Contracts for difference
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Slideshow from Harrison Clark Rickerbys Employment seminar.
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Contracts for difference
- 1. Contracts for Difference Harrison Clark Rickerbys
- 2. Solar Strategy and EMR • Drive to increase building mounted solar PV projects on roofs of commercial/industrial buildings • EMR policy to replace ROC’s with Contracts for Difference( CfD’s) • Drive to increase the number of Community Schemes
- 3. Contracts for Difference (CfD’s) • What they are • Who will be eligible • When they will be available
- 4. What is a CfD ? • A 15 year contract between an eligible generator and a government owned counterparty • They are funded by a charge on suppliers • The generator is paid the difference between a market reference price and CPI linked contractual strike price ( or pays the counterparty if the reference price exceeds the strike price) • Eligible generators will compete for CfD’s • CFD’s will replace ROCs which will close in 2017
- 5. What is a CfD ? • CFD’s will replace ROCs which are to be closed by 2017 • They will not replace PPA’s • The implementation timetable and availability of CfD’s will differ for differing technologies • There are proposed changes to RO for Solar PV above 5MW that propose closing RO from 1 April 2015 leaving CfD’s as the prime source of support • In addition technologies will be allocated budgets and possibly maxima and minima to control the deployment of differing technologies.
- 6. Community Schemes – Proposal for added support for community renewable projects over 5 MW • In May 2014, DECC launched a consultation (in three parts) on its proposals for FITs for community energy projects: • Part A. Introduction and estimates of deployment, which explains the importance of community energy, and sets out the current financial support, costs and interdependencies. • Part B. Increasing the FITs ceiling from 5 megawatts (MW) to 10 MW, which proposes using the power under section 146 of the Energy Act 2013 to increase the maximum capacity for community energy projects for all renewable technologies in the FITs scheme. • Part C. Combining FITs and grants.
- 7. How Does the CfD Work • The Generator will enter into a PPA agreement • The Generator will enter into the CfD • The Generator will be paid for the power under the terms of the PPA • The Generator will be paid the difference between the Strike Price and the Market Reference Price under the CfD
- 8. Strike Prices and Reference Prices • Strike Prices. These are capped by legislation but determined by bidding and are adjusted for CPI on an annual basis and for certain risks under the CfD • Max SP(£/MW2012 Prices Solar PV ) Year 15/16 16/17 17/18 18/19 120 115 110 100 • FiT Market Reference Price set by reference to market position • The generator is paid the difference between a market reference price and CPI linked contractual strike price ( or pays the counterparty if the reference price exceeds the strike price)
- 9. Strike Price & Reference Price
- 10. CfD payments
- 12. PPA • The Generator will also have the option to enter into a long term PPA agreement or to rely upon the OLR • The Generator is guaranteed a backstop form of PPA through the Offtaker of Last Resort (OLR)
- 13. Offtaker of Last Resort • All renewable CfD generators have a right to a ‘backstop PPA’ throughout their CfD enshrined in regulations & supply licence conditions. • Terms grandfathered from the point of CfD signature • Provides a guaranteed route to market at a fixed discount of £25/MWh to the market price; • When combined with CfD top up, it creates a fixed price per MWh significantly below the strike price but still provides lenders with comfort over the worst case revenues the project will receive. • Backstop PPAs are 1yr in length, with a minimum tenor of 6 months
- 14. Implications • The purpose behind the structure as seen by DECC is to allow flexibility with back stop certainty. • Generators can raise debt against the OLR and a short-term PPA to maximise their upside potential • The OLR effectively ‘caps’ generators’ long term route to market costs (eg imbalance/basis risk) • Can raise debt on any combination of PPA and OLR revenues, giving greater flexibility to choose the contracting structure and counterparty which best suits their appetite for risk, for example: – Some generators will continue to secure long-term PPAs to remove risk – Some generators will seek to raise debt against the OLR and a short-term PPA to maximise their upside potential
- 15. Who will be eligible • Applicants for CfDs will be required to provide the Delivery Body with • evidence that the proposed project meets the eligibility criteria, i.e.: – Qualifying eligible generating station (technology type); – Non-receipt of funds under other Government support schemes; – Applicable planning consents; – Connection agreement requirements (including Private Network – agreements); – Statement identifying standard CfD terms and conditions that apply or – any modifications agreed; – Inclusion of relevant supporting information; – [Supply chain plan (only for facilities >300MW)].
- 16. CFD Budget Notice • July 2014 – indicative CfD budget allocations released to National Grid for allocation round one in October set out indicative budgets for Group 1 (including solar) • September 29th 2014 – legal CfD budget notice as required by the secondary legislation (NB may change from the July indicative budget) • October 2014 - Allocation process opens
- 17. Allocation Process Timetable • October 2014 • Allocation opens for applications – expected mid-October 2014 • Deadline for applications + 10 working days • Dispute Resolution processes (varies) • Analysis of whether budget allocation is exceeded (varies) • Sealed Bids invited Circa Mid November 2014 • CfD Award End 2014 • CfD Signature Early January 2015
- 18. Pre-Commissioning Obligations • Milestone Delivery Date (MDD) • Prevents premature application • Ensures developers demonstrate sufficient financial commitment towards completion; – Evidence of Actual spend = 10% of the Total Project Pre-Commissioning Costs or – by evidencing contracts are in place for material equipment for generation/export of electricity, entering an EPC contract and proving you have the means to finance the projects.
- 19. Pre-Commissioning Obligations • Target Commissioning Window (TCW) – Encourages timely commissioning and applications with realistic dates, whilst providing flexibility to projects. – Each project nominates a commissioning date which is then afforded a window to allow for variation in delivery. – The length of the TCW varies and reflects the technical challenges varying across technology type: 3 months for solar.
- 20. Pre-Commissioning Obligations • Long Stop Date (LSD) – Encourages timely commissioning and – applications with realistic dates. – A point after TCW by which a project must either qualify for payment or be terminated. Varies by technology. LCC will need to monitor progress, adjust contract capacity and consider termination.
- 21. Pre-Commissioning Obligations • Non-Delivery Incentive (NDI) where applicant • does not sign CfD or • has contract terminated between Signature and Milestone Delivery date • Applicant prevented from making an application until 13 months after contract (should have been) signed • LCC will decide whether to permit early termination.
- 22. Tim Willis Partner Head of Renewables Business Services twillis@hcrlaw.com 01905 744872 07818 410326 Worcester Office
Notas do Editor
- I have about 10 minutes to consider the principal commercial and insurable risks under an EPC contract. By that I mean an “ Engineer Procure and Construct” contract. My fellow panellists are going to consider other aspects of an AD project. I will begin by just reminding ourselves of the commercial context of these projects. We can divide a project into stages ;
- Each stage gives rise to different considerations and requirements. We are not going to consider all of those. I am going to consider primarily the stages from procurement through to the performance measurement and ongoing maintenance of the plant. These stages are managed through the EPC contract and its related maintenance contract. There are also related but separate documents such as bonds and parent company guarantees that I will touch upon. In this short run through I just want to remind us of the main risks that are managed through these documents and consider some of the implications of managing these risks or failing to managing them.
- The EPC contract is the contract entered into with the supplier of the plant. Ideally from the purchaser’s perspective it should be a single supplier who has a turnkey responsibility to design procure construct and test the project. Where the purchaser enters into separate contracts with individual suppliers the liability chain in the event of a problem arising becomes more difficult to establish. In practice unlike some other industries where the purchaser’s control the project , in the context of AD often it is the case that the supply chain, and the particular supplier which drives the contract documentation. Whoever drives the contract documentation sets the initial base line risk allocation. On larger scale projects and in the wider process engineering industry this may be a joint venture or major purchaser who will be professionally advised and will provide the terms on upon which it wishes suppliers to contract. Quite often in the context of the AD and Biogas and particularly in the context of farm scale projects it is the supply chain which proposes the form of contract. In those circumstances what we see is that the purchaser is offered either a bespoke contract or a contract based upon and amended process engineering industry standard form. Further,we see significant risk transfer from the supply chain to the purchaser. I want to look briefly at some main areas of risk. It easy when we talk about risk to lose sight of the consequences of risk materialising, so let us just remind ourselves of those. An EPC contract is usually a lump sum contract with a completion date and a performance guarantee. From a purchaser’s perspective it is there to give a degree of certainty to the price, the completion date and the income stream that will be derived from the project. So project cost increases, delays and quality are matters which the supplier should manage subject to certain exceptions. Further the purchaser wants to know that what is done is done legally and that if certain events occur which threaten to interfere with or prevent the project going ahead that there are mechanisms in place that will allow for completion of the project. However, in practice what we see is significant risk transfer in relation to these aspects of the project from the supplier to the purchaser.
- For example take “ Physical conditions” relating to the site. Under a standard contract in many sectors of the process engineering industry physical conditions are a risk held by the supplier unless the conditions are such that they would not reasonably have been foreseen by an experienced contractor. Typically in an AD project the site conditions are made a “purchaser’s risk” and the purchaser is required to “ensure” that the site and the site conditions are such that the supplier can construct the plant. Another example is planning. The purchaser is usually responsible for any changes arising from planning constraints or conditions. Feed stock or substrates is another example. The contract will provide that the purchaser must provide the feed stock within the required parameters. Depending on how these are drafted they can provide a very fruitful area of disagreement as to the cause of such failure if the plant fails to perform. The performance guarantee is also critical if it is to provide any real comfort. Typically it will specify a level of output and the compensation payable for any shortfall in output up to a level of a cap. But it will also contain a long list of exclusions which may dilute the performance guarantee so that the possibility of reliance upon it is severely restricted. In some cases the guarantee may be insurance backed so as to provide cover in the event the supplier becomes insolvent. Depending upon wording, the insurance may also limit the availability of compensation. It will also be subject to caps on liability and sums recovered under the insurance will be within the overall liability cap.
- The EPC contracts often limit the nature of the warranties given. Typically they will exclude any “fitness for purpose obligation”. They may also make an explicit link between remedies arising in the defects liability period and defects in workmanship and materials. Design liability is limited to reasonable skill and care and all liability for information documentation or design provided by the purchaser is customarily excluded. Delay damages are incurred for late completion. In terms of delay,the events that are purchaser’s risks and / or which entitle to the supplier to extensions of time are quite broad. Typically they are more extensive than would be the case in the standard contracts or other process engineering contexts. Damages for delay will be liquidated at a rate per day and subject to a cap on liability or an overall cap. They must be a genuine pre-estimate of the loss. Difficulties can arise where the rates of loss change dramatically as in the case where a tariff changes after a certain date. Low performance damages apply after testing and are also liquidated and subject to a cap. As mentioned above they may be insurance backed.
- Defects liability regimes. The general law on these types of arrangement is that they are in addition to and not instead of a purchaser’s right to damages for breach of contract. However often we see drafting that seeks to make these an exclusive remedy. The drafting can be quite onerous in that it creates an artificially short period in which a claim can be made. It may be linked to an obligation to assign manufacturer’s warranties that extend beyond the end of the defects liability period. From the purchaser’s perspective the terms of the warranties and any limitations must be known in advance if they are to be relied upon. The alternative to a single cut off date is also often used where differing liability periods are give for differing components or items of equipment. Among the exclusions in terms of ongoing liability for defects will be defects that arise due to failure to comply with the operating and maintenance requirements. Entering into the operating and maintenance contract may also be a condition of any insurances in respect of the performance guarantee. It is therefore an important document. The operating and maintenance contract should cover routine services and “call out” services. It should be adequate to warrant the performance of the plant if complied with. The exclusions of liability or excluded services must be considered with care.
- Another area of concern can be the payment structures which provide for instalment payments to a supplier by “milestones” which are not proportionate to the value transferred when payment is made. The milestone payment structure needs to be carefully considered and also when title and risk in materials and plant and equipment transfers. Advance payment bonds may provide a means of providing cash flow to the supplier while protecting the purchaser from insolvency or non-performance risk. Parent company guarantees or performance bonds can also provide security if the financial strength or ability to perform of the supplier is a concern. Further, materials plant and equipment can be lost or damaged. There are also other risks that are potentially insurable.
- The following speakers will deal with these in more detail. The main point I have to make is that even for the construction phase there is quite a lot of variation in who provides the insurances and what sort of cover. Contractor’s “All risks” insurance varies and the level of cover provided varies. Whilst it covers loss or damage to the works plant and possibly materials pre-delivery to site the extent of the cover, which is dictated by the “excluded risks”, varies greatly. Defects due to design or defects in materials and workmanship will be excluded from the All risks policy. Further such a policy responds to physical loss and damage not to broader economic loss. Liability insurance has a specific meaning and is limited to physical damage to property other than that being constructed. Who is responsible for insurance of the purchaser’s property – should it be the purchaser ? Has the supplier provided professional indemnity insurance ? There are mixed responses from the supply chain as to whether they see that as the market position. Product liability insurance – again is this considered market position ?