Innovation and new technology is central to a successful energy transition, but working out who bears the financial risk posed by largely untested tech can see proposed projects fail to get off the ground.
Developing, testing and scaling new technology and processes is vital to a successful energy transition. The amounts that will need to be spent on green projects in order to produce and transport alternative forms of energy are in the trillions.
Elements of the projects that will be undertaken will involve well known construction and engineering like expanding ports and infrastructure and building vessels and pipelines. However, even within these traditional projects, there is likely to be elements involving new and untested technology that have not been used at scale before.
This of course introduces technology risk into the project and in order to ensure that these projects are successful, the risk needs to be allocated and managed appropriately between the parties.
There are a variety of issues that come into play when considering the risk of new technology, but most importantly, the source of funding will have a significant impact on who carries the main risks of the project. Funding can come from a combination of bank funding, government funding, private equity funding or other sources. These funding sources will differ significantly in terms of whether they have a mandate to take technology risk and how they are compensated for it.
Compensation for technology risk can take many forms. Ownership of a new technology can be valuable and a potential source of revenue in itself (and may hold value outside the individual projects) and in such instances, ownership of the technology and the right to deploy it elsewhere may be key to managing risks.
On the flipside, financial backers such as investment funds and pension funds rarely have the risk appetite to take technology risks. Banks are even less keen to do so.
Avoiding a ‘graveyard of contractors’
Typically, where banks provide non-recourse project funding, they will not be willing to take any technology risk, and they will prefer to see that all project risks (including technology risk) are tied up neatly in an Engineering, Procurement and Construction (EPC) contract. These contracts provide a higher level of certainty that the project is built on a turnkey basis on time and for a specific price so that the employer/owner is free to start commercial operations of the project at the agreed time and the debt service of the bank finance is secure.
However, for contractors, this does require taking on a lot of risk, including any unknowns causing cost overruns or delays. This may be manageable for the contractor when carrying out a standard project where the risks are quantifiable and well understood so that it can be priced into the contract. However, this may be more difficult where new technology is being deployed.
© Supplied by Addleshaw GoddardIf we insist on the EPC model, contractors may demand higher prices to compensate them for the additional risk, which may then be passed on to consumers, who are already feeling the pinch.
Smaller contractors who don’t have the resources to take this risk may not bid on projects, raising prices further. Some projects where there are several large components but there is no obvious main contractor may not attract project financing. If the technology risk becomes too great, contractors may become insolvent, causing supply chain disruptions.
This happened in the energy from waste industry which created a graveyard of contractors and it is imperative that we avoid the same mistake.
Giving contractors ‘skin in the game’
In situations where the contractor is unwilling or unable to guarantee to deliver the project on time and for a fixed budget, it often makes sense to provide a piece of the equity to the contractor to ensure that the interests of the sponsors and the contractor are aligned. The technology risk will then be managed by the combination of the supply agreement and the shareholders’ agreement.
This also means that the contractor is entitled to the consideration under the supply agreement, and it also earns a revenue stream from the project once it becomes profit generating. It is often debated whether the contractor should be permitted to sell down its stake at that point. This often depends on whether the same contractor will carry out the operations and maintenance role.
The supply agreement itself may not provide sufficient remedies for the project company in case of a breach by the contractor, but the shareholders’ agreement often includes a right for the sponsors to forfeit the shares of the contractor upon a fundamental breach of the supply agreement. A well designed shareholders’ agreement will also keep the relevant IP within the project company in that case, which means even more pain for a defaulting contractor.
EPCm model
If there is no obvious main contractor who can take on an EPC role, the technology provider may agree to act as an EPCm consultant to coordinate the project contractors, but without underwriting that the project will be built on time and on budget. The fees of the EPCm contractor usually carry a large contingent element to create the right incentives and helps make the project bankable. This also means that other risks can be allocated across different contractors, thereby reducing the risk that single contractors will end up taking excessive or unmanageable risks.
There is not a single, simple answer to the question of who shoulders the risk of new technology in a project. As we have explored above, there are a number of contractual structures that can be used, depending on the project requirements and the financing requirements. Additionally, innovators and technology providers can explore a range of technical certifications or insurance solutions to alleviate risk.
Examples of positive initiatives include the Net Zero Technology Centre and ORE Catapult, both of which provide support for innovators through a number of different mechanisms such as technology verification, research and acceleration programmes. These will help drive early success for innovative projects.
However, more is required to bridge the gap from early stage projects to the large scale investment and development required to meet the needs of the energy transition.
Solutions must be found to facilitate innovation and ensure that progress is not halted due to a lack of available funding.
Marton Eorsi, a Partner at Addleshaw Goddard, is an international infrastructure and energy lawyer specialising in the green transition. Maren Strandevold is a Legal Director at Addleshaw Goddard, specialising in risk management in energy transition projects.
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