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International arbitration report
In this edition, we focused on the Shanghai International Economic and Trade Arbitration Commission’s (SHIAC) new arbitration rules, which take effect January 1, 2024.
The BESS is yet to come: Legal trends in Australia’s large-scale battery sector
Australia | Publication | August 2024
The authors acknowledge Sam Cowan’s contribution to this article.
Content
Introduction
Australia’s push towards renewable energy has seen a sharp increase in utility-scale Battery Energy Storage Systems (BESS) projects. In 2023, Australia saw the strongest year for new financial commitments in large-scale storage and hybrid projects with storage, totalling AUD $4.9 billion. Building more large-scale BESS projects helps stabilise fluctuations in energy output from renewable sources such as wind and solar and enhances grid stability.
Alongside this growth, developers are adopting new procurement and contracting models. Increasingly, developers favour split contracting over the traditional engineering, procurement and construction (EPC) contract model. This article explores:
- the reasons behind this shift;
- the key differences between the two contracting models;
- key risks and potential solutions for developers; and
- where to from here – future contracting trends for BESS projects in Australia.
Reasons for the growing preference for split contracts over EPC contracts in BESS projects in Australia
Historically, EPC contracts have been the mainstay for large-scale energy projects in Australia, including BESS projects. An EPC contract is a fully integrated solution where a single contractor takes full responsibility for the engineering, procurement, and construction aspects of a project, excluding specified grid connection works. The contractor must reach commercial operation by a specified date for a fixed lump sum price, with limited entitlements to time and cost adjustments for specified events. The contractor also provides performance guarantees, which ‘wraps’ the performance risk of all the components, engineering and construction comprising the project.
Split contracting usually separates the procurement and construction elements into distinct agreements. This practice allows developers to select specialised suppliers / contractors for each package, ensuring that each package is handled by experts in that specific area. Typically, a split contract includes a BESS supply or supply and commission contract and a balance of plant contract. Some developers engage separate integration contractors for technical integration and supervision of testing and commissioning. Further package splitting may be possible – for example, supply of inverters and splitting electrical and civil balance of plant.
The key differences between split contracting and EPC contract models
The EPC contracting model has the advantages of relative simplicity, a single point of accountability, reduced interface risk for the developer and being preferred by Australian financiers.
However, in the current market a limited number of contractors in Australia are willing to take on a traditional EPC contractor role. A split contracting model opens the market to more tenderers for various packages, which may reduce reliance on a limited pool of EPC contractors and reduce overall project cost. As BESS projects evolve in complexity and scale, developers and stakeholders are looking to utilise split contracting models to cater for the current economic and procurement environment and to make projects economically viable.
Below we compare how the split contracting and EPC contract models deal with key risk issues.
| Feature | Split contracts | EPC contracts |
| Guarantees and warranties |
Direct warranties and / or performance guarantees provided by each supplier / contractor but no system-wide performance guarantees. |
Performance guarantees and warranties for the entire BESS are provided by a single contractor, providing system-wide performance guarantees. |
| Market competition and pricing |
Opens the market to more tenderers, which should increase pool of suppliers / contractors for each package and lower tender prices. | Higher pricing due to risk contingency and margin applying across the whole scope of works under the single EPC contract. |
| Interface Risk |
The division of works and responsibilities under split contracts can increase interface risks. On the other hand, by spreading risk across multiple contracts, developers may find it easier to better tailor risk allocation to the party best able to manage it and mitigate potential issues, if managed effectively. |
The EPC contractor is the sole point of responsibility and takes on the risk of interface issues arising between its suppliers and subcontractors. Interface risks remain with respect to connection works and division of responsibility for compliance with approvals, energy regulations, land agreements and connection agreements. |
| Technical Specialisation | By using split contracts, developers can ensure that experts perform each package. This can lead to superior system performance and reliability. | The EPC contractor is responsible for the entire project (save for certain connection works). The EPC Contractor and its subcontractors will need to have the required expertise. This can be managed via a typical subcontractor approval process. |
| Bankability | Popular overseas and being considered by many more developers in Australia. Split contracts may be less problematic for projects fully funded by equity investors with experience of this model. |
EPC contracts remain the dominant model in Australia. They are readily bankable and favoured by the Australian financiers. |
| Time certainty |
Individual critical path programs and tailored time / cost adjustments can give rise to interface risks if not managed effectively. This requires carefully up-front planning and programming to identify interfaces. Suppliers / contractors may not agree to cover the delay costs incurred by other contractors which they cause. |
The EPC contractor is responsible for achieving key milestones by specified dates under a single contract and takes the risk of programming and interface issues arising. |
| Cost certainty | Usually these contracts will be for fixed prices, subject only to limited adjustments. Some contracts will require forex and commodity adjustments. | EPC contracts will have a fixed price, subject only to limited adjustments. Some contracts will require forex and commodity adjustments at financial close / notice to proceed, but no further adjustment for labour/supply costs increases or rise and fall. |
| Payment Terms | Flexibility in payment terms and timing based on progress or milestones, often with deposits or advance payments. | Milestone payment regimes with financier oversight, streamlined under a single contract. Usually advance payment required. |
| Insurance | Developer to decide whether to take out project-level contract works, public liability and marine transit insurances, or each supplier / contractor to take out these for their scope. All other insurances are usually effected by suppliers and contractors (eg products liability, professional indemnity, workers compensation, motor vehicle etc, as applicable). | Developer to decide whether to take out project-level contract works, public liability and marine transit insurances, or EPC contractor to take out these. All other insurances are usually effected by the EPC Contractor (eg products liability, professional indemnity, workers compensation, motor vehicle etc, as applicable). Usually EPC Contractor must ensure its suppliers and contractors are similarly insured. |
| Security | Security will be tailored to scope, risk, and payment profile for each contract, to secure the relevant supplier / contractor’s performance under its contract only. Security for deposits / advance payment depends on the contract and parties. |
Security will cover the EPC Contractor’s performance under the EPC Contract for the full scope of works. Advance payment security required for 100% of any advance payment. |
| Parent company guarantee (PCG) | Whether this is required or market depends on the contract and parties, and will only cover the relevant supplier / contractor’s performance under its contract only. |
It is market standard for developers to receive a PCG covering the EPC Contractor’s payment and performance obligations under the EPC Contract. |
| Liquidated damages (LDs) | Separate liquidated damages for each supplier/contractor’s scope. LDs rates and LDs caps may be lower than those accepted by an EPC contractor (individually and in the aggregate). |
The EPC Contractor will be liable for liquidated damages for delays to completion and shortfalls in guaranteed performance of the whole project, subject to caps. |
| Limitations of Liability | Separate limits for each supplier / contractor which can be negotiated on a case-by-case basis. |
A higher aggregate limitation of liability, as based on the EPC Contract price. |
Key risks and potential solutions for developers
Below we identify several key risks of split contracting and potential solutions for developers.
Key risk 1: Interfaces
Risk: No single contractor is responsible for the entire project. Contractors / suppliers will often not take the risk of delays caused by other contractors / suppliers. This can be complicated by issues related to battery degradation and storage requirements.
Solutions for developers
- Maintain a detailed project program, including the activity of all contractors involved. When a project needs to split the scope of work among multiple contactors, provisions in the separate construction contracts can be drafted to fill in the gaps caused by such splitting.
- If possible, coordinate milestones and liquidated damages regimes across contracts to cover critical path impacts on other contractors.
- Ensure contracts include divisions of responsibilities which set out works and program interfaces and activities. Ensure contractors allow for these interfaces and coordinate and avoid delays to other contractors' / suppliers' scope of work.
- The scope of work under each contract must, when reviewed as a whole, cover the full scope of the project. It may be appropriate to allocate any residual scope to the balance of plant contractor.
Key risk 2: Technical Integration
Risk: Incompatible equipment and software that does not work together as an integrated system.
Solutions for developers
- Use proven designs and equipment to reduce technology risk and expense from troubleshooting issues.
- Engage a trusted third party integrator to integrate the BESS components in a tested and proven manner.
- Engage a technical advisor / engineering consultant, from the initial stages of project development, who can provide expertise necessary to review specifications and advise on the technology integration.
Key risk 3: Implementation / project delivery
Risk: Implementation risk can test a developer's ability to manage contracts during the design and construction phase. Developers implementing a split scope procurement approach must consolidate design and delivery schedules, create consolidated progress reporting, address flow on impacts between contractors, and manage multiple contractors at the project site.
Solutions for developers
- It is critical in BESS projects for the developer to have enough capacity to run multiple agreements, manage multiple contractors and address the impacts of individual contractor failures to perform.
- Strong developer control can help mitigate implementation risks. If the developer lacks the resources itself to do the job properly, then it should bring in third party consultants to manage these activities for it.
Where to from here?
The shift towards split contracting models for BESS and other renewable energy projects will continue as contractors in the Australian market are increasingly unwilling to accept the risks associated with EPC contracts, and as developers seek to lower the cost of their projects and enhance flexibility, control and risk management.
This trend indicates a broader move towards project modularisation, where each component of a complex project is handled by a specific expert. A good example is offshore wind projects in Europe and Asia, where it is common now to see developers enter into a large number of separate contracts with specialised suppliers / contractors. We expect future projects to continue leveraging this model to drive efficiencies, save costs and manage the risk allocation across the contracting parties.
However, split contracts require careful management of the complexities and risks involved in coordinating multiple contractors and suppliers. Financing considerations, such as concerns around interface risks, operational risks and warranty coverage, will continue to influence the adoption of the split contracting module within the Australian market.
We expect that the EPC model will remain important in the Australian market given these challenges and while there remain several strong EPC contractors currently actively tendering for and constructing BESS projects.
As the renewable energy sector in Australia evolves, further innovations in contract procurement and management strategies will emerge, many borrowed from more mature overseas markets. Similarly, as more experienced and specialist suppliers and contractors enter and gain experience in the Australian BESS market, this will increase options available to developers and help overcome key risks in split contracting.
Norton Rose Fulbright is at the forefront of the energy transition and renewables project development. Complemented by in-depth knowledge of the Australian market, we will draw on our global expertise and experience to facilitate the delivery of your strategic BESS projects.
Please contact us for more information on how we can assist.
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