1. Overview
The age of utility scale battery storage is here and looks set to stay well into the future. Battery storage projects have seen a sharp uptick in development with an unprecedented number of projects coming online globally in the last two years, and in so doing largely easing market concerns relating to the supply chain issues previously experienced within the market between 2020–2022. While constraints on the battery storage supply chains are still an ever-present consideration and risk to the development of battery storage projects, several key factors are driving an increase in production and an overall reduction in the pricing of components in battery energy storage systems ("BESS"). The chief amongst these is a surge in the manufacturing capacity of battery suppliers, the increase in the supply of lithium, and the development of new, more efficient battery technologies. The causal effect of this being the overwhelming acceptance of the technology and its role in the energy mix, resulting in a boom in the number of BESS facilities being developed.
The beauty of BESS facilities lies in its versatility. Beyond the traditional use of BESS for peak demand periods, BESS provides system operators with grid balancing services, unlocks grid capacity, provides "black start" capabilities and facilitates energy trading through aggregator platforms. It is no surprise why governments around the world have been quick to implement policies supporting the development of new BESS facilities in recent years. With the projected pipeline of projects going forward, it seems likely that BESS equipment suppliers, contractors and developers are each going to have their hands full trying to keep up with this 'BESS fever'.
The question then becomes: what is the development of these projects going to look like and how best can developers structure their contractual arrangements to maximise their returns amidst this boom in development? This article looks at the current approaches being adopted in the development of BESS facilities; what the adoption of a split-contracting arrangement could look like, as well as the benefits and risks related to a split-contract strategy; and the mechanisms that key project parties could adopt to manage risk.
2. The Current Field of Play
Much like the construction contracting structure adopted in the early years of project development in more traditional renewable energy assets such as solar and wind, the approach to BESS contractual structuring has largely been characterised by turnkey Energy Performance Certificate ("EPC") contracts. The allure of this structure is understandable as it provides a single point of responsibility covering engineering, procurement and construction of each component of a BESS facility all the way through to testing and commissioning of the facility, culminating in the handover of an operational asset at the end of the construction period.
Where projects have encountered delays or defects in fulfilment of services under a well-drafted EPC contract, the responsibility to remedy such delay or defect sits with one person: the single turnkey EPC contractor. Equally, in assessing the overall bankability of a BESS project, having a single turnkey EPC contractor means lenders have only had to assess one entity when determining the track record and credentials of an EPC contractor.
The comfort provided by a turnkey EPC contractor comes at a price – developers pay for the single point of responsibility. However, the time may be approaching where developers may be looking to rethink their approach to contracting. With the maturing of the BESS market, developers grow more comfortable with the construction process and the associated risks and look for innovative ways to cut costs and raise yields. One such option that has emerged in recent years is to adopt a split-contracting strategy when procuring the construction of a BESS project.
3. Split-Contracting and Benefits
For many developers in the battery storage industry, specifically those developers in established markets, revenues are typically not contracted, meaning that developers (and by extension their financiers) are taking "merchant" revenue risk. With the cost of procurement of equipment and development of BESS facilities being a much larger consideration and having a much larger impact on the business case and ultimate success of BESS projects as compared to traditional renewable assets, it is understandable that a greater focus is placed on project cost and the strategies to control development and construction costs.
As alluded to above, split contracting is emerging as a viable alternative to the turnkey EPC model and has the potential to unlock significant value in BESS projects for developers. The primary driver behind the adoption of this strategy is to reduce the construction cost required to develop a BESS project. Unlike the traditional construction contractual structure detailed in the previous section, the split contract approach – as the name dictates – splits the procurement of construction services across two or more contractors, each with detailed scopes of work that, when pieced together and viewed holistically, aims to place the developer in the same position they would have been in had they employed a turnkey EPC contractor. Instead of a turnkey EPC contractor covering all aspects of the development of the project, key elements involved in the project development are split across a number of contractors. The most common approach being adopted is to split the procurement of the BESS equipment, on one hand from the installation and civil and electrical works on another.
Focusing on the procurement of BESS equipment, a developer is able to approach the market solely for the supply of the component pieces of the BESS facility (i.e. the required battery units, inverters, energy management systems, etc.), noting that, depending on the approach of the developer, each of these components could be procured through one or more suppliers. A potential benefit to this approach is that it could afford developers the opportunity to leverage existing relationships with equipment suppliers. Where developers have a pipeline of BESS projects in the works, there are benefits in entering into a master agreement with a specific BESS equipment supplier to regulate the procurement and provision of equipment across the entire pipeline of projects that sets out the key terms upon which the parties agree to contract, along with an agreed form of supply agreement, which specifically limits terms to be negotiated on a project-by-project basis, resulting in streamlined supply negotiations in respect of each project.
In parallel with the procurement of the required equipment, the developer is able to approach one or more "balance of plant" contractors to provide services required to install the BESS equipment, construct the necessary civil works in relation to the plant and provide for the electrical connection works in linking the BESS facility to the grid.
But where are the benefits derived from the split? The primary benefit is an overall reduction in procurement and construction costs, and the cost savings. Under a traditional fully wrapped EPC contract, due to the fact that the turnkey EPC contractor is responsible for the procurement of equipment and fulfilment of all project works, the EPC contractor prices for the risks absorbed related to the construction programme, the equipment procured, the works performed and the overall performance of the BESS facility, resulting in a higher price associated with the fulfilment of each workstream as compared to sourcing the procurement and works components separately. The margin applied to these costs relate to the procurement services provided, as well as to cover the interface risk being absorbed by the turnkey EPC contractor. The split contract model helps developers eliminate the delta between these two sets of pricing.
Another factor driving a reduction in cost relates to the fact that the BESS market is still primarily driven by BESS equipment manufacturers, which retain the bargaining power in negotiations. Although the manufacturing capacities have increased in recent years and growing competition has delivered some benefits to developers (such as longer warranties). Providing a BESS equipment manufacturer with an opportunity to solely provide the BESS equipment, without the need to provide any installation or related services during the construction of the project, results in more manufacturers being willing to place competitive bids in for projects. The increase in bids offers developers an opportunity to select the most economic bid meeting their technical requirements.
With the potential savings being in the region of 10%–15%, these savings present developers with a genuine decision to make on which structure may be best. However, with more rewards also comes more risks, and developers looking to implement a split contract strategy will need to be cognisant of these risks.
4. Potential Risks in Split-Contracting Strategies and Key Risk Mitigants
BESS projects present specific nuances compared to developments under wind and solar projects; however, much can be learned from the transition from turnkey EPC to split contracting models experienced in each of these technologies. For wind at least, projects were originally split and subsequently became an EPC market when the turbine suppliers had to become more competitive. Below we set out a few key risks and issues that developers and contractors should consider prior to the implementation of this contract structure.
Previously, developers could take comfort in the fact that all project risks were covered under one contract, with the turnkey EPC contractor accountable for all delay and defect risk. While the management of project risk is not a new consideration during EPC negotiations, the use of a split contracting structure draws this into sharp focus. Technical risk, delay risk, delivery and ownership risk each need to be catered for appropriately across each contractor under a split contract structure.
Technical risk
Unique to BESS facility development, the procurement of each component poses a risk to the developer in that each component must be compatible with the other in order to ensure the operation of the facility and the efficient performance of the asset to meet project specification. As a result, careful consideration must be given to the technology proposed to be used in each project. The use of tried and tested technologies with a proven track record of success in operation relieves the risk associated with incompatibility across components in a BESS project. Additionally, the use of expert technical advisors from the outset in the feasibility stages of a project will ensure appropriate technologies are procured.
Delay risk
Another risk needing to be adequately addressed is the sequencing of services to be fulfilled by each various contractor. Delays in any of the workstreams can result in a knock-on effect preventing a particular contractor from fulfilling their scope of services until another has completed theirs. Each of these delays have an impact on the overall construction schedule and place the project at risk of missing deadlines for key milestones. The management of the construction schedule and interaction across each of the contractors will need to be a priority for any developer to avoid running into scheduling issues.
Similarly, the sequencing and timing of contractual performance by each contractor must be an area of focus requiring inputs from technical and legal advisers to ensure that each contract operates in harmony with one another and that no delay in fulfilment of their performance by one contractor shall permit another contractor to raise a claim for damages due to the delay to the fulfilment of their performance under their respective construction contract.
Delivery risk
Flowing from delays, another risk that may arise throughout the construction period is the timing of equipment deliveries as paired up with other construction milestones. Where the obligation to control and manage the delivery of equipment in accordance with the construction schedule would ordinarily sit with the EPC contractor under a fully wrapped EPC, this responsibility is likely to move to the developer under a split contract regime. Developers should future proof each contract with suppliers and pre-bake contractual mechanisms to avoid issues with misalignments in the forecasted delivery schedule. Contractual mechanisms to change the delivery date and the dates on which ownership is transferred should be standard across each agreement with suppliers and contractors. Potential mechanisms to cater for the need to store equipment on the supplier's premises post manufacturing should also be negotiated.
Responsibility coverage
A clear risk presented by a split contract as opposed to a fully wrapped project is the potential for gaps to arise in the scope of services to be provided by each individual contractor. In covering off this risk, developers, along with the help of their advisers, should seek to ensure that the scope of work and terms of each contractor agreement are clear. Each of these should clearly set out where the responsibilities of one contractor ends and where the next begins, and this process should be followed and repeated for each equipment component through from the initial procurement to installation, testing and commissioning, and ending in handover.
Performance standards
Similar to the need to ensure the entire scope of work is captured under the suite of contractor agreements, so too careful consideration must be given to the warranties, guarantees and performance bonds to be provided across the suite of contractor agreements. Each of these aspects come with their own difficulty in implementation when encountered in a split contract. When it comes to warranties, difficulties arise in ensuring the maintenance of warranties provided by suppliers. Often these warranties come with express exclusion events, which place restrictions on the cover provided by each warranty. Supplier warranties typically provide that the warranties will only be effective where the supplier's installation guidelines and procedures are followed. Where these restrictions are present, developers should ensure the appropriate undertakings are provided by contractors fulfilling the installation works; however, developers should guard against accepting supplier positions that are overly restrictive and prevent the developer and its contractors from upgrading the BESS facility over time. Another related issue to restrictions imposed by suppliers is where suppliers will only supply the necessary BESS equipment if one of their affiliates acts as the installation contractor, or even the eventual operations and maintenance contractor. Developers should look out for these conditions as they may have an impact on the overall pricing of a project and run up on the overall benefit and flexibility afforded by the split contract model.
On the provision of guarantees and performance bonds by suppliers and contractors for a BESS project under a split contract model, care should be taken to ensure the sizing of the guarantee and performance bond package is appropriate for the project size. As the traditional method for limiting liability under guarantees and performance bonds is to define these upper thresholds with reference to the overall contract value, issues can arise where a split contract model is adopted. Due to the contracts being split, the value of each contract is significantly lower and the resulting guarantees and performance bonds will be lower. Under a fully wrapped EPC contract, specific guarantees or performance bonds can be called for delays or defects across the various workstreams being covered by the single EPC contractor; however, under a split contract model, the developer will not have this flexibility as each guarantee and performance bond provided by a contractor will limit the liability to cover only its scope of work. Those components or services that are low value but likely to have a big impact on the project should there be a delay or defect are particularly tricky. Here, a developer may be best served in incorporating the fulfilment of these services with other higher value scopes of work being covered by a particular contractor to ensure any guarantees or performance bonds have sufficient headroom if they are called.
Contractor co-operation
During the negotiation and contract drafting phase with each separate contractor, a critical piece that will need to be incorporated into each contract is specific contractual undertakings requiring each contractor to co-operate with each other on a good faith and best-efforts basis to bring about project completion. Despite the separation of the contractual arrangements, there will undoubtedly be an interplay between the fulfilment of each contractor's scope of work and the next, which will require these contractors to work together to fulfil each of their obligations.
Developer resources
A potentially easy to overlook element in the development of a split contracting project is the human resource capabilities of the developer. As a result of the increase in the number of suppliers and contractors involved, developers will need to ensure that their teams are sufficiently well resourced and skilled to manage the increase in the number of contractual negotiations with each supplier and contractor. Developers will also need to ensure that their teams have the technical capabilities to manage multiple contractual arrangements running in parallel, as well as managing the interface that each of these contracts have with each other.
Project sizing
Flowing from the demands that a split contract model places on a developer's resources, a developer, at the outset of the project development process, must assess the appropriateness of utilising a split contract structure. Due to the increased demands placed on developers as well as the increased cost of more detailed advisor involvement, a split contract model may not prove beneficial for smaller BESS projects. Additionally, a balance of plant contractor is unlikely to provide competitive pricing for smaller projects where a split contract structure is utilised due to the higher demand for balance of plant contractors in the market. For smaller projects, the traditional fully wrapped model is proving more effective and appropriate.
Lender considerations
The appetite of traditional project finance lenders to provide debt funding for BESS projects has grown in the last couple of years, although there remains a reluctance from certain lenders to take "merchant" risk on single asset BESS project financing. Split contracting regimes are not new to lenders. This being said, the risks applicable to a split contract structure under a BESS project are largely untested and it is likely to be a challenge for developers that are "early movers" in introducing a split contracting approach to the development of a BESS project. Much like the early stages of implementing split contracts in wind and solar projects, market practice takes time to develop and we are more likely to see lenders funding split contract BESS projects once a firm precedent begins to emerge. Until this time, BESS split contracting remains mostly relevant in the context of equity funded BESS projects.
5. Conclusion
While the split contract model offers project stakeholders, especially developers, potentially large efficiencies and cost savings, the appropriateness of the model must be assessed on a case-by-case basis. The risk appetite of suppliers, contractors and lenders are each key factors dictating the decision on whether to implement a split or not. For a developer, this assessment will include a balancing exercise between reward and risk: on the one hand you have significant potential savings and, on the other, there is increased resourcing requirements, as well as increased developer and lender advisor costs. But as split contracting models applicable to BESS development become more common place within the market, structuring and mechanisms to manage risks are likely to become entrenched, and in so doing, lowering development costs and potentially tilting structuring decisions in favour of the split model.
Originally published by ICLG
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