Credit: Phuc/Adobe Stock

Sarah-Jane Fick
Senior associate, Freshfields Bruckhaus Deringer, Dubai and Singapore
sarah-jane.fick@freshfields.com

Jon Gilbert
Knowledge lawyer, Freshfields Bruckhaus Deringer, London
jon.gilbert@freshfields.com​​​​​​​​​​​​​
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What are energy transition projects?

Energy transition projects support the move away from carbon-intensive power generation to zero or lower-carbon alternatives. This transition in energy generation is vital if ambitious national emissions targets (many of which are legally binding) are to be achieved.

Obvious examples of energy transition projects are those that provide for power generation using renewable energy sources; for example, the construction of an offshore wind farm, solar plant or tidal facility. However, the energy transition is wider than renewables. It includes projects aimed at reducing the carbon intensity of conventional oil and gas assets such as carbon capture, utilisation and storage (CCUS) and those relating to energy storage (eg, battery and pumped storage hydropower). As nuclear energy production does not directly involve burning fossil fuels, it will also play an important role in the transition to less carbon-intensive energy generation.

Many of these projects are groundbreaking. They use cutting-edge technology, are being planned and constructed in unpredictable climatic and political conditions and accordingly raise new legal risks. Effective management of these risks is critical to ensuring the ongoing promotion of energy transition projects in the face of regional energy security fears. In recent months, energy shortages and increased prices for consumers have seen states turn away from innovative energy solutions, towards lower-cost and lower-risk investment in expanding existing fossil fuel extraction and processing projects.

What are these risks and how can they be mitigated?

First, energy transition projects face many of the same legal risks as can arise on traditional construction projects. Construction of any project can entail issues such as quality deficiencies with design or workmanship, disruption, issues affecting the timely achievement of milestones, price escalation of materials and labour, unforeseen ground conditions, unforeseen external factors (such as extreme weather events), the impact of changing local
legislation, poor contract administration and ambiguities in contract documents.

Such risks have the potential to:

• Delay ultimate completion – if the critical path of the works is changed, this could have a knock-on effect to the required completion date (or a milestone date). Delay damages may become payable by the contractor, and the employer will likely face onward liability and/or incur its own losses;

• Increase costs – of obtaining materials (sometimes at short notice and/or in a high demand scenario), labour or equipment. Cost impacts can also result from currency fluctuations as well as supply and demand dynamics;

• Impact the quality of the project – defects in the works could result in the asset failing to perform as anticipated (which may in turn result in further delay and/or costs as rectification measures are taken); and/or

• Disruption to project cash flow – for example, because an asset is delayed in becoming operational and generating income.

In the context of energy transition projects, it pays at the stage of contract negotiations to consider the following additional risks and issues, which can exacerbate anticipated construction risks:

Emerging technologies and engineering innovation

Capital cost is generally perceived as the major barrier to investment in energy transition projects. By nature, they involve new technologies and engineering, and project stakeholders cannot rely on decades of proven performance records before electing to invest in these types of ground-breaking and often unique projects. For instance, off-takers of any energy project will be reluctant to invest if there is uncertainty over the start date for commercial operation of assets with untested performance. 

As the saying goes, ‘perfect planning prevents poor performance’ and feasibility studies, the development and maintenance of a safety case and environmental assessments, and training staff in the use of new technologies are all important preparatory steps to mitigate disputes arising during project delivery. A lack of developed industry standards provides an opportunity for new technology adopters to prepare detailed specifications tailored to the specifics of the project at hand. It may also be difficult to obtain planning or regulatory approvals for truly ground-breaking projects without some level of governmental investment.

The move towards allocating risk for innovation in construction projects generally is gathering momentum. Apportionment of risks should be clearly set out, with parties considering the potential for disputes to arise across all stakeholder interfaces. Pan-project dispute resolution agreements that involve blanket joinder and consolidation provisions for disputes arising between project stakeholders may reduce the risks of protracted legal action.

Sensitivities in supply chains

Recent world events have demonstrated the fragility of international supply chains and the impact supply chain disruption can have on project delivery, incuding cost, schedule and even feasibility.

Pricing has traditionally been used to mitigate supply chain risks:

• if the risk at issue is one of material availability and price, a lump sum contracting arrangement with spot-price contracts further down the supply chain can insulate project stakeholders from overspend; or

• if a closed labour pool is likely to be an issue for constructability, fully reimbursable contracts for labour, staff and associated costs (such as recruitment, housing and travel in less accessible geographies) over a project duration can give project owners greater flexibility on manpower in exchange for less certainty on project cost.

However, energy transition projects are potentially more susceptible to supply chain risks for the following reasons:

• Certain raw materials may be critical for delivery of the project. The sheer volume of a specific material required may be significant enough to impact the general market for it, affecting both price and availability. Requirements for certain raw materials can also have environmental implications which could, ultimately, present reputational risk to end users.

• As the technology and engineering involved in many planned energy transition projects is innovative, contracting parties must work on a project-by-project basis to assess what risks are posed by these innovations and how those risks can (and should) be shared.

• Coupled with new technologies come new parts and equipment necessary for implementation, as well as associated limitations on worldwide availability. New market entrants may find it difficult to scale quickly enough to deliver services and compete with established manufacturers. This can lead to unexpected insolvencies, and procurement difficulties with alternative suppliers.

Understanding the regulatory context surrounding a planned project at the outset of contract negotiations is key and can more easily lead to the inclusion of due diligence requirements passed down a supply chain to manage some of these risks. Project stakeholders can protect themselves with contractual provisions including representations, warranties and indemnities, while contractors and subcontractors are likely to negotiate provisions concerning pricing certainty (including price escalation, currency fluctuation and general payment structuring clauses). There has also been an increased focus on applying circular economy thinking to projects to maximise opportunities for recycling, refurbishing and repurposing materials and equipment.

Workforce issues

Where energy transition projects are pencilled to take place in geographies with developing employment and human rights regimes, particular consideration at contracting stage will be required in relation to bribery and corruption, forced labour, child labour and worker health and safety risks. Each of these issues can be the source of disputes between project stakeholders (particularly where international stakeholders are legally required to make human rights-related disclosures) and cause significant reputational damage. Increasingly, states are legislating requirements to conduct modern slavery and supply chain due diligence in a similar way to the widespread adoption of anti-bribery legislation concerning corporate disclosure requirements. As a result of these laws, project participants are increasingly required to ensure that their labour force is free from human rights abuses, or risk significant fines or legal challenges.

In geographies with developed labour laws, workforce risk on energy transition projects tends to lie in working conditions and the commitments to safety precautions and reporting adopted by project participants. Specific health and safety issues are raised by offshore projects and due to land scarcity and environmental issues, natural resource-intensive projects are increasingly carried out in remote locations with minimal or non-existent social infrastructure. Project stakeholders may need to develop relationships with unions and other third-party employment organisations to develop locally acceptable employment packages for labour and staff that will minimise the risks of direct actions by employees once the project is under way.

Joint venture partnering

Joint ventures (JVs) are an increasingly popular form of business partnership on energy transition projects. In recent years, many oil and gas majors have formed some of the largest consortia, in some cases partnering with smaller partners brought in for strategic reasons – for example their specialist technological or local expertise.

JVs typically take the form of a special purpose vehicle, which is incorporated to enter into the principal contracts for the project and own the resulting assets.
They allow businesses to tap into their collective resources, including funding, know-how, technology, network and knowledge of the local market.

However, there are some specific risks that should be considered:

• State of the art technology utilised on energy transition projects is often the result of significant capital expenditure. There is a risk of disputes arising in relation to the ownership and treatment of intellectual property (IP) where this is not properly considered. The JV agreement should clearly address issues such as the retention of ownership of pre-existing IP, the support services to be supplied in relation to technology, the scope of ownership of IP advancements during the course of the project and the specific steps to be taken at the end of the project (or on termination of the JV) in relation to ownership of IP and return of confidential information. Parties should also consider the impact of an insolvency, bearing in mind that any partner brought on board for its IP may be in a more precarious financial position.

• Disputes can arise between JV partners absent a clear allocation of risk and delineation of responsibilities in connection with the project’s scope of work. This is particularly relevant on energy transition projects where untested technology or unusual site conditions may increase the risk of cost overruns and delay. Setting out rights and obligations clearly in the JV agreement, as well as efficient expert referral and dispute resolution mechanisms, can go some way to mitigate this risk.

• It is common on energy transition projects for one of the JV partners (or an affiliated company) to be a supplier, operator and/or contractor on the project, particularly where it provides the technology. In such cases, conflict can arise, for example, if the contractor’s works cause delay to project completion and delay damages need to be triggered. Accordingly, the JV’s decisions need to be carefully managed, potentially via the use of a non-conflicted JV committee and/or an efficient deadlock resolution mechanism. 

Collaborative delivery structures

Collaborative delivery structures could potentially play a role in ensuring that, where one of the above risks materialises, the likelihood of it jeopardising successful project delivery or damaging relationships between owners, contractors and suppliers (potentially resulting in a dispute) is reduced.

A range of options could be considered, including:

– Partnering: The parties agree to work in a cooperative manner, in good faith and to achieve mutual goals. Partnering obligations can include the requirement to work together to achieve the employer’s and other partners’ objectives, share information, give early warning of matters that could impact other partners and implement core group decisions.

– Alliancing: This is an extension of the partnering model. The employer, contractor and parties in the supply chain enter into a single alliance agreement, which includes measures to incentivise participants and promote positive contractor behaviour. These are reinforced by financial incentives (in the form of a carrot or stick); that is, if the project is completed by a target date or costs come under a certain amount. Of particular note is that the parties agree not to bring claims against each other, although an alliance board can be put in place to encourage amicable resolution.

– ‘Sweat equity’: This colloquialism refers to a person’s or company’s unpaid contribution to a business venture. In a project context, ‘sweat equity’ may refer to the contribution of design services, construction work or technology development in return for an equity stake in the project or deferred payment for that contribution. Although a ‘sweat equity’ approach has historically been seen in other sectors (such as real estate) or smaller projects, the overall shift towards alliance-based contracting structures could mean this model is on the horizon for energy transition projects, too.

The above examples may not be appropriate for every energy transition project, but the principles behind these models could help to guide the parties’ approach to balancing risk and reward on such projects. Ultimately, having clarity between project participants regarding risk allocation at the conclusion of a contract should reduce the potential for surprises during the delivery of innovative energy transition projects.