July 14, 2022 • Paul Rodden • Season: 2022 • Episode: 130
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In episode 130, An article written by a legal team at Orrick, Herrington & Sutcliffe LLP aims to help hydrogen operators with their developer contracts. It’s a critical piece in being a hydrogen operator, and I’ll go through their article today on the hydrogen podcast.
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An article written by a legal team at Orrick, Herrington & Sutcliffe LLP aims to help hydrogen operators with their developer contracts. It’s a critical piece in being a hydrogen operator, and I’ll go through their article today on the hydrogen podcast.
So the big questions in the energy industry today are, how is hydrogen the primary driving force behind the evolution of energy? Where’s capital being deployed for hydrogen projects globally? And where are the best investment opportunities for early adopters who recognize the importance of hydrogen? I will address the critical issues and give you the information you need to deploy capital. Those are the questions that will unlock the potential of hydrogen, and this podcast will give you the answers. My name is Paul Rodden, and welcome to the hydrogen podcast.
In an article from JD supra.com Craig Bruce, Lucy Preston, Adam Smith, Jon Thursby, and Alexander Witt write hydrogen, splitting the contracting packages, interface risks and avoiding leaks. They write the energy transition and climate crisis continues to be a hot topic in political and economic circles. Current global events only serve to demonstrate the need for nations to diversify their sources of energy. Whilst nuclear and traditional renewable power such as solar and onshore and offshore wind will play an important role in nations achieving their netzero goals. The energy market is also exploring new technologies such as floating wind and green hydrogen. Although these new technologies are still developing, it is clear that the opportunities they offer market participants or significant floating wind projects will have the benefit of developing within a pre existing market of offshore wind, where developers and contractors are both familiar with the general technology, how to construct the project and associated contract structures. Green hydrogen project developers will however need to forge their own path and consider how best to structure project development. This article will consider what structures developers and lenders may expect to see on green or blue hydrogen projects and whether any lessons can be learned from other more mature technologies.
First, they talk about the contract and structure form. They say in their experience, large scale and complex energy projects are often procured using an amended version of the FIDIC Yellowbook, which is a standard form of construction agreement. They say that they would not expect that approach to differ on a hydrogen project. Given that an FIDIC structure offers the flexibility needed to easily reflect the commercial and technical needs of the technology and is familiar to lenders operating within the energy market, or that it’s easily amendable to be in a bankable form. Now developers must then decide whether to pursue an EPC wrap or a multi contract structure and truth no large scale energy project is likely to be developed on a true turnkey EPC basis. In other words, we’re one contractor delivers the whole project under a single contract. The cost of that developer of that approach is likely to be prohibitively expensive, given the premium that a contractor would attach to the offering to reflect the level of risk assumed by it, a risk which is unlikely to be commercially attractive to any contractor on the market.
They say in their experience, large infrastructure projects can be delivered on one of two basis. The first is the limited multi contract basis, where an EPC wrap is applied across various packages of work, which results in a project being developed with three or four EPCs covering the major components. For example, in an offshore wind market contracts may cover civils electrical and turbine work, or the second one true multi contract basis, where developers enter into 10s of contracts splitting out structures into their component parts. For example, on offshore wind and nuclear projects, developers may seek supply and installation agreements from each original equipment manufacturer of key components resulting in many contracts being procured for the overall project. They say that as the hydrogen market evolves, we may see that some contractors are willing to wrap more packages into sub contracts as the risk of any technology included in those packages becomes more known and or quantifiable.
The second consideration that they mentioned are the commercial considerations. They say the developer will need to consider the development as a whole when determining the contracting strategy, including considering technical, commercial and financing considerations. Common commercial considerations may include one price, generally, the fewer contracts a developer enters into on a complex infrastructure project, the more subcontracts the head contractor will need to wrap. This pushes the interface risk, both in the sense of packaging, management and liability from the developer onto the contractor who will in turn, attaches a greater premium to the overall contract price to account for such risk. The second is management capability. If the developer enters into a larger number of contracts, it will need the resources and expertise to manage on a day to day basis a large number of contractors. Next is the debt and equity funding. Traditionally, lenders were nervous of multi contracting structures. However, multi contracting and the risks associated with multi contracting are now well understood and provided that the developer and its advisors can guide the lenders through the structure and explain as clearly as possible, the rationale for the chosen strategy and the relevant mitigant. Lenders can and do get comfortable with funding a development constructed on a multi contract structure.
The next consideration that they bring up is the contractor experience. They say that in new technologies or contractors may yet to have demonstratable market experience, it may be preferable to limit the number of contracts and or ask those larger, more experienced contractors to wrap packages of work. This offers the developer more protection from nonperformance and insolvency risk of smaller entities, and may also have the benefit of involving no names in the project, who may be large international contractors that are diversifying their business and which can provide some comfort as to the technical capabilities on key packages to sponsors and any debt providers. On the other hand, it is likely that such contractors will be less willing to negotiate on cost and may impose more onerous terms knowing there is no reliable alternative for developer. Although it may be better to agree lighter contractual protections with an experienced contractor than more robust protections with an inexperienced contractor who may be unlikely to perform. The last commercial consideration they bring up are the legal considerations. They say notwithstanding of the commercial implications of the level of multi contracting deployed on a project, all construction contracts should look to mitigate the interface risk inherent in such a structure. Now Furthermore, they also consider some common pitfalls, that the parties may come across as a multi contracting structure and how the legal terms can protect their interests.
These are all issues that can be mitigated with the correct drafting. The first legal consideration they bring up is the consistency of terms. They say perhaps the simplest mitigate available to all parties is to ensure that wherever possible, the key terms of the contracts are aligned across the packages. In particular attention should be paid to those terms relating to program delivery, coordination and cooperation between contractors information sharing indemnities variations force majeure delay governing law and dispute resolution. commonality across contracts will ensure ease of delivery and operation by the developer on a practical basis, as it can be sure that the project is working on a common baseline.
Consequently, if and when an issue arises, contracts should respond in a similar manner, rather than one contractor being treated out of step to the others. The next consideration is coordination. They say it’s vital in the management of an interface risk to ensure that contractors are facilitating the different packages both and allowing personnel access to the site to work and providing for any contingent works and the relevant programs. Base FIDIC includes a cooperation provision, although the developer may wish to make amendments to provide for a more detailed interface mechanism between the contractors. contractors should also be required to review and comment on other contractor designs that interface with or are relevant to their works to ensure technical and design interfaces align. Now there are key considerations that developers may wish to address which include price certainty and operational requirements.
The next consideration that they mentioned is the interface matrix. They say many developers will create an interface matrix or division of responsibility, which from a technical capacity clarifies what obligations sit with each contractor across the project, it may be helpful to append this document to the contract as an aid to explain the obligations of the parties in relation to the interface points and or scope of work. However, to the extent such a document is attached to the contract, it will be vital to ensure that it is sufficiently detailed and complete as to aid clarity rather than create ambiguity within the contract which can lead to greater uncertainty and disputes between parties. The next consideration are employees requirements. In addition to clarify the legal interfaces, it will be important from a technical perspective for the scope of work of each package to be accurately defined in the technical documents to ensure that there are limited gaps between the various project packages.
Ensuring a detailed review is undertaken. Each package by the technical team will be vital To maintain a clearly defined technical scope. In addition, it would be prudent to ensure that sufficient Technical Support is available in circumstances where technology could advance during the lifetime of the project design and build. It’s also worth considering how to allow for technological advances to be captured by appropriate change provisions. Finally, for any party, it is important to review whether there are any provisions relating to mistakes or technical requirements, which may be mistakes due to developments in technology down the line. Now, this article goes into several more considerations that need to be taken, including delays, variations, changes in law and regulations, and dispute resolution causes. But since I’m butting up against my time, I’ll forego discussing those. And if you are interested in learning more about those considerations, we’ll have the link to this article in the show notes. But the last thing that they talk about is a bankable structure. And this is important. Although hydrogen is a nascent technology, it is likely looking at other technologies, that projects will be developed on a multi contracting structure with degrees of varying package numbers.
Looking at other energy technologies, they expect this will be a bankable approach, provided that developers ensure the packages contain a balanced risk profile that protects against inherent interface risks within the structure. Okay, I know legal considerations can be a bit dry for most people, but they’re very, very valid right now, as the hydrogen hubs start building up around the globe. And developing contracts with developers is a vital part of maturing the hydrogen industry, especially as a lot of smaller players who are just getting into energy development, and technology developers who want to operate their own technologies look to deploy and operate in the field past their pilot or demonstration projects.
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