One deal, two jurisdictions – interpreting competing jurisdiction clauses
The Court of Appeal has provided comfort to the derivatives market by giving a wide, commercial interpretation to an exclusive English jurisdiction clause.
Developers are focusing on what terms to put in new offtake agreements for energy storage facilities.
Many in the industry are starting with pro forma power purchase agreements designed to sell output from conventional or renewable power plants. While several provisions of these PPAs are appropriate for “plug-and-play” use in storage contracts, there are issues unique to energy storage that warrant special consideration. This article discusses 10 issues that deserve careful analysis when drafting offtake contracts for energy storage facilities.
Energy storage is exciting technology because it can perform multiple functions essential to the US electric system. It can operate as a generation resource, as energy load or a “sink,” and as a transmission and distribution asset.
As a consequence, many PPAs for more traditional generating facilities do not work properly given the intended use of a storage unit or else they lack flexibility to accommodate multiple uses. It is of paramount importance for the parties to a PPA to understand all the ways in which the storage system will be used. The rights to various services and products from the system must be allocated and appropriate compensation determined. Each service or product that will transfer under the PPA should be clearly defined. Similarly, services and functions that the seller will retain should also be clearly documented to avoid confusion (and litigation).
There are several energy storage models, each requiring different approaches to product definitions and performance parameters.
The most prevalent model appears to be storage combined with a solar project, where the two are treated as a single system. Therefore, the power contract covers both.
There is a natural synergy. The storage system, which is typically comprised of batteries, can charge from the solar system and then provide back-up electricity at times of no or low sunlight. The popularity of behind-the-meter solar systems located on the premises of net-metered host customers has also driven adoption of co-located storage systems. Under this model, the storage system is generally treated by the host customer as simply a part of the overall generating unit, and the pricing terms of the PPA are generally set at a per-megawatt-hour basis, regardless of whether electricity is coming from the solar panels or the storage unit. In other words, nothing extra is charged for storage.
Larger solar-plus-storage systems may specify rights to additional products from the system, such as renewable energy credits or certain ancillary services, but these are also generally treated as stemming from one integrated source, with solar playing the leading lady. In contrast, the Kauai project that Tesla developed in Hawaii reportedly relies on a PPA with a local cooperative for sales in the evening hours from batteries discharging energy captured from a co-located solar project during the day. The grid is too saturated during the day to be able to accept any of the solar energy.
We are beginning to see a rise in co-located storage plus other resource units where the generating facility and storage are treated like two separate projects. The products from the storage system in these instances may be measured and paid for separately from energy sales. Anyone drafting a PPA for this type of system must consider the extent to which the co-located systems should be treated separately or as one and what each party’s attendant rights and obligations are with respect to each system.
Aggregated behind-the-meter storage is another growth area. Storage can respond to grid needs relatively rapidly by charging to store excess energy or discharging to supply electricity. Certain markets permit companies to offer capacity from aggregated energy storage systems placed behind customer meters. The aggregated storage capacity is offered to the local utility. In such cases, the product is responsiveness rather than energy sales.
Another model is a stand-alone storage facility selling energy, capacity and ancillary services to the grid. Absent particularly lucrative products or government mandates, it remains difficult to bring stand-alone utility-scale storage to market under a PPA structure.
Small stand-alone storage systems such as Tesla’s “powerwall” are often purchased or leased outright without a PPA. The success of larger systems typically depends on a market for products other than electricity because storage is not yet economically competitive with other forms of pure generation. For example, flywheel storage units were built in both the New York ISO and PJM markets based on the value they were paid for providing regulation ancillary services in each market. Certain states also have policies that incentivize or require storage deployment. In California, for example, regulators ordered utilities to achieve a minimum amount of utility-scale battery storage capacity. Some corporate customers have expressed an appetite for storage that may result in above-market PPA prices. As with lucrative markets or governmental directives, this would require special circumstances.
There are mixed approaches to setting the term for energy storage PPAs.
Some forms of energy storage are considered to have a longer useful life than the related generating source. In a battery system, for example, individual batteries can often simply be replaced and the unit will carry on. This is marketed as a benefit that has value and may warrant a longer term than PPAs for other generating sources.
On the other hand, most energy storage resources are “unproven” technology, in that there has not yet been operating experience over the full life of a system and there are risks of the unknown. This may cause parties to look at shorter terms (and lenders to seek shorter financing terms), with the option to renegotiate as the technology advances and more data on operations can be collected.
Establishing the delivery term is more complicated if the storage system is co-located with other generating resources. The storage unit will often be ready to come on line much sooner than other resources and, as already mentioned, may have a significantly different useful life. A PPA for a combined unit may require separate delivery terms for various products and services depending on which resource will be the predominant provider.
The parties should determine whether the storage system will be expected to perform at a certain rate and, if so, what the penalty is for non-performance.
A seller may want to look to warranties to determine whether it has any recourse if the storage unit does not perform as anticipated. Because the technology is relatively new, it may be more challenging to guarantee performance as confidently as a seller may with another resource.
The seller should also understand how performance may be affected over time. For example, a battery storage system will typically degrade by some percentage each year until or unless the batteries are replaced. Certain factors may accelerate degradation, and it may be prudent to pre-assign liability if any of these factors occurs. The parties to a PPA will need to account for natural degradation in negotiating any performance guarantees, as well as the overall term of the PPA. Consideration should also be given to how the reduced performance of the storage unit may affect or correlate to the performance of any co-located generating resources.
Closely related to product and performance is determining who will have the authority to control the storage system.
Some offtakers intend actively to use storage systems rather than passively to purchase project output. For example, the buyer may want to deploy the system to reduce energy costs during peak hours or use it as a demand-response resource. The offtaker might also want to use the system to meet load obligations or to balance a distribution system that it operates.
The practicalities of which party will control the system, whether control will be on-site or remote, and what authority the other parties to the PPA have to step in are all key to this analysis. Secondary issues of access, liability, maintenance, and compliance with permits and other regulatory obligations should also be thought through. It may be that control rights change depending on the year of the term, the season, or even the time of day.
To tie back to the discussion of product, there is also the question of how the right to control the energy storage system is compensated, if at all.
Building on the concept of performance requirements and control is the need to comply with the manufacturer’s operating requirements for the storage system.
Some operating requirements are unique to storage. For example, most battery storage systems require a certain amount of “cycling” (charging and discharging) each day. The party controlling the unit will need to control the facility within these parameters. The other party should be aware of the requirement in order to manage performance expectations.
Operating storage outside of the manufacturer’s requirements could adversely affect the life and performance of a facility, as well as any outstanding warranties. It could also have safety and reliability impacts that could increase potential liability. It may be appropriate to account for any failure to comply with the manufacturer’s requirements in default and indemnity provisions.
Combining an energy storage system with other forms of generation may affect the tax status of the entire project. Many of these considerations have been discussed in prior NewsWire articles (for example, see “Batteries and Tax Credits” in the October 2016 NewsWire). How the storage system is combined with other resources and treated under the PPA will affect whether tax credits can be claimed on the entire project.
Accelerated depreciation and investment tax credits generally cannot be claimed on any equipment considered “leased” to a government agency or tax-exempt entity. It is helpful to say that the parties to the PPA intend it to be a “service contract” for federal income tax purposes, but this may not be enough if the PPA permits the offtaker substantial unfettered control over the facility. The analysis may also be harmed if the storage facility is on land leased by the offtaker and there are other factors that tend to support a finding that the facility is really being leased to the offtaker.
The expected useful life of the particular energy storage technology should also be considered in determining the term of the PPA. If a contract term is too long, there is the chance the offtaker will be treated as the tax owner of the facility. An asset that is dedicated for substantially its entire life and value to a single customer may be considered owned by the customer from inception. This is why typical solar PPAs are 20 years for solar panels so that the solar company can show it has retained a meaningful residual interest in the solar panels.
The type of technology is important to the charging analysis. A concentrating solar power project, for example, should factor in the risk of reduced sunlight available to charge the storage unit. This may be built into performance guarantees, force majeure events and default provisions. It may also appear in the form of restrictions on the offtaker from interfering with insolation and possibly maintaining vegetation if the project is on the offtaker’s premises.
The PPA for a battery storage system should specify charging parameters. If the battery is allowed to charge from the grid, when may it draw from the grid and at what percentages? The answer may have regulatory or tax consequences.
Moreover, the manner in which the energy used to charge the system versus the manner the output is measured will need to be determined. If the PPA offtaker is the same entity that is supplying the electricity to charge the system, the pricing mechanisms may need to be negotiated. The seller could end up paying more to charge the unit than the PPA price it receives for selling the product from the system.
The costs of some forms of energy storage systems such as batteries are declining. The rate of decline is expected to accelerate over the next few years. Nevertheless, the costs are still high and may remain high for new energy storage technologies.
There are several aspects of a PPA for energy storage technologies that are still in the developmental phase that should be considered. First and foremost is whether the PPA price will justify the cost of construction and operation. Will the cost of construction decrease by the time purchase orders will need to be submitted to meet the milestones in the PPA? May the term of the PPA be delayed if it becomes difficult or more expensive to procure construction materials? If the system will receive any federal or state funding under various incentive programs, there will probably be ongoing compliance requirements that the PPA parties must satisfy and that should be built into the contract.
Many early entrants into the energy storage space rely on stacked revenue streams to make the economics of developing the system work. For example, storage facilities are typically combined with tested resources that have proven production streams (such as solar, discussed above). The storage system may also sell multiple streams of products, such as energy and ancillary services or demand response. The PPA will need to be clear regarding the rights to each product and service if a single offtaker will not be entitled to all of the multiple revenue streams.
To date, there is a lack of clear precedent about how energy storage units are to be regulated under the Federal Power Act. The regulatory regime may influence how the system is used, the ownership structure, and how any co-located or integrated systems, such as solar resources, may also be treated in the PPA. (For more on regulatory implications, see “Solar + Storage: US Regulatory Issues” in the August 2017 NewsWire.)
There is also uncertainty about the scope of services and products that energy storage systems will be able to monetize during the term of a PPA. For this reason, it is important to incorporate flexibility into the PPA. The Federal Energy Regulatory Commission has taken steps to facilitate storage, including making it easier to interconnect storage systems. FERC has also proposed wholesale market rules to encourage storage, such as ensuring energy storage resources are eligible to provide all of the products they are capable of providing in organized wholesale markets. FERC has not taken further action in this rulemaking to date, but it has sparked considerable discussion about the many possible value streams of storage.
Energy storage is relatively new and such a different animal than other generation resources that we are sure to see new products and services unique to storage develop. There will invariably also be policy changes and changes in subsidies and incentives for both energy storage and any co-located generating facilities.
For these reasons, it is especially important for energy storage PPAs to address what happens if a revenue stream develops or goes away during the term, and which party has the risk or benefit related to such changes.
In the rooftop solar-plus-storage context, we frequently see the owner or developer retain the right to any new “green attributes” that may be awarded during the term. This makes sense where the host customer is not able to monetize new revenue streams. In contrast, a commercial and industrial offtaker may want to split the value of new revenue streams, and a utility offtaker may want to be able to claim all new facility attributes.
Along with who gets the new revenue streams is the question of how the parties are compensated. In some instances, PPAs contemplate splitting any increases in value stemming from new products or incentives. Other PPAs simply let the party claiming the new attribute also claim all of the additional revenue.
If a party has the potential to benefit from a new attribute, then it would make sense also to place the risk of the reduction in value on such party. Other PPAs bring the parties back to the negotiating table to reform the contract in the event there is a change of law that reduces the value of the product, especially when a substantial portion of the PPA value is at stake.
No one wants to think about early termination and it may be hard to imagine the end of a 20+-year contract term, but the PPA should contemplate these eventualities.
One benefit of certain types of storage resources is that they may be portable. For example, a battery can be moved to another location to be used by another offtaker more readily than a generating facility can be moved. It is important to specify when the right is triggered and which party must pay for the removal and any damages. Alternatively, the seller may want the right to leave the equipment in place and sell products and services to a nearby third party or market in an event of offtaker default or an extended force majeure event.
Many PPAs include purchase options at set times and upon termination of the PPA. Any purchase option is usually at fair market value at time of purchase. It may be difficult to predict the future value of unproven technology. For that reason, it may be necessary to include certain floor prices for the system that ensure the seller can satisfy any debt obligations in the course of selling the facility.
Once a storage device has reached the end of its useful life, it will need to be discarded or recycled in some fashion. The proper disposal techniques and related costs may be relatively uncertain and higher for novel storage technologies. Nevertheless, the cost of properly disposing of the system should be factored into overall project economics.
The Court of Appeal has provided comfort to the derivatives market by giving a wide, commercial interpretation to an exclusive English jurisdiction clause.