In this series of articles, Burges Salmon’s Energy team provides an “A-Z” of key legal and practical issues in renewable energy projects. This fourth instalment covers “M to P” and sets out a number of issues that our construction, energy, corporate and insurance teams regularly encounter.
M&A: entering into a JDA to buy/sell a pipeline of projects
Joint Development Arrangements (JDAs) are variously referred to as framework arrangements, pipeline agreements and collaboration or co-operation agreements. However, they all typically follow a similar approach and constitute a contract between two parties to develop out a portfolio of renewable energy projects over a phased period, leading to their eventual sale.
Structuring the JDA
Just as JDAs are referred to by different names, they can also take many different forms. A JDA can be structured in a manner akin to a binding heads of terms: short, simple and quick to agree, this approach leaves the bulk of the legal costs and detailed terms to be picked up later on, as individual projects are drawn down. Equally, a JDA can be structured so that it is completely “pre-wired”, with pro formas of all of the various terms and documents which will be required throughout its life. Whilst this latter approach costs more to implement upfront, it can be very cost effective over the life of a portfolio as it minimises the need for legal involvement later on. JDAs are therefore very flexible arrangements and should be tailored to the exact needs and budgets of the parties in each case.
What type of JDA would suit you?
This will depend on a range of different factors, for example, whether you are buying or selling, your appetite for risk, your budget, the timetable for the deal and for building out the projects, whether a competitive process is involved, the current status of the projects and whether they will be sold at consented or operational stage, what each party brings to the table (in terms of financing, skills, reputation, track record, etc.), tax considerations and, ultimately, what each party wants (and expects) from the arrangement.
Before entering into a JDA - be prepared!
While a JDA can bring many benefits, it will also bring challenges. As with any joint venture, a JDA can take time to negotiate and will require the parties to devote at least some management time and costs to the ongoing relationship. Ultimately a JDA requires a degree of trust in order for all parties to get the best out of the arrangement. It is therefore important to approach a JDA with your eyes open to all possibilities.
Typical steps to entering into a JDA
- Due diligence: the timing and extent of the DD required before signing a JDA will depend upon a buyer’s budget, attitude to risk and the size and current status of the portfolio. It will usually include legal, financial and technical DD and focus on the “viability” of the pipeline assets, as a bare minimum.
- Agree the price: the pricing of JDAs can be complex and can include provisions for staggered payments as milestones are met, formulas to deal with general shifts in market pricing and with changes to the subsidy regimes, as well as performance ratio adjustments.
- Agree the content: JDAs typically cover a wide range of matters. Parties should consider, amongst other things, key milestones and the criteria for draw-down of each project, exclusivity / rights of first refusal, each party’s day-to-day roles and obligations, project oversight, how pricing will work and when and how project sales are triggered.
More complex JDAs might include provisions to cover financing obligations, substitution of projects (e.g. where planning fails) and pro forma project documentation such as a PPA term sheet and/or an agreed form EPC and/or sale agreement.
What happens if things don’t go to plan?
Although failure is always far from a party’s mind when it enters into a JDA, it is still important to consider at the outset what will happen in the event that things do not go to plan. Whether because of the actions or failure of one of the parties or a third party, it is important to think about what happens next – what happens if the parties disagree, how should a deadlock be resolved, how can a party exit and what happens to the pipeline?
A JDA can provide a very attractive structure for ‘selling’ a portfolio of pipeline projects and (potentially) securing the cash and/or skills needed to see those projects through to consented and/or operational stage. The options for structuring a JDA are broad and bring potentially significant cost savings for both parties, however, it is important that a party enters into a JDA with its eyes open and gives due thought upfront to the type of JDA which will suit it best.
We have advised on a wide range of JDAs, both simple and complex, and across a number of different technologies. We would be pleased to hear from you if you are considering exploring a JDA.
New technologies: new challenges?
The challenges facing new technologies (particularly in making the leap from demonstration sites to commercial use) are considerable. Burges Salmon is working together with developers, funders and contractors across a variety of new technologies to assist in this transition. One such technology is tidal energy. In terms of the development of tidal energy projects, 17 September 2014 should prove to be a watershed moment, at which the UK was placed at the heart of the worldwide industry. On that day the first phase of MeyGen’s Pentland Firth tidal stream energy project reached financial close.
The importance of this milestone should not be underestimated by the industry. It marks the point at which a developer and
its supply chain for the first time successfully persuaded third parties (and their advisors) that a tidal energy project was viable and worthy of major financial investment. Ok, that investment has come to a large extent from the Government and The Crown Estate but arm’s length commercial principles and robust due diligence was applied. That type of financial hurdle is not easy to overcome for any emerging technology which is unproven on a commercial scale. Notwithstanding the level of research, development and testing at the likes of EMEC and elsewhere, the risks involved in deploying generation assets like this in uncharted waters are significant. As a result only the best projects are likely to receive backing and, of these, only the select few will be trail blazers.
But what does it take to secure financial backing to make the leap from test facility to commercial operation? In simple terms it needs a committed and ambitious developer, a technically competent but also flexible and innovative supply chain, a robust procurement structure and a sound commercial model. But allied to this it requires dogged determination from all parties involved to deal with adversity, be innovative and to accept the fact that being at the cutting edge means that the risks are large and often unknown. How those risks are identified, mitigated and shared is critical to the financial viability of the project. Recording that risk allocation is a fundamental requirement of the procurement documents.
MeyGen, along with its supply chain and advisors, overcame these problems to secure funding. The “small” matter of detailed design and construction awaits. It will be at that stage that the robustness of the procurement strategy and contract documents will be tested in real world conditions. While every care was taken in the drafting, and the documents were subject to rigorous due diligence from funders’ advisors, it is only during the delivery phase that their efficacy can be truly judged. So what was it that gave funders and their advisors sufficient confidence that the procurement structure and documents would enable the project to be successfully realised?
Firstly, as with any new technology, MeyGen sought to learn lessons from analogous projects. The obvious starting point was to consider what approach had been used successfully in other complex offshore works. Offshore wind, particularly rounds 1 and 2, was sufficiently mature to provide examples of successful projects but also to highlight where problems or disputes might arise. Offshore oil and gas was also a useful reference point about how construction works in hostile ocean sites can be successfully procured. However, the economic landscape of oil and gas, dominated by cash rich developers, is fundamentally different to the reality of small scale renewables developers seeking to attract third party funding, so the examples needed to be treated with caution. And finally, the lessons learned from complex onshore infrastructure, particularly energy projects, were considered.
It very soon became apparent that the scale of the risks involved in developing a commercial tidal stream project (many of which were largely unknown) meant that there was very little chance of a single contractor being able, or willing, to wrap the whole risk in a single EPC (Engineer Procure Construct) turnkey contract.
It was far more likely that the project would be split into smaller chunks so that each contractor carried less of the overall risk and better understood the risks it was taking on as its scope of work would be more closely aligned to its own area of expertise.
This approach is relatively common in both onshore and offshore procurement. The trick is to make sure that the interface risk (the risk that the contractors will not work well together or that crucial elements of their designs will be incompatible) are adequately covered off. This process has already been fairly well explored
in offshore wind and conventional energy projects where the number of packages is usually small. However, in the MeyGen
project it became clear that the technology solution and the desire of contractors to only take on the elements of risk they felt comfortable with meant that there would be nine package contracts. This increased the interface risk by an order of magnitude and could have created a deal breaker for potential investors if it was not adequately dealt with. Notwithstanding the legal and commercial challenges of this approach to procurement, the nascent state of the industry meant that the
problem could not be avoided by simply consolidating packages.
A workable legal solution was required that gave investors sufficient confidence to commit. The answer was to let each package on contracts based on a standard template but with bespoke amendments to reflect the nature of the works and the risks associated with each. It was essential to maintain absolute consistency in certain provisions, most notably the interface provisions which placed rights and obligations on the developer and contractors to cooperate, swap design information and align programmes. Delicate negotiations were required to make this happen as, understandably, each contractor was concerned not to get saddled with the risk of others simply failing to perform. Critical to the effectiveness of the contracts and the interface provisions is the role of the engineer. He is tasked with administering the contracts and
ensuring that the package contractors’ inputs are coordinated.
Looking forward, it is likely that tidal stream projects will continue to be procured on a multi-package basis (with more packages than an analogous project in a more mature sector) for the foreseeable future. This is likely to be the favoured approach until sufficient experience is gained in commercial roll-out to give key supply chain members the confidence to assume a greater scope of responsibility thereby reducing
the number of packages. This may ultimately result in two packages becoming the norm as in onshore wind (one for turbine supply and one for everything else). Together with the benefits of economies of scale derived from large scale arrays, this should bring down costs, thereby attracting more investors to ensure that the MeyGen project is the first of many and secure work and renewable tidal energy for decades to come.
Offshore transmission network owners: the basics
The UK is home to the world’s leading offshore wind market, with offshore wind set to play an increasingly significant role as part of the UK’s energy generation mix over the coming decades. The development of the vital offshore transmission
networks required to connect these UK offshore projects to the grid has been an area of significant regulatory evolution over the last decade.
In the early years of offshore wind development, each developer was responsible for consenting, licensing, constructing and maintaining all of the grid connection assets required for its project, from the offshore turbines to the onshore substation. This meant it fell to developers to design, install, own and operate the offshore cables and other connection infrastructure required to connect into the onshore electricity networks.
The requirement for Offshore Transmission Network Owners (“OFTOs”) was introduced by the Government in 2009 to address the requirements of the EU Third Energy Package relating to the unbundling of ownership of generation and transmission assets. The regime (the “OFTO Regime”) was also designed to encourage competition in the process of designing, installing and operating offshore transmission infrastructure at or above 132kV, which was seen as important given the extent of the UK’s offshore wind ambitions and the desire for cost efficiencies.
The OFTO Regime’s core principles include the following:
Offshore transmission licences are required to operate high- voltage connections to shore; Licences must be obtained through a competitive tender process in accordance with the relevant Tender Regulations; Companies bid under a competitive tender process for a licence to be the OFTO of particular offshore networks, which entitles them to earn a 20-year regulated rate
of return on the costs of building and operating these networks;
The generator is not able to be the OFTO, i.e. in general there must be separate ownership of generation and transmission assets.
Whilst no public funds are directly involved in paying for and maintaining transmission assets, OFTOs receive their
income via National Grid, which in turn recovers its costs from electricity suppliers and generators. In practice, these costs are passed onto consumers through electricity bills. This explains why there is significant political pressure for the margins payable to OFTOs to be no higher than is necessary.
The OFTO Tender Process
New Tender Regulations came into force in 2013, aimed at ensuring the enduring OFTO Regime is suitable for future projects. The tender process now includes the following stages:
Developer requests Ofgem to commence a tender exercise and must specify whether it will be a generator build or OFTO build (see below);
Once Ofgem is content the developer has satisfied certain pre-tender requirements, it publishes a notice of its intention to commence a tender exercise for all qualifying projects;
Bidders are narrowed down via various pre-qualification and potential qualification stages, until only a few reach the invitation to tender stage;
At the invitation to tender stage, qualifying bidders may become the preferred bidder or reserve bidder for each qualifying project. Having made best and final offers, Ofgem determines the successful bidder to whom the transmission licence is to be granted for a qualifying project and will publish a notice to this effect;
Once the successful bidder follows the agreed steps, the developer will transfer to it the transmission assets (in the case of generator build – see below) or the preliminary works (in the case of an OFTO build). The successful bidder is granted an offshore transmission licence.
The Role of OFTOs
The OFTO Regime had a transitional phase for projects achieving a prescribed stage of development by 31 March 2012, but since then an enduring regime has applied. The original intention behind the enduring OFTO Regime was for “OFTO build” projects, where OFTOs designed and
constructed offshore transmission assets as well as financed, operated, owned and maintained them. However, whilst
this approach may have promoted innovation and achieved consumer value, developers understandably expressed serious concern over the increased investment risks from losing control over this critical project component. In addition, though the OFTO build option reduces the initial capital
requirements of the developer, the cost of the transmission assets might typically only equate to 10-20% of the capital cost of the whole project. As such, this advantage was not generally seen as outweighing developers’ concerns of potential revenue loss if, for example, there was to be a late delivery of the transmission assets by the OFTO. DECC and Ofgem therefore revisited the original policy and amended the OFTO Regime to introduce a “generator build” option on an enduring basis, under which a generator finances and
constructs the transmission assets before transferring them to an OFTO for operation.
Due to the exclusive popularity (to date) of the generator build option, DECC and Ofgem are continuing to try to improve
the flexibility of the “OFTO build” options in order to address the concerns of generators, with updated policy proposals published by Ofgem on 12 December 2014. The main focus is on allowing the generator to consider more tender options with different degrees of control held by it and the OFTO. It remains to be seen whether generators will be persuaded to engage in these new, more flexible, “OFTO build” processes.
The insurance arrangements for a renewables project are a critical consideration for employers, contractors and funders alike. Contractors All Risk, Professional Indemnity and Latent Defect cover will inevitably need to be procured, but depending on the nature of the project, cover for some of the following risks may also be necessary:
Delay in Start Up (“DSU”) to cover the delay costs caused by damage to the works mid-construction.
Financial Loss (typically offered with DSU) to cover loss of revenue if a delay in construction leads to the plant not becoming operational within the expected time. This cover may be an express requirement of the lenders funding the project.
Marine Cargo to cover loss or damage to project critical parts and equipment, such as turbines or boilers. This cover is also particularly important where construction is likely to take place off-shore.
Political Risk. This may be necessary as an adjunct to marine cargo insurance to cover the risk of goods being confiscated in transit. However, if the project is taking place in a politically volatile jurisdiction, wider Political Risk cover may be needed for risks such as forced abandonment or damage caused by political violence.
Where the project in question is a large or complex one the owner may wish to take responsibility for insurance and obtain cover for these risks under a single Project Insurance programme (rather than simply placing the obligation on the contractor to ensure that adequate insurance is procured and maintained).
There are a number of distinct advantages to the owner in deploying a Project Insurance solution:
Transparency. The owner will be able to negotiate the terms of the insurance itself, giving it greater control and visibility over the precise scope of cover that is taken out.
Improved policy compliance. The owner will have a level of control over ensuring policy compliance (such as following notification and claims procedures), helping to reduce the risk of insurances not paying out. Simplification. On a large project with many contractors and consultants, separate insurances arrangements can lead to a complex and potentially inadequate level of cover, leading to increased risk of litigation. A single, global policy for the whole project helps simplifies the picture and reduces the risk of litigation. Certainty. The owner can be more certain there is valid insurance in place, rather than taking the risk that the individual contractors fail to procure its own insurance or vitiate the policy terms (which may only be discovered far
too late). The owner will also have control over renewal of the policy, allowing it to ensure that all aspects of the project remain insured for the appropriate duration.
However, by taking responsibility for insurance the owner, potentially: (i) increases its management and operational costs in procuring and monitoring the programme; and (ii) exposes itself to liability if the insurance is wrong or inadequate. The owner also needs to take care when procuring such insurance that it is structured to match the requirements and structure
of the project documentation. It is therefore important that owners and contractors engage with brokers, insurers and lawyers at any early stage to ensure that the insurance can be tailored to meet the project requirements.