The term “partnering” has been used extensively in the power generation services sector in an effort to differentiate service provider offerings as distinct and beyond the traditional supplier-buyer model. These “partnering” arrangements have a wide range of scope and risk transfers which attempt to align the interest of the parties but typically result in the owner assuming the majority of the financial risk.
Combustion Turbine Long Term Service Agreements (CT LTSA)
CT LTSAs typically provide a fixed price for a defined scope of work including a defined number of outage events. Risks assumed by the CT LTSA provider include capital parts life and repair fall-out replacements, capital parts repair cost, outage execution productivity and quality. Based on the CT LTSA provider fleet experience with parts and repairs, capital parts life risk can be priced into the CT LTSA thereby minimizing the risk to the provider. Outage execution risk can be effectively managed by the provider through training, outage procedures, personnel selection, job site management and quality control procedures.
CTLTSA provided services or component failures are considered insurable events and the risk is borne by the owner’s property insurance carrier. Typical CT LTSA contracts have a provision that mitigates some or all of the owner’s property insurance deductible if the failure is due to a defect in the parts or services provided under the CT LTSA. The risk to the CT LTSA provider can be mitigated through parts manufacturing design and quality control with a factor included in the CT LTSA pricing to reflect provider experience in parts or services failures. Risks are further mitigated by the performance of all of turbines in the service providers CT LTSA portfolio. Therefore, a prudently designed CT LTSA by a reputable provider would be expected to largely mitigate and compensate the CT LTSA provider for risk and financial exposure assumed in the CT LTSA. In this case, the CT LTSA provider is not assuming owner risk and controls or manages its own business risk.
The CT LTSA buyer enjoys a fixed and predicable price and cash flow for the scope of work provided and is not exposed to capital parts life and repairability risks nor to outage execution cost risk. The buyer is exposed to outage duration risk as well as turbine component failure risk well beyond the financial mitigation offered in the CT LTSA. A typical component liberation event can cost up to $15 million and require 3 months of forced outage. Even if a large portion of the property insurance deductible is funded through the CT LTSA and the property insurance carrier funds the rest of the restoration work, the owner is exposed to a “wait period” (a time-based deductible) before business interruption coverage begins. This can be 45 to 60 days or more during which time the buyer is not able to sell power, loses energy margin sales on the order of $8 million, must unwind natural gas futures contracts potentially at a loss, and may be exposed to power market spot prices to satisfy firm forward power sale contracts – an uncapped market risk. The buyer is also faced with increased future premiums for property and business interruption insurance based on claim history. Therefore, the financial risk exposure to the owner is substantially greater than the financial risk mitigation provided by the CT LTSA for an event that is included in the scope of the CT LTSA.
Based on the allocation of risk and the risk transfer compensation to the parties for risks assumed, the typical combustion turbine CT LTSA would not be considered a partnering arrangement.
Emissions System Partnership Models
In a true partnering relationship, the supplier assumes a significant portion of the owner’s risk for the performance and life cycle maintenance of the scope of supply. In addition to firm pricing for the scope of work and assuming the resultant execution cost risk, the supplier would also step up to owner financial exposures for covered system performance failures. For an emission system partnering arrangement or ES LTSA, this would include environmental agency fines and penalties resulting from the failure of the emission system to meet the unit environmental permit limits. While the owner retains responsibility for environmental permit compliance, the financial hedge provided by the emissions system ES LTSA largely mitigates the owner’s cost of noncompliance. This balances the risk between the parties and places responsibility for emissions exceedance costs with the party that has the responsibility to maintain the emissions system. The owner has completely transferred this financial risk through the ES LTSA.
The ES LTSA provider, like the CT LTSA provider, assumes the risk of outage execution and quality control in addition to catalyst life and system performance. Outage execution risk can be effectively managed by the provider through training, outage procedures, personnel selection, job site management and quality control procedures but, unlike the CT LTSA, the emissions system outage durations are relatively short and the emission system work is not typically on the outage critical path thus mitigating owner risk of outage extensions. Catalyst life risk is assumed by the ES LTSA provider and these risks are mitigated in a manner similar to the capital parts risk in a CT LTSA. The expertise in catalyst life, life forecasting, contract fleet performance, and unplanned performance issue mitigation allows the ES LTSA provider to properly manage these risks in the normal course of business.
This leaves forced outage risk associated with a failure of the emission system to perform. A catastrophic structural failure or unplanned depletion of the catalyst of the emissions system would potentially result in a forced outage duration weeks and untold costs. The restoration cost risk is assumed by the ES LTSA provider while the owner is exposed to lost market opportunity. As the restoration cost is likely to be less than the property insurance deductible, the owner is not exposed to ongoing insurance premium increases as a result of claims history. The owner would be exposed to lost operation costs for the duration of the forced outage. It should be noted that the risk of a full system or catalyst failure is extremely unlikely due to the annual inspections and maintenance performed on the system. Any structural or imminent failure issues or change in catalyst performance would be identified early and the failure prevented through proactive maintenance measures. Therefore, the owner exposure to a catastrophic failure of the emissions systems is effectively mitigated through the normal course ES LTSA work scope.
The ES LTSA described above would meet the criteria and qualify as a true partnering arrangement.
Conclusion
The features required for a true partnering arrangement in a LTSA like contracting structure include:
– Well-defined work scope, coverage, terms, and pricing
– Alignment of the LTSA provider financial interests with those of the owner – sharing of gain and pain
– True risk transfer to the LTSA provider including a substantive financial hedge for any owner incurred expenses resulting from a performance failure of the system provided through performance guarantees or warranties
– Minimizing risk transferred to third parties, such as property insurance carriers, and elimination of owner risk of economic loss and long-term insurance premium cost increases due to claims
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