Waste to energy – too much risk for too little reward?

April 2022 | SPECIAL REPORT: INFRASTRUCTURE & PROJECT FINANCE

Financier Worldwide Magazine

April 2022 Issue

On 21 January 2022, the Paris Commercial Court granted a request from CNIM Groupe (a French listed global equipment manufacturer and industrial contractor) for the opening of a safeguard procedure and, at the same time, the opening of a court ordered reorganisation procedure for its energy from waste (EfW) subsidiary CNIM Environnement & Energie EPC.

In a press release of the same day, CNIM Group cited: “cash flow difficulties sharply increased in the last quarter of 2021 due to new late penalties charged and delays in signing new projects. This situation makes it necessary to place CNIM Group under the protection of the Commercial Court due to the financial guarantees granted to the partners of the EPC division”. The collapse of CNIM Environnement & Energie EPC has led to the shutdown in the construction of a number of EfW facilities, leaving project sponsors and lenders searching for replacements, with subcontractors and suppliers unpaid.

Within days of this announcement, the sponsors of the Hoddesdon EfW facility (Bioenergy Infrastructure Group), located near London, announced their decision to mothball the facility following the termination of the engineering, procurement and construction (EPC), and operation & maintenance contracts (O&M). The Hoddesdon EfW Project reached financial close in 2015 with financing provided by a number of parties, including Foresight and the then UK government owned Green Investment Bank. This project was one of a portfolio of new EfW facilities developed using advanced gasification technology and supported by green subsidies, which only applied to advanced thermal treatment technologies developed in the UK.

These are not the first or the largest failures in the sector, which remains as the well-publicised failure of the Air Products Teesside waste gasification facilities at Teesside in the UK. These facilities were mothballed in 2016 and resulted in Air Products writing down a loss of between $900m and $1bn. They do, however, again raise questions for lenders and sponsors as to whether the risk profile of EfW projects is acceptable, and in particular, what can be done to mitigate against the risk of the failure of the technology and the EPC contractor.

So, what are the causes of these recent failures and how have the contractual mechanisms and security structures in the project documents responded to the challenges? Technology failure appears to be the root cause of the failure of several facilities, so either the technology does not process the fuel and waste at the volume required or in accordance with the required specification, or the facility is unable to operate reliably for the number of operating hours specified in contracts, which underpin the financial base case for the facility.

Technology risk is transferred by sponsors to the EPC contractor and is demonstrated by the facility being required to demonstrate, via performance tests set out in the EPC contract, that the facility will meet specified performance guarantees during the commission phase. The performance guarantees typically contain both pass and fail guarantees which the facility must pass in order to achieve takeover and for the full operation period to commence, and performance guarantees which if not met will require the EPC contractor to pay liquidated damages to the project company to compensate for future loss of revenue or increased operating costs. Following the successful completion of the performance tests or the payment of any liquidated damages, the facility will enter full operation.

While operational risk will now transfer to the O&M contractor, the EPC contractor will typically remain on the hook if the facility does not meet the availability guarantee, measured over a period of six to 12 months. If the facility does not meet the availability guarantee, the EPC contractor will be required to resolve any issues or defects that are causing any unplanned outages or shutdowns and to pay the project company liquidated damages to reflect the loss of revenues from waste gate/tipping fees and electricity sales.

Once performance has been demonstrated by the EPC contractor through these tests, risks are transferred to the O&M contractor via the O&M contract which will contain equivalent availability and performance guarantees to those in the EPC contract, with liquidated damages payable to the project company if these guarantees are not met on an annual basis.

So why, if the risk of performance and availability is transferred to the EPC contractor and then to the O&M contractor, are we seeing an increasing number of facilities fail or be mothballed by their owners? A common denominator in a number of these failed or mothballed projects is the contractual relationship between the EPC contractor and the supplier or owner of the technology, which includes the proprietary intellectual property that is crucial to the success of the project.

Many of these technology suppliers are relatively small in terms of turnover and balance sheet, having invested in developing their proprietary technology. They require partners to design and deliver the civils and mechanical and electrical works and deliver an ‘EPC wrap’ that can stand behind the performance and availability guarantees to the project company and to provide financial security in the form of parent company guarantees and performance and retention bonds.

The EPC contractor will undertake its due diligence of the technology supplier and seek to back-to-back its contract with the project company as far as possible, but ultimately if the facility is unable to deliver against the performance or availability guarantees it may not be able to recover its losses from the technology supplier. This is precisely what happened in 2016 when gasification technology supplier Energos entered a form of insolvency proceeding in the UK, leaving the EPC contractors on its projects to try and complete the projects or face termination of the EPC contract and claims from sponsors for the cost of completing the facilities and the delays incurred.

So far, we have looked only at risk issues that are clearly allocated to the EPC contractor or O&M contractor, such as technology risk. However, another root cause of the issues at a number of these facilities is the specification of the fuel delivered to the facility by or on behalf of the project company. This is typically a risk that is retained by the project company, which it will seek to back off in its fuel supply or waste supply agreements.

While traditional EfW technology based on a moving grate will generally accept black bag residual waste that does not require any form of pre-treatment, advanced thermal treatment facilities, including gasification plants, often require fuel and waste to be pre-treated to remove large items and produce a more homogenised refuse derived fuel (RDF). A specification for the RDF will be included in the EPC and O&M contracts and will contain minimum and maximum levels for moisture, calorific value, material size, as well as levels of heavy metals (mercury), chlorine and sulphur which may cause fouling or damage to the facility.

Where project companies are unable to supply fuel and waste that meets any fuel specification, it will be difficult to enforce performance and availability guarantees as the EPC and O&M contractors will argue that the cause of the failure is the fuel not being in accordance with the specification. This can lead to disputes and the renegotiation of performance guarantees to reflect the fuel and waste that is actually delivered to the plant versus the specification or the need for further equipment to be installed in order to meet the original performance guarantees.

Technology or fuel issues are not the only cause of failures and in the case of CNIM E&E, the projects that caused the reported financial losses (including the Earls Gate Project in Scotland and the Sharjah Project in the UAE) all utilise conventional EfW technology developed by CNIM and operated under licence. As an EPC contractor, CNIM, as with other EPC contractors in the sector, relies heavily on its supply chain or joint venture partners to deliver large elements of these facilities, including civils works and mechanical and electrical works.

As the civils works are at the front end of construction (including foundations and groundworks) if these are delivered late or not to the required standard, they can substantially delay the completion of the facility, triggering a risk of substantial liquidated damages for delay being payable to the project company, which it may not be able to fully flow down to its subcontractors or partners. This is what we understand happened to CNIM in 2020 when Clugston Construction collapsed into administration in the UK citing acute cashflow pressures as a result of onerous EfW contracts. Clugston had partnered with CNIM on a number of energy and waste projects.

So, in summary, what are the lessons parties should draw from these latest and previous failures? The failures highlight the importance of undertaking detailed technical, financial and commercial due diligence on partners that are critical to the delivery of these complex projects. EPC contractors need to be satisfied that if a key technology supplier gets into difficulty, they can access the IP and knowhow to complete the project if required. For project sponsors and lenders, it is to understand the interdependencies within the supply chain for the EPC and O&M contractors and how the parties would manage the failure or insolvency of a key supplier of equipment or process technology. Incorporating early warning measures into EPC contracts that alert the sponsors to potential issues with suppliers, including regular provision of financial information linked to the release of milestone payments, is advisable.

The positive news for the sector is that despite these failures, projects in the UK are still reaching financial close, with Enfinum recently reaching financial close on the Kelvin project in West Bromwich and Skelton Grange in Leeds, while Biffa, together with Covanta and Green Investment Group, are reaching financial close on the Protos EfW project in Cheshire. The interesting aspect of these three projects is they all feature different EPC contractors – Acciona (Kelvin), Hitachi Zosen Inova (Skelton Grange) and Mytilineous and Standardkessel Baumgarte (Protos).

James Snape is a partner at CMS Cameron McKenna Nabarro Olswang LLP. He can be contacted on +44 (0)20 7524 6804 or by email: james.snape@cms-cmno.com.

James Snape