Solving the EPC equation for utility-scale solar developments

https://www.pv-magazine-australia.com/2022/03/07/solving-the-epc-equation-for-utility-scale-solar-developments/

 

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Some of the most critical risks facing utility scale solar developments in Australia are widespread delays and constraints in achieving connection agreements in a congested national grid, supply chain delays and workforce constraints arising from international and domestic responses to Covid-19 and the ever-present issue of unidentified site risks. At the same time, the insurance market has tightened and corresponding insurances have become more expensive.

In recent years, some EPC (Engineering, Procurement, and Construction) contractors have suffered heavy losses on solar projects, which has contributed to high-profile construction firms departing the Australian solar market and, in at least one notable instance, insolvency. Nevertheless, EPC contracts are likely to continue to be the most commonly used form of construction contract for utility-scale solar projects in most jurisdictions, given their flexibility and the value and certainty that owners and lenders derive from them. 

For the EPC contract to work best, to allocate risk effectively and to protect the parties, we recommend that it is carefully developed on a project-by-project, contract-by-contract basis. One size won’t fit all. Every project is different and project drivers will vary; for one project the key driver may be timely delivery, whereas for another it may be cost control.

Ultimately, the EPC contract is one part of a complex set of project documentation and agreements. We need to view the EPC contract not in isolation but in terms of how it fits in with other documents such as the connection agreement, power purchase agreement (PPA) and more. Managing the interfaces between the agreements will all feed into the way the EPC contract should be shaped. It is in everyone’s interests – investors, lenders, developers, contractors, offtakers, insurers – to get the risk allocation, drafting and timing correct.

From our experience partnering with our developer clients to solve their EPC challenges and get the best development service fee, we recommend attending to the following considerations.

1. Allocating risk should not be an automatic process, so critically examine the risk allocation to match the circumstances of every project. 

For example, if a project is being undertaken in an area with unknown geology and without the time to undertake a proper geotechnical survey, the developer may be best served by bearing the site condition risk itself as it will mean the contractor does not have to price a contingency it has no way of quantifying. This approach can lower the risk premium paid by the developer. Alternatively, it may wish to pay for the contingency in return for passing off the risk, which quantifies and caps its exposure. This type of project-specific analysis should be undertaken on all major risks prior to going out to tender.

2. Take care in selecting a contractor that has sufficient knowledge, expertise and available resources to execute the works. 

Given the significant monetary value of EPC contracts, and the potential adverse consequences if problems occur during construction, the lowest price should not be the only factor when selecting a contractor.

A major disadvantage of an EPC contract becomes evident when problems occur during construction. Developers should have limited ability to intervene. The more they interfere, the greater the likelihood of the contractor claiming additional time and costs. In addition, interference by the developer will make it substantially easier for contractors to defeat claims for liquidated damages and defective works (i.e. the contractor will be able to argue that it is not liable for either delayed or defective performance).

3. Pay attention to the interface of the EPC contract with the other agreements necessary to develop the solar project, such as the PPA, grid connection agreement, commissioning and testing regimes, equipment warranties, and the development application requirements. 

Smoothing the interfaces between all the project agreements is best dealt with at the contract formation stage, drawing on the expertise of experienced project and construction lawyers.

A variety of projects we have worked on in Asia, and more recently in Australia, have incurred significant delays and costs to determine the grid access obligations under the EPC contract. This experience has taught us that grid connection is a matter that must be resolved at the contract formation stage, to pave the way towards timely completion of construction, commissioning and testing, including generator performance standards and compliance with the requirements of the market operator.

It is also important to check that the commissioning and testing regimes in the EPC contract appropriately mirror the requirements for commercial operation under the PPA. Mismatches can result in delays, lost revenue and liability for damages, all of which have the potential to cause disputes.

The increasing size and complexity of utility-scale solar projects mean that the days are gone where schedules could be attached to the EPC contract at the last minute without review. Discrepancies between the relevant testing and commissioning requirements will only serve to delay and distract all parties from successful completion.

4. Don’t overlook the need for clarity in lines of communication with relevant government agencies, landowners, local communities, the project company and the contractor. 

At a fundamental level, it is imperative that the appropriate party corresponds with the relevant project stakeholders and that responsibilities are clearly articulated in the contract. Any uncertainty may see the contractor liaising directly with these third parties and possibly risking the relationship of the developer with key stakeholders and long-term neighbours. Significantly, the developer must develop and nurture the ongoing relationship with key stakeholders, particularly the offtaker.

5. The EPC contract must clearly articulate expectations and responsibilities relating to damages, guarantees and unforeseen events.

Given the role that delay and performance liquidated damages play in ensuring EPC contracts are bankable, it is vital that these clauses in an EPC contract are properly drafted so that parties cannot void liquidated damages liability on legal technicalities.

With the Covid-19 pandemic having impacted manufacturing and supply of key equipment and materials used in the construction of solar facilities in Australia and with uncertain times ahead as virus variants emerge, careful attention should be given to force majeure clauses so that all parties can better understand their legal and financial responsibilities. 

Although force majeure clauses are almost always included in EPC contracts, they are rarely given much thought unless and until one or more parties seek to rely on them. Especially in the current global environment, it is appropriate to examine their application. We favour explicitly defining what is included or excluded from the definition of force majeure, to provide greater certainty over generic references and subjective terminology, and to take the matter out of the hands of the courts and give clarity and control to the parties. We expect to see a greater emphasis on the categorisation of both Covid-19 and similar outbreaks in definitions of force majeure going forward. 

When a solar project falls into the shadow of adverse events, or when difficulties emerge between parties, the EPC contract will come under scrutiny. If it has been well developed, it can be the central factor in maintaining clarity of responsibilities and risk allocation. It will provide a strong foundation to steer the project through to a successful resolution and a bright future. 

6. Supply chain constraints may cause a rethink on the free issue of the generation equipment.

The concept of free issuing generation equipment is relatively new in the context of utility-scale solar developments. Previously, there has been a reticence from the contractor market to accept free issue of one or more categories of generation equipment due to a loss of margin. However, with much larger solar projects becoming more prevalent, the impact of the contingent liability of a supply chain failure (let alone an actual failure) on the balance sheet of a contractor may result in a rethink, albeit all parties (including lenders) need to carefully understand and work through the appropriate allocation of responsibility for a failure to meet the performance guarantees and defects.

About the authors

Damian McNair is a Partner in PwC’s Integrated Infrastructure practice, based in Melbourne.

Chris McAlinden is a Director in PwC’s Integrated Infrastructure practice, based in Perth. 

The views and opinions expressed in this article are the author’s own, and do not necessarily reflect those held by pv magazine.

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