16 July 2020

The Law behind wind energy in Spain (iii), contracts

This is the third of a series of three articles covering different legal aspects of wind energy in Spain. The present piece covers the most relevant contractual agreements in wind energy projects. You can also access the first and second articles of this series here

I. Introduction

Renewable energy projects in general and wind energy projects in particular are highly complex undertakings requiring substantial financing and long-term foreseeability for their development. Likewise, wind energy projects go through multiple stages along their 20-30 years life span, from wind resource assessment and site selection to operation and maintenance, involving a substantial number of different actors in the process. 

All of the above contribute for contractual agreements to play a key role in these enterprises, determining the liability of the parties, generating certainty, establishing standards of performance, and apportioning the risks of the transactions. In addition, given that the renewables market is heavily regulated, contractual agreements also contribute to distribute the numerous obligations generated as a result of the applicable legal framework of these projects, thus, allowing for specialization among the different actors participating in this market and, ultimately, making these projects feasible.  

Business contracts are typically written agreements entered into by and between two or more parties designed to establish and distribute a series of obligations emerging in the context of a transaction. It serves as the blueprint for the parties involved to interpret and execute such a transaction. Consequently, the contracts entered by the parties in wind energy projects mainly depend on the stage of the project itself, since that is the main element determining the necessary transactions to be carried out. 

In this regard, we can find an important diversity of contracts along the main stages of the life of a wind energy facility, with a rich diversity of companies specialized in each one of those areas:

i. Wind resource assessment and site selection.

ii. Planning, grid connection, and environmental approvals.

iii. Project financing and bankability. 

iv. Engineering, procurement, and construction. 

v. Operation and maintenance. 

vi. Power sale.

vii. Repowering and/or decommissioning.    

This article will focus on phases (iv) to (vi), describing the main features of the most relevant contractual agreements in each one of them:

II. Engineering, Procurement and Construction (EPC) contracts

Once the location of the facility is determined and the necessary authorizations and approvals are obtained, the planned wind energy facility enters the engineering, procurement, and construction stage. This phase represents the bedrock of a wind energy project since it is when the project company or developer will make the major capital disbursement -see tables II.1 and II.2 for information about the evolution of the costs of wind energy facilities in Spain and their cost breakdown, respectively-: 

Although the different activities to be carried out during this phase can be contracted with separate entities and through several different contracts, EPC contracts -also known as turnkey construction contracts- allow the developer to contract the whole process through a single agreement, typically with a single contractor who will be obliged to deliver a complete facility for the agreed price, date and performance level

EPC contracts grant a high degree of flexibility, certainty, and guarantees to developers and financiers alike, encapsulating the complex process of building a wind energy facility in a single contractual agreement, therefore, providing a single point of responsibility. The latter also contributes to improving the bankability of the whole project, given that it clearly quantifies and assigns the liability assumed by each one of the parties involved in it. That is the reason why it is not surprising that EPC contracts are the preferred choice for developers and lenders. 

Despite the advantages of EPC contracts, however, the developer may opt to enter into a set of individual agreements covering each one of the activities otherwise comprehended within an EPC contract. Due to the substantial obligations assumed by the contractor under such agreements, in some cases there are not reputable contractors interested in entering into an EPC contract for the price that the developer is willing to pay.

In those cases, the EPC contract will be substituted by a set of contractual agreements covering each transaction or activity that would otherwise be covered under an EPC contract. This practice is also called “split EPC contract”. As a result of the latter, the developer will enter into individual equipment supply contracts (e.g. wind turbine generator supply contract), installation agreements, balance of plant (BOP) contracts -for civil and electrical works-, warranty operating and maintenance (WOM) agreement -for guaranteeing the performance level-, etc. 

III. Operation and maintenance (O&M) contracts

O&M contracts are designed to govern the operation and maintenance of the facilities once they are built. The terms of these agreements vary greatly depending on the company operating the facility. In this regard, there are two typical cases: when the facility is operated by the development company itself and when this activity is outsourced to another company specialized in operating already-built wind energy facilities in exchange of remuneration or the participation in the benefits of the project (whether through an agreement or by entering in the development company’s share capital).

IV. Power purchase agreements or PPAs

PPAs are agreements in which the client (typically a company consuming large amounts of electricity) undertakes to pay for a set amount of electricity every year during a set period of time (e.g. 15-20 years). The developer will in turn undertake to produce a minimum quantity of electricity. The main advantage of PPAs (vs. merchant power plants) is that they provide certainty of cash flow to the developer while securing a fixed price of electricity to the client for the duration of the agreement. 

The latter improves the bankability of the project, hence, facilitating the entrance of lenders and investors in it. Likewise, PPAs shield the client against fluctuations in the electricity market and allow it to plan the costs of power purchases every year until the expiration of the agreement. Long-term revenue/cost foreseeability is typically achieved through a cap and floor mechanism, allowing for a certain degree of flexibility and adapting the price of electricity in accordance with the variables agreed by the parties.

V. Conclusion

Legal contracts are one of the supporting pillars facilitating the development of the wind energy market in Spain. With governments, investment funds, and international organizations wagering on climate-friendly recovery measures funded by massive coronavirus stimulus packages, the need for regulatory compliance and contracts drafting services in relation to renewable energies will certainly surge in the forthcoming years.   

However, the technical nature, fast-changing technology, and complex regulatory environment of renewable energy projects require a high degree of specialization from lawyers advising on this field. That is the reason why law firms and renewable energy companies need to strengthen their legal departments in order to deliver on the increasing demand for renewables-related legal services. 

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