Since I joined the wind power industry the offshore installations in Europe grew 8 times and are now exceed 8000 MW. The future will bring even more: EWEA has identified 22 GW of consented offshore wind farms and future investment plans for more than 133 GW.
There are several developments accompanying this growth such as technology R&D, construction innovation, as well as financing schemes, etc.
In this blog post I will focus on some of the challenges related to the commercial contracts management (more particularly on the Turbine Supply & Installation Agreements and Service Agreements) and their interrelationship with the so called Concession Agreements (CA).
Let us take the example of offshore wind in Denmark. In order to be eligible to build and operate an offshore project the investor has to participate in a tender organized by the state authorities. The successful tenderer is awarded on the criteria of lowest bidding price and is eligible to sign the CA, and receive the related licenses and authorization.
Here are some of the main characteristics of the Concession Agreement:
- Revenue model
- Penalty of defective performance
- Delay penalties
The investor participates in the concession tender with a binding price quoted in Danish “øre” per kWh. This price is fixed and covers only a predefined production volume (e.g. 20 TWh for a 400 MW farm). It is the owner’s responsibility to sell the production directly on the power market. The actual revenues are the sum of two components: (i) the spot power price, which is calculated as the mean hourly spot price on Nordpool for the relevant market zone and (ii) a price supplement calculated per hour as a difference between the quoted price and the spot price.
The supplement is not paid during the hours when the spot price is negative. The price supplement is a negative value during hours when the spot price is higher than the quoted price. Balancing costs for the electricity from the wind turbines are not compensated.
By entering into the CA, the investor undertakes to build the wind farm. If a power plant is not build (for whatever reason) OR the construction work is not commenced by a defined date, a fixed penalty becomes immediately payable to the authorities. The amount of this penalty can reach tens of millions of Euro. A guarantee from top rated financial institution shall cover this obligation.
If less than 95 % of the capacity of the farm is connected after a pre-defined target date, the production eligible for price supplement is being reduced by certain portion (e.g. 0,2 TWh for each 6 months). When calculating the percentage of connected capacity, the capacity of one turbine is included starting from the time the first KWh to the grid has been delivered. This shall apply even if subsequent technical problems should temporarily render the turbine out of service.
The impact on commercial contracts
The above framework sets challenging conditions that need to be respected during the entire contract management lifecycle (negotiation, implementation and day-to-day management). Let us see how they impact some specific areas in the commercial contracts with the wind turbine supplier.
- The revenue model has a significant impact on the Long Term Service Agreements. Contrary to the situation where the power is purchased at a fixed price (Feed-in-Tariff) here we have an offtake price depending on the time of production. This means that the asset owner should have the right to shift the scheduled maintenance planning. Additionally, the varying power price changes the way we look at the Availability Warranty. They owner and the contractor have an incentive to look a bit further beyond the standard time- or energy-based availability definitions and discuss a value-based availability concept.
- The penalty for defective performance under the concession agreement sets quite a big challenge during the contracting process. The owner would like to pass a bigger portion of this risk to his contractors.
One specific topic is agreeing on the amount of Liquidated Damages for Delay (Delay LDs). Under this framework the owner should ensure not only that the power plant is completed on time, but also that the installation works have started before the pre-defined deadline. Hence, the parties will potentially need to discuss how the set the LD amount with respect not only to the cause and the time of eventual delays, but also to the consequence of such delays.
A separate (but even more significant) issue is the total limitation of liability (caps) under the turbine supply and installation contract. Firstly, the total cap normally never exceeds 100% of the contract value (remember, in case of delays, the owner might lose much more than lost production). Secondly, the turbine supplier usually sets sub-caps for Delay LDs that are a fraction of the total cap.
- The financial sanctions for delayed connection to the grid imapct several areas in the turbine supply and installation agreement (TSA). Here again the owner may lose much more than the opportunity to produce power.
Let us not forget that “grid connection” under the CA is defined per wind turbine as the moment when it produces the first kWh. This is not the only precondition for Taking Over of the turbines by the owner under the TSA (e.g. the taking over usually happens after the tests on completion that include much more than just 1 kWh). Simply said: the turbine can be “connected” as per the CA, but not “taken-over” as per the TSA.
On top of that there is a challenge related to the fact that under the CA the owner has limited excuses for delays. In different situation the parties will be able to agree relatively easy on the cases where Extension of Time may be granted to the contractor (e.g. changes in law, permits, adverse weather, etc.). As there is almost no relief for the owner, he would seek to pass this to the contractor too.
Trading and asset operations teams need to work closer
The CA framework is relevant not only for the contracting, but also for the execution and operation phase. The direct marketing of power and revenue model alone mean that contract managers, asset operation teams and power trading units will have to work in coordination.
Zero payments during hours with negative spot prices means that the wind operator is paid nothing and the farm should be paused. In order to enable trading optimization, the farm should be equipped with proper production forecasting system, etc. I will focus on that in one of the following posts.
As the industry grows the commercial contract management is becoming more complex task than ever.