiations within a relatively
short period of time.
- It prevents the private negotiators from having
undue leverage during the negotiations as could
be the case if alternative firms were not waiting.
A potential problem with sequential negotiations
is that a winner is named and the tendency is to
stick with the best choice rather than justify
the second best bidder.
A sequential negotiation procedure was not
established following evaluation of the several
responses to CRRA's (Bridgeport) RFP for a resource
recovery system. As a result the negotiation
process appears to have been somewhat more protracted
than if there had been no pressure on OXY to conclude
mutually satisfactory negotiations as rapidly as
possible. However, it should be noted that while
Milwaukee did establish such a procedure it did not
implement it because they were satisfied with the
agreement reached with American Can.
SIMULTANEOUS
NEGOTIATIONS
A procedure whereby qualified bidders are negotiated
with simultaneously (two, at most three bidders), and
where the municipality selects the best proposal at
the end of negotiations, is also worthy of consideration
because:
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SIMULTANEOUS
NEGOTIATIONS
(continued)
-It keeps the pressure upon both parties to complete
negotiations within a relatively short period of
time.
- It prevents private negotiators from having undue
leverage during negotiations as could be the case
if negotiations were sequential or if alternative
firms were not also competing.
- It creates leverage for public sector negotiators
in that the companies have an incentive not only
to negotiate a fair agreement but also to improve
their bid when opportunities present themselves.
Simultaneous negotiations require more work and
excellent coordination in order to maintain
secrecy and competitive pressure. The major
problem with simultaneous negotiations is that
the end product (contracts with each company) may
be too complex for the governing authority to
adequately and properly analyze. It should be
noted that there is little experience with this
approach and it is not clear how it will work in
practice.
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CHAPTER VI
CONCLUSIONS
Bringing a resource recovery project to construction and operation
as expeditiously as possible is critically dependent upon the skillfulness
and vigor of public officials in designing and executing the entire
implementation process. Managing the implementation process is a
challengingoften arduous task, and there are many pitfalls to be avoided
if the process is not to be side-tracked or derailed. The experience of
pioneers in resource recovery, however, offers important guidelines for
those that follow. These pioneers have shown that the processfrom
perception of need through to a signed contractis highly manageable and
doable.
Because the contractual process is an integral part of the implementation
process, the management of risks and the form and substance of their
resolution in a contract is, to a large extent, influenced and shaped by the
success or failures of implementation managers. The importance of early
implementation decisions to contract negotiations often is overlooked by
those entering the resource recovery field because of the attention given to
the many problems that occur during contract negotiations and even after a
contract is executed. But, as shown by the experience of Milwaukee,
Bridgeport, and Nashville, problems, difficulties, and delays encountered
during contract negotiations frequently stem from decisions or indecisions
that occurred earlier in the implementation process. Recognition of this
fact is especially important where full service contracts are contemplated.
Each resource recovery project to be initiated must deal with a common
set of factors, even though the end product of the implementation/contractual
process--the contract-- will vary in form and substance from one recovery
project to another. This variation will arise because perceptions about the
probability of a risk occurring and the seriousness of the consequences,
should they occur, will differ as a result of diverse economic, political,
and legal contexts in which recovery projects are undertaken.
Important factors common to all projects range from the source of the
local market for fuel to risks (such as labor strikes and packaging
legislation) that affect the quantity and quality of the municipal waste
stream. Other factors affecting the form and substance of contracts include
choice of procurement (e.g., conventional, full service with public or
private ownership, etc.), type of financing including amortization period,
and the amount of redundance required to provide systems reliability.
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Establishing the liabilities of each party must be done in recognition
of his goals and his ability to manage or control certain types of risks.
Negotiating these allocations of liabilities, while difficulteven
exhausting, can be facilitated by project managers. One way to facilitate
negotiations is to incorporate in the RFP documents a draft contract, or
the anticipated major contract provisions, in order that potential
qualified bidders can clearly understand the key negotiation issues at the
time of preparing their proposals.
The three cases analyzed here point to the important contribution that
can be made to resource recovery project implementation through a sharing
of specific methods for managing risks. The knowledge gained from these
pioneer endeavors clearly demonstrates that, no matter how risky resource
recovery may seem at the start, equitable approaches to allocating those
risks can be reached based upon good faith between the parties.
In conclusion, anticipating the key issues requiring resolution is
critical to contract negotiations. The earlier these issues are anticipated
by recovery project managers, the more likelihood there is that contract
negotiations will be successful and not unduly protracted. The kinds of
issues of which managers must be cognizant in embarking upon a resource
recovery project have been documented and found essential to successful
implementation.
yall60f
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U. S GOVERNMENT PRINTING OFFICE : 1976 623-301/493
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