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James BookerJames BookerVice President, Operations & Project DevelopmentVice President, Operations & Project Development

PT Paiton Energy, IndonesiaPT Paiton Energy, Indonesia

Minimising Risk in NegotiatingMinimising Risk in NegotiatingEnergy ContractsEnergy Contracts

energy riskenergy risk& & insuranceinsurance

2020--22 November 2006, Kuala Lumpur, Malaysia22 November 2006, Kuala Lumpur, Malaysia

Contractual StructureContractual Structure –– Power PlantPower Plant

LendersLenders

Operator

ConstructionContractor

Fuel Supplier

OfftakerOfftaker

GovernmentGovernment

SponsorsSponsors

Project CompanyProject Company

Fuel Supply Agreement

Power Purchase Agreement

Guarantee or Support Facility

Loan Agreements

O&M Contract

EPC Contract

Shareholding

Flow of Funding Flow of Funding –– Power PlantPower Plant

Project Company

Offtaker

Sponsors

Lenders

Operator

Construction Contractor

Fuel Supplier

Equity

Return on Investment

Tariff

Fuel Cost

Debt

EPC Price

O&M Fees

Debt Service

Risk IdentificationRisk Identification•• What is Risk?What is Risk?–– The Oxford Dictionary defines ‘risk’ as:The Oxford Dictionary defines ‘risk’ as:

•• The possibility of danger, loss, injury, or other adverse The possibility of danger, loss, injury, or other adverse consequencesconsequences

•• What can be done about it?What can be done about it?–– In a perfect world one would negotiate risk as far In a perfect world one would negotiate risk as far

away from oneself as possibleaway from oneself as possible»» BUT…BUT…

–– This isn’t Utopia This isn’t Utopia –– so risk is allocated to the party so risk is allocated to the party that is best able to bear it (or will accept it that is best able to bear it (or will accept it –– which is which is not always the same thing!!)not always the same thing!!)

“Living at risk is jumping off the cliff and building your wings on the way down.” – Ray Bradbury

Risk IdentificationRisk Identification•• In private power generation projects all In private power generation projects all

stakeholders face risk stakeholders face risk –– and all parties and all parties want to shift risk onto others’ shoulderswant to shift risk onto others’ shoulders

•• Principal stakeholders:Principal stakeholders:–– Project Company (and behind, shareholders)Project Company (and behind, shareholders)–– Offtaker (state utility)Offtaker (state utility)–– Lenders (Lenders (ECAsECAs, multi, multi--laterals, commercial)laterals, commercial)

•• Lenders have the greatest leverage to Lenders have the greatest leverage to move risk onto othersmove risk onto others

“A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain.” – Mark Twain

Risk IdentificationRisk Identification

•• ConstructionConstruction–– Completion RiskCompletion Risk–– Engineering RiskEngineering Risk–– Force Force MajeureMajeure

•• OperationalOperational–– SupplySupply–– MarketMarket–– OperationsOperations–– EnvironmentalEnvironmental–– InfrastructureInfrastructure–– Force Force MajeureMajeure–– PoliticalPolitical–– LegalLegal–– ForexForex/Interest Rate/Interest Rate

Two Phases of ConcernTwo Phases of Concern

Allocation & ManagementAllocation & ManagementConstructionConstruction

•• Completion RiskCompletion Risk–– Project not completed on time and/or Project not completed on time and/or

within budgetwithin budget–– Project Developer risk but partially Project Developer risk but partially

allocated to EPC Contractor & Insurersallocated to EPC Contractor & Insurers–– Management:Management:•• Completion Guarantee Completion Guarantee –– additional equityadditional equity•• Lump Sum Turnkey PriceLump Sum Turnkey Price•• Liquidated Damages Liquidated Damages –– delaydelay•• Warranty passWarranty pass--throughthrough•• DelayDelay--InIn--Startup InsuranceStartup Insurance

“Risk comes from not knowing what you’re doing.” – Warren Buffett


•• Engineering RiskEngineering Risk–– Risk of failures in analysis, technology Risk of failures in analysis, technology

and/or equipment specificationand/or equipment specification–– Project Developer risk but mostly allocated Project Developer risk but mostly allocated

to EPC Contractorto EPC Contractor–– Management:Management:•• Liquidated Damages Liquidated Damages -- PerformancePerformance•• E&O Insurance (but seldom sufficient cover)E&O Insurance (but seldom sufficient cover)•• Independent Engineer (Lenders)Independent Engineer (Lenders)•• Owner’s Engineer/RepresentativeOwner’s Engineer/Representative


•• Force Force MajeureMajeure RiskRisk–– Acts of nature Acts of nature –– fire, flood, seismic, etcfire, flood, seismic, etc–– Acts of man Acts of man –– strike, theft, accident, etcstrike, theft, accident, etc–– Risk mainly on Project DeveloperRisk mainly on Project Developer–– Management:Management:•• Insurance (acts of nature & certain acts of man)Insurance (acts of nature & certain acts of man)

–– Construction/Erection All RiskConstruction/Erection All Risk–– DelayDelay--InIn--Startup/Advance Loss of ProfitsStartup/Advance Loss of Profits–– Marine CargoMarine Cargo–– Third Party LiabilityThird Party Liability

“Never try to walk across a river just because it has an average depth of four feet.” - Milton Friedman

Allocation & ManagementAllocation & ManagementOperationalOperational

•• Supply RiskSupply Risk–– Interruption or failure in fuel supply chainInterruption or failure in fuel supply chain–– Project Developer risk for supply, but price Project Developer risk for supply, but price

risk allocated to risk allocated to OfftakerOfftaker–– Management:Management:•• LongLong--term contracts with established suppliersterm contracts with established suppliers•• Fuel cost passFuel cost pass--through in PPAthrough in PPA•• Fuel reserves adequate for loan tenureFuel reserves adequate for loan tenure•• QAC Suppliers (Failure of Primary Suppliers)QAC Suppliers (Failure of Primary Suppliers)•• Independent Fuel Advisor (for Lenders)Independent Fuel Advisor (for Lenders)


•• Market RiskMarket Risk–– Demand for power reduced or interruptedDemand for power reduced or interrupted–– Risk allocated to OfftakerRisk allocated to Offtaker–– Management:Management:•• TakeTake--asas--delivered contract (PPA)delivered contract (PPA)•• Capacity payment covers debt & equity Capacity payment covers debt & equity providedprovided plant is availableplant is available•• Adjustments Adjustments –– escalation, benchmark, indexes, escalation, benchmark, indexes,

fixed pricefixed price

“If you’re not a risk taker, you should get the hell out of business.” – Ray Krok


•• Operating RiskOperating Risk–– 3 components 3 components –– technical; cost; technical; cost;

managementmanagement–– Project Developer risk, mostly allocated to Project Developer risk, mostly allocated to

EPC & Suppliers, O&M Contractor and EPC & Suppliers, O&M Contractor and OfftakerOfftaker

–– Management:Management:•• Liquidated Damages for Performance Liquidated Damages for Performance –– (EPC)(EPC)•• Equipment/technology warranties Equipment/technology warranties –– (Suppliers)(Suppliers)•• Fuel cost passFuel cost pass--through through –– ((OfftakerOfftaker))•• Inflation adjustment Inflation adjustment –– ((OfftakerOfftaker))•• PerformancePerformance--linked O&M Contract linked O&M Contract –– (O&M (O&M

Contractor)Contractor)


•• Environmental RiskEnvironmental Risk–– 3 types 3 types -- emissions, catastrophe, locationemissions, catastrophe, location–– Project Developer riskProject Developer risk–– Management:Management:•• EIS/EIA by independent specialistEIS/EIA by independent specialist•• Technology/equipment warrantiesTechnology/equipment warranties•• Continuing reporting, revue & managementContinuing reporting, revue & management•• Catastrophe/disaster response planCatastrophe/disaster response plan

“Those who trust to chance must abide by the results of chance.” – Calvin Coolidge


•• Infrastructure RiskInfrastructure Risk–– Access to stable transmission grid and Access to stable transmission grid and

adequate fuel supplyadequate fuel supply–– OfftakerOfftaker risk for transmission gridrisk for transmission grid–– Fuel supply addressed under Supply RiskFuel supply addressed under Supply Risk–– Management:Management:•• OfftakerOfftaker commitment to ensure grid availabilitycommitment to ensure grid availability•• OfftakerOfftaker controls grid developmentcontrols grid development•• Capacity payment depends on Capacity payment depends on plantplant availabilityavailability


•• Force Force MajeureMajeure RiskRisk–– Acts of nature Acts of nature –– fire, flood, seismic, etcfire, flood, seismic, etc–– Acts of man Acts of man –– strike, theft, accident, etcstrike, theft, accident, etc–– Risk mainly on Project CompanyRisk mainly on Project Company–– Management:Management:

•• Insurance (acts of nature & certain acts of man)Insurance (acts of nature & certain acts of man)–– Industrial Special Risk/Boiler & MachineryIndustrial Special Risk/Boiler & Machinery–– Business InterruptionBusiness Interruption–– Third Party LiabilityThird Party Liability–– TerrorismTerrorism

•• Deemed dispatch in certain instances Deemed dispatch in certain instances –– ((OfftakerOfftaker risk)risk)

“Educated risks are the key to success.” – William Olsten


•• Political RiskPolitical Risk–– Risks essentially under the control of StateRisks essentially under the control of State•• War/Insurrection/Civil DisturbanceWar/Insurrection/Civil Disturbance•• Nationalization/Creeping ExpropriationNationalization/Creeping Expropriation•• Currency InconvertibilityCurrency Inconvertibility•• Terrorism & SabotageTerrorism & Sabotage•• Willful Breach of ContractWillful Breach of Contract•• Change of GovernmentChange of Government•• Change in LawChange in Law


•• Political RiskPolitical Risk–– Management:Management:•• Political Risk Insurance (PRI) cover to include Political Risk Insurance (PRI) cover to include

Confiscation, Expropriation, Nationalization, Confiscation, Expropriation, Nationalization, Deprivation (CEND) coverDeprivation (CEND) cover•• Commitment by Commitment by OfftakerOfftaker under PPA to convert under PPA to convert

local currency into debt currencylocal currency into debt currency•• Terrorism Insurance coverTerrorism Insurance cover•• Government Support FacilityGovernment Support Facility•• Investment Treaty or ICSID arbitrationInvestment Treaty or ICSID arbitration

“If a man’s gonna eat fried chicken, he’s gotta get greasy.” - Unknown


•• Legal RiskLegal Risk–– Project documentation does not work as Project documentation does not work as

anticipatedanticipated–– Risk to all stakeholdersRisk to all stakeholders–– Management:Management:•• Clear understanding of local legal regimeClear understanding of local legal regime•• Appropriate Governing Law for each contractAppropriate Governing Law for each contract•• Dispute resolution by international arbitrationDispute resolution by international arbitration•• Lawyers specializing in project development & Lawyers specializing in project development &

experienced in the region/countryexperienced in the region/country


•• Interest Rate RiskInterest Rate Risk–– Risk of hits to Risk of hits to cashflowcashflow due to increases in due to increases in

interest rates on debtinterest rates on debt–– Project Developer RiskProject Developer Risk–– Management:Management:•• HedgingHedging•• Currency SwapsCurrency Swaps•• BondsBonds•• Supplier CreditsSupplier Credits

“People of privilege will always risk their complete destruction rather than surrender any material part of their advantage.” – John Kenneth Galbraith


•• Foreign Exchange RiskForeign Exchange Risk–– Risk of mismatch between currency of Risk of mismatch between currency of

debt and operating costs, and currency of debt and operating costs, and currency of revenuerevenue

–– Risk allocated to Risk allocated to OfftakerOfftaker–– Management:Management:•• PPA terms provide for adjustments of tariff PPA terms provide for adjustments of tariff

components for changes in FXcomponents for changes in FX

Summary of Contract ClausesSummary of Contract Clauses•• PPAPPA–– Payment on availabilityPayment on availability–– Coal price passCoal price pass--throughthrough–– Inconvertibility protectionInconvertibility protection–– ForexForex adjustmentadjustment–– Escalation protectionEscalation protection–– Deemed dispatch for Force Deemed dispatch for Force MajeureMajeure–– Political risk protection (limited)Political risk protection (limited)–– International arbitrationInternational arbitration

“The laws of a state change with changing times.” – Aeschylus

Summary of Contract ClausesSummary of Contract Clauses

•• EPC ContractEPC Contract–– Lump sum turnkey priceLump sum turnkey price–– LDs for delay and performanceLDs for delay and performance–– Warranty assignmentWarranty assignment–– International arbitrationInternational arbitration

•• O&M ContractO&M Contract–– PerformancePerformance--linked bonus/penaltylinked bonus/penalty–– International arbitrationInternational arbitration

Summary of Contract ClausesSummary of Contract Clauses

•• Fuel Supply ContractsFuel Supply Contracts–– LongLong--term, renewableterm, renewable–– Expert determination in event of nonExpert determination in event of non--

agreement on price at renewalagreement on price at renewal–– Contract quantity sufficient for operationsContract quantity sufficient for operations–– “Plus” options“Plus” options–– No minimum take provisionsNo minimum take provisions–– International arbitrationInternational arbitration

“Don’t get it right, just get it written.” – James Thurber

External Risk ManagementExternal Risk Management

•• Government support/guaranteeGovernment support/guarantee•• InsuranceInsurance–– PRI cover through loan periodPRI cover through loan period–– Construction Construction -- CEAR, DSU, Marine Cargo, CEAR, DSU, Marine Cargo,

GLGL–– Operational Operational –– ISR/B&M, BI, GLISR/B&M, BI, GL

•• Owner’s RepresentativeOwner’s Representative•• Lender’s EngineerLender’s Engineer•• ICSID/IT protectionICSID/IT protection

Closing PointsClosing Points

•• Goal Goal –– efficient risk managementefficient risk management•• Practice Practice –– risk allocated on basis of strengthrisk allocated on basis of strength•• Improperly allocated risk impacts all partiesImproperly allocated risk impacts all parties•• Allocate risk to the party best able to manage Allocate risk to the party best able to manage

and bear such riskand bear such risk•• Ensure “back to back” implementation Ensure “back to back” implementation

between contractsbetween contracts•• Efficient risk allocation Efficient risk allocation –– successful, successful,

profitable project profitable project –– benefit to all partiesbenefit to all parties“Make fair agreements and stick to them.” - Confucius

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