FEATURE / Renewable Energy in recent deals are ( 1 ) procuring all project works under a single , lump-sum turnkey construction contract , and ( 2 ) obtaining bonds from the construction contractor which are ( among other things ) back-to-back with the developers ’ bonds ( bid bonds or subsequent development bonds ) in favour of the procurer / offtaker . Unfortunately for contractors that have signed up to this market accepted practice , they have effectively committed to developing projects which , with every day , are increasingly more expensive to execute .
To put this into perspective , on one occasion we were told by a contractor that inflation in the last two years has hit an unbearable level : steel and copper rising by 55 per cent , aluminium by 50 per cent , silicon materials , required for the manufacture of photovoltaic modules , by a 270 per cent , and logistics escalating in price by 700 per cent . We cannot confirm the veracity of these claims , but if they are half true , the picture is pretty bleak , particularly since it does take on average 18-24 months to close a renewables deal tendered under a competitive bid .
WHY SHOULD WE ALL CARE ? The fact that no one had anticipated this inflationary environment is now resulting in considerable pain in the renewables market which no stakeholder should ignore . While developers and procurers might conceptually be shielded from this issue by virtue of robust , wrapped , construction subcontracting , the reality is that contractors cannot execute works at cost , or worse still at a loss , for an extended period . There will come a point , if it hasn ’ t arrived already , at which contractors will weigh the loss of a bid or performance bond being called as less severe than to develop a project which is firmly in the red . After all , why throw more good money after bad !
This may have a damaging consequence on the market .
Firstly , if contractors continue to lose money on existing deals , the likelihood of their exit from the market increases . Some may even go insolvent , in which case the market will be left with even lower levels of supply in relation to escalating demand for renewables deals .
Secondly , even if developers and procurers / offtakers are contractually protected in relation to contractor default or underperformance , the resultant insolvency or walk-away by contractors may lead to stranded incomplete assets , potentially poorly manufactured primarily because of the contractors ’ desperate attempt to keep to budget , and are thus wholly unfitted for the long-term performance that they are meant to deliver .
Thirdly , the inflationary burns suffered by contractors and other stakeholders will leave a scorched market which might require considerable amount of time to recover . In the very least , the glorious record-breaking prices previously set by Middle Eastern renewables deals might be replaced by significantly more expensive assets .
THE COUNTERINTUITIVE UPSIDE However , therein might also lie the benefit . Developers and contractors alike have for years been complaining of diminishing margins in the face of a hypercompetitive ( race to the bottom ) market . Perhaps the exit of some speculative stakeholders who had previously bet on continuously decreasing cost of development and relaxed legal structuring will open the market to a more a balanced model . Imagine a new wave of deals which will be commercially rational and legally sound – now that doesn ’ t sound all that bad !
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Text by : 1 . ANDREJ KORMUTH , partner , Bracewell Dubai 2 . ADE MOSURO , senior projects lawyer , Bracewell Dubai theoath-me . com • the Oath 19