Coal, Gas

Minding the Gap

Issue 6 and Volume 109.

As new generation projects enter the planning stages, owners who coordinate negotiations for turbine purchase and long-term service agreement can increase their leverage and reduce their risk.

Former British Prime Minister Benjamin Disraeli once warned that “the most dangerous strategy is to jump a chasm in two leaps.” If this advice is true anywhere, it is true in the world of power plant development, where prudent strategic planning can make the difference between the “Owner” power company’s leaping to solid ground or leaping into the chasm. However, when it comes to negotiating the contracts that will support the construction, operation and maintenance of a project, prudent strategic planning can often be eclipsed by other practical realities.

Separating negotiation of an owner’s turbine procurement agreement (TPA) from the negotiation of the long-term service agreement (LTSA) for the turbine is one example. It might be a separation of time – TPA first and LTSA second as well as a separation of people who are involved in these matters. The result can be that one team doesn’t know what the other is doing. Several issues can drive such a separation. It might be a tight deadline to purchase the turbine coupled with the perception that there is no time at present to negotiate the LTSA. Perhaps there is the belief that the LTSA need not be in place until the plant’s commercial operation date. Related to this may be the valid premise that time only increases the competitiveness and maturity of the non-OEM vendor LTSA products hitting the market.

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Another factor may be that there is an intra-company division between teams who deal with construction, and the teams who handle operations and maintenance issues. Finally, where a turnkey engineering, procurement and construction (EPC) contract approach has been selected to deliver the project, the owner can find itself contractually separated from the details of the TPA because it will be a subcontract of the EPC. It is in this case particularly – where the owner may not even be dealing directly with the OEM – that separation of the TPA and the LTSA can become exacerbated.

All these factors can separate the negotiation activity sequence and the teams undertaking the negotiation of an owner’s TPA and LTSA. This separation, for reasons that will become apparent, can be tantamount to jumping the chasm in two leaps. Instead, a nimble owner will consider negotiating its TPA and its LTSA simultaneously and with the same team. There are at least two main reasons why an owner should adopt this strategy.

Negotiation Leverage If properly played, at no time does an owner have greater leverage than when selecting its turbine vendor. Unlike the great turbine rush of the late 1990s, today’s market undoubtedly belongs to the owners. Competition for sales and growth among turbine vendors continues to get tougher. A prudent owner will realize this and take advantage of the negotiating leverage this competition creates. Even if the owner is seriously considering a non-OEM LTSA vendor, introducing all parties into the competitive process at the early stages of project development will be advantageous.

Coordinating COD Crossover Issues A second reason for simultaneous and consistent LTSA/TPA negotiations is that the owner will be able to address key issues that interrelate between the LTSA and the TPA. Given that most of these issues bridge the commercial operation date (COD), the general connection point between the end of the TPA and the beginning of the LTSA can be considered “COD crossover issues.” The following sections describe a few of the many COD crossover issues. For the sake of illustration, these examples hypothetically assume different and uncoordinated TPA (or perhaps EPC if a turnkey EPC is envisioned) and LTSA teams negotiating documents separately and at different times.

Situation: Warranties on Initial Spare Parts

Separated Approach: Certainly it’s prudent for an owner to have a set of initial spare parts in stock prior to turbine startup. Consider the hypothetical situation where the TPA team decides to purchase these parts under, or concurrently with, the TPA perhaps as a final OEM deliverable. The OEM only offers a limited warranty for the parts that will expire 18 months after parts delivery, and the parts are delivered just prior to startup. Perhaps as a matter of luck, they are not used then. Instead, they sit on the shelf and await the day when they will finally be sourced for the first combustion or hot gas path inspection months or years later.

But by that time their warranty will have expired. Meanwhile, the LTSA team negotiates a deal with the OEM, or even with a non-OEM, whereby the warranty coverage only applies to parts actually provided under that contract and not the initial spares. Thus, when the initial spares get put into the turbine, they are in no-man’s land – a place with no warranty coverage.

Coordinated Best Practice: Simply put, a coordinated TPA/LTSA effort that is mindful of this COD crossover issue can eliminate this risk by assuring the initial spares are covered by either an extended warranty under the TPA or a pick-up warranty under the LTSA.

Situation: Pre-COD/Post-COD Product Improvements

Separated Approach: As another hypothetical, assume that the TPA team decides to procure the turbine through an EPC contract. And assume that the criteria for acceptance include the standard fare: a turbine that meets the required levels of output, heat rate, emissions and noise. No mention is made of compliance with any updated engineering improvements published by the OEM, such as improvements that may be announced via technical information letters, engineering change notices or product improvement bulletins. Meanwhile, the LTSA team negotiates a deal whereby the LTSA contractor’s scope is limited to traditional planned maintenance.

So, what happens when, after COD, the OEM issues letter, after notice, after bulletin requiring work on the turbine to correct fleet-wide issues? In this scenario, the owner must pay for such improvement work à la carte, including work to correct problems with the turbine covered by improvement publications issued prior to COD.

Coordinated Best Practice: A coordinated TPA/LTSA effort can tackle this COD crossover issue head on, by negotiating to transfer this risk to the OEM consistently under both contracts. For example, an owner might structure the TPA so that, as a condition of acceptance of the turbine, the OEM must have completed all work recommended by those improvement publications published prior to COD. At the same time, the owner might structure the LTSA to include full coverage for all product improvement recommendations published after the COD.

Situation: Pre-COD Hours/Starts

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Separated Approach: As a final hypothetical, assume that the LTSA team structures compensation under the LTSA based upon a payment of dollars per operating hour and/or per turbine start. During startup, the OEM puts three times the normally anticipated number of hours and starts on the unit in a troubled effort to bring the turbine online. A month later, the bill that arrives under the LTSA is equally as excessive, hitting the owner’s budget and bottom line. Of course, the hypothetical TPA team, only concerned with reaching commercial operation, never thought to address the hours/starts issue in that document.

Coordinated Best Practice: Perhaps this COD crossover issue could have been addressed under the LTSA alone. But given the retrospective nature of an LTSA in this context, the OEM may have low limits on how much risk it is willing to bear for excessive pre-COD hours and starts under the LTSA. Moreover, a non-OEM LTSA provider will not likely be willing to take any pre-COD risk under an LTSA. Thus, an owner with a coordinated and prospective view of its TPA and LTSA documents will have an advantage, namely, knowing how pre-COD hours/starts under the TPA will impact payments under the LTSA. With this in mind, the owner may seek to shift the risk of excessive pre-COD hours/starts to the OEM under the TPA, rather than under the LTSA.

Assuming that under the TPA the OEM will have control over the turbine prior to COD, this means that the OEM is better situated to manage and control this risk. And consequently, the owner is in a strong position to argue that the OEM should bear more risk in this area under the TPA than it would under the LTSA.

Making the Jump in One Leap

As outlined here, when an owner coordinates LTSA and TPA negotiations from both time and team standpoints, it can leverage its strong negotiating position to drive more favorable LTSA terms and also ensure that COD crossover issues are properly covered by the contracts. Although some people might not be surprised by this conclusion, they would be surprised at how often these negotiations become separated.

As has been discussed, there are many reasons why this happens, including the owner’s frequent desire to enter into a turnkey EPC contract for project delivery. This can separate the owner from the TPA negotiating process. Although separate negotiations cannot always be overcome, a prudent owner can almost always find a way through thoughtful strategic planning.

What You Need To Do

Owners might consider the three-phase approach (detailed in Figures 1, 2 and 3) as a guideline for coordinating LTSA and TPA negotiations. This approach assumes the owner wishes to have a full-wrap, turnkey EPC contract and also assumes a single, well-coordinated project development team. Finally, it assumes that after COD, the owner will operate the turbine itself. It should be noted that these three phases represent one of several approaches to conducting coordinated LTSA/TPA/EPC negotiations. Several variations of this approach may make sense, based upon relevant circumstances. p

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Author: Richard E. Thompson II is a partner with Troutman Sanders LLP. As part of the firm’s Energy and Project Development and Finance practice groups, he represents energy companies in matters worldwide.