Construction and renewable energy projects: transition in the energy transition

December 2023 | EXPERT BRIEFING | SECTOR ANALYSIS

financierworldwide.com

In the run up to the 28th UN Conference of the Parties to the Climate Change Agreement (COP28) in November and December 2023, it is important to reflect on present challenges, as well as opportunities, in renewable energy. From inflation-fuelled prices halting some new and existing projects – causing share price pressures for certain listed players – to governments, as well as private funders, moving the goal posts on funding, several challenges have arisen for an industry also dependent upon new technologies that can still have unexpected issues in the development and deployment phases.

Alongside these issues, the landscape of disputes in the sector is continuing to evolve and requires constant attention, as do expanding opportunities in some markets that continue to forge ahead with support for renewable energy, which still sits front and centre in the world’s response to the long-term threat of climate change.

Funding pressures

In the UK, the developer of the Norfolk Boreas offshore wind power project announced in the summer that it would stop developing a major offshore wind farm and would review its participation in the 4.2GW offshore zone. Some of the reasons cited by the developer included high inflation and capital costs that were said to be affecting the entire energy sector, with costs increasing for the relevant project by up to 40 percent. Reference was also made to the geopolitical situation that has made offshore wind and its supply chain particularly vulnerable. It certainly appears that, from Russia’s invasion of Ukraine, to cooling relations between the US and China, as well as recent conflicts in the Middle East, the global geopolitical situation shows little sign of immediate improvement.

It follows that these problems are not confined to the UK or Europe. In the summer of 2023, a major developer announced similar issues were affecting offshore wind projects in the US, particularly the Sunrise Wind offshore project in New York and the Ocean Wind 1 project off the New Jersey coast. In each case adverse impacts relating to supply chain, high interest rates, and an absence of tax credits at a level necessary to offset project costs were confirmed to the market as negatively impacting the projects. The impact on one of the developers was immediate in terms of around a 25 percent share price tumble in late August 2023, even though it confirmed the US offshore wind market remained attractive in the long-term. These kind of share price falls have occurred to many renewable energy stocks in 2023, with the S&P Global Clean Energy Index down around 30 percent for the year.

Government commitments meet reality

That the US market remains attractive in the long term to many renewable energy market participants is doubtless in no small part due to the current US administration’s Inflation Reduction Act (IRA), which was passed just over a year ago and contains $369bn in renewable energy incentives.

Even so, promised incentives are not always enough to offset sudden price shocks, either in delays to the supply chain or unexpectedly high interest rates. Those costs have been significant recently and erode long term cost recoveries over the life of a project. This appears to remain an issue for New York’s Sunrise Wind project, as in October 2023 the responsible New York state regulator rejected the project’s bid (and that of other developers) to charge more under future power sale contracts in inflation adjustments and other cost increases.

While the New York state government was also quick to announce an updated plan supporting the renewable energy industry, the UK’s recent experience shows that power prices are a critical component and must keep pace with inflation. This year in the UK, the national government’s latest regular subsidy auction failed to attract any bids for offshore wind projects, in what amounted to a hit to the country’s attempts to reach net zero by 2050. Offshore wind in the UK is targeted to supply 50GW by 2030, compared with 14GW today, as part of what has been described as the backbone of the future energy system. Like New York, the UK government was quick to talk-up its renewable energy credentials after the failure to attract any offshore wind bids. The absence of any bids, however, speaks volumes about the project pipeline impact that can occur when the market’s long-term pricing needs are not met.

Technology disruptions

One area where finance questions as well as renewable energy technology questions have converged is green hydrogen, with some investors having gone so far as to question the utility of hydrogen altogether. Among the concerns expressed have been the high capital cost and the need for constant power input to maximise hydrogen output in circumstances where constant power cannot always be generated by all renewable energy sources.

One of hydrogen’s biggest potentials is as a clean fuel in processes which cannot be easily electrified, such as steel manufacturing, and so hydrogen remains a significant piece of the puzzle to reducing emissions. Japan was the first country to create a national hydrogen strategy in 2017 and has recently agreed a new plan to generate $107bn of public and private funding for hydrogen power over the next 15 years.

In the US, the IRA is still seen as a game changer for green hydrogen, although there are calls for greater clarity on the legislation’s section 45V clean hydrogen production tax credit, particularly in circumstances where weak standards for the credit could potentially increase greenhouse gas emissions. These issues tend to arise because most of the hydrogen produced today is produced using carbon-heavy fuel sources and that must be eliminated if the IRA and green hydrogen are to have the much-needed environmental role of reducing emissions.

More conventional technology issues are also impacting the final mile of renewable energy projects, including delays in connection to regional and national electricity grids. As part of the energy transition, large energy powerhouses are being replaced by smaller, more numerous renewable projects, some of which now face extreme waiting times to get connected to the central grid. In the UK, this has increased to years for some projects, due to delays being experienced by the National Grid.

While the situation may not be as delayed in Europe, a report recently published by Eurelectric, the energy sector association in the European Union (EU), nonetheless stressed that investment in the EU electricity grid must be 8 percent higher until 2030 in order to accommodate decentralised power generation and reach sustainability goals.

New fronts and disputes in the energy transition

The stability and profitability of all participants in the energy transition is essential to tackle the challenge of climate change and build a credible net zero energy future. If construction and energy power contracts do not ensure that current and foreseeable risks are borne by the party best positioned to manage and mitigate them, disputes are all but guaranteed to arise.

While the headlines of those disputes are well established, including escalation, delay, poor performance, defects, force majeure and misrepresentation claims, the outcomes will be unpredictable for the unprepared. Financial distress will inevitably drive participants to adopt hardline positions that will make disputes even more intractable, particularly if participants are facing their own share price pressures and potential financial and shareholder claims that can arise as a result. Of course, this says nothing of the lost opportunities that can result when participants simply withdraw from the market, as happened recently during the UK’s offshore wind auction and may happen in the US if power purchase prices cannot rise to offset project cost increases.

The renewable energy industry requires rapid expansion to meet the challenge of climate change in the time remaining to do so, such that there is no merit in any strategy that simply holds existing participants to old prices and expectations. This only has the potential to cause market failure and disputes that will jeopardise global commitments to net zero emissions goals. It is therefore hoped that COP28 will result in a renewed commitment by national governments and key global participants to a sustainable renewable energy transition.

Adam McWilliams is a partner and Miles McCollum is a legal assistant at Quinn Emanuel Urquhart & Sullivan UK LLP. Mr McWilliams can be contacted on +44 (0)20 7653 2052 or by email: adammcwilliams@quinnemanuel.com.

Adam McWilliams and Miles McCollum

Quinn Emanuel Urquhart & Sullivan UK LLP