PV Performance Guarantees (Part 1): Page 4 of 8
Inside this Article
The EPC contractor. As a rule, EPC contractors are intimately familiar with evaluating contracts as they pertain to getting things built. However, measuring plant performance over a long period of time and assuming responsibility for the possible associated damages is far from the norm.
The typical EPC contract has a definite beginning and end. For large-scale solar projects, this duration is usually a little over a year. PV performance guarantee structures ask the EPC provider to extend contractual obligations for several times that duration. EPC contractors are accustomed to designing solar farms, building them, proving that they operate properly and then moving on to another project. In fact, all of the business structures for an EPC contractor—from design work through commissioning— are organized in this manner: beginning (the notice to proceed), middle (the work), and end (final payment and turnover). The PV performance guarantee is a distinct departure from this simple, predictable model.
While EPC contractors are not afraid of risk, they may not know how to evaluate or estimate it well. When this is the case, they are likely to evaluate project risk on the high side. EPC contractors can mitigate risk associated with system design and construction, but they cannot control the weather. Therefore, contractual conditions that assess damages based on climate data are often unacceptable to them.
From the contractor’s perspective, there is a nearly incalculable risk associated with quantitatively comparing sitemeasured system output data with historical data. In other words, they avoid putting themselves in the position of having to hit a MWh goal irrespective of the weather. They do not want to do this because they cannot predict the weather. If the assessed liquidated damages have anything to do with a less sunny year than normal, then a prudent EPC contractor is probably going to pass on the project. From the contractor’s point of view, a PV performance guarantee must be structured so that a relatively simple approach can be taken to assess the risk it is contractually obligated to assume.
Concepts and Calculations
The complexity of PV performance guarantee approaches can sometimes overshadow the intent of the agreement. Performance guarantees should not be structured to sell projects; they should be structured to ensure that systems work as intended. It is critical that all parties understand their responsibilities. In other words, it needs to be clear what risks are being mitigated and by whom. The keys for successful negotiations are establishing clear rules, formulae and responsibilities; determining consequences of nonperformance; and limiting liability. As a general rule, the parties closest to the risk should be responsible for the risk.
It is also important to understand the constraints of the plant monitoring data. For example, most PV systems have a monitoring system that has technical restrictions on the type, accuracy and granularity of the data collected. This can directly affect the ability to calculate or prove system performance, or the methods used to do so. When making decisions about what to measure and how, it is advisable to get input from all team members responsible for these activities in order to accurately weigh the cost and benefit of monitoring, reporting and measurement validation. The degree to which a plant must be measured is analogous to the expectations of the performance guarantee. Nearly constant monitoring is required to keep everyone informed with the appropriate data. The owner, developer and contractor must know how the asset is performing in order to mitigate having to pay damages.
The duration of the guarantee can help reduce the administrative and payment risks associated with proof of performance. The longer the term, the more flexibility there is to cure or fix the problem; however, a longer term also broadens the contingent liability. It should be clear who requires or prepares documentation to determine if and how payout for damages is to be made. The beneficiary of the guarantee is typically the system owner but not always. Sometimes a third-party investor is the downstream beneficiary.
Determining meaningful measures of performance is one of the most challenging aspects of contract negotiation. While there are many standard assumptions and models, the global financial markets have continued to tailor the required measures of performance for each set of underwriting needs. These underwriting needs are specific to local incentives, feed-in tariffs or tax equity. For the US, performance guarantees are generally governed by the need to leverage the 5.5 years of potential tax recapture allowed under the Investment Tax Credit and ensure acceptable debt service levels.