Balancing financial risk and innovation in the pursuit of a successful energy transition
As the world strives towards a sustainable future, the role of innovation and new technology in the energy transition cannot be overstated. However, the of untested technology poses financial risks that can hinder the progress of proposed projects. The allocation and management of these risks become crucial to ensure the success of green initiatives. With trillions of dollars needed to develop and implement alternative energy sources, it is essential to understand how different funding sources and contractual structures influence the distribution of technology risk.
The Complexity of Technology Risk Allocation:
When considering technology risk, funding sources play a significant role in determining who bears the responsibility. Bank funding, government funding, private equity, and other sources each have their own risk appetite and compensation preferences. For instance, investment funds and pension funds are generally averse to technology risks, while banks providing project funding prefer to see all risks, including technology risk, bundled in Engineering, Procurement, and Construction (EPC) contracts.
The Burden on Contractors:
The EPC model, while providing certainty for banks and project owners, places a substantial burden on contractors. These contractors must assume all risks, including unknown factors that may lead to cost overruns or delays. This is manageable in traditional projects with well-understood risks, but it becomes more challenging when deploying new technologies. As a result, contractors may demand higher prices to compensate for the additional risk, potentially passing these costs onto consumers.
The Risk of Insolvency and Supply Chain Disruptions:
The failure to address technology risk adequately can result in a “graveyard of contractors.” If the risk becomes too great, contractors may become insolvent, leading to supply chain disruptions. Smaller contractors without the resources to manage such risks may choose not to bid on projects, further driving up prices. Additionally, projects lacking an obvious main contractor may struggle to attract project financing, hindering progress in the energy transition.
Aligning Interests through Equity Participation:
To mitigate the risk of project delays and cost overruns, equity participation can align the interests of sponsors and contractors. By providing a share of the equity to the contractor, their commitment to delivering the project on time and within budget is reinforced. This approach allows the contractor to earn a revenue stream from the project and ensures the interests of both parties are aligned. However, the consideration of whether the contractor can sell down its stake depends on its future role in operations and maintenance.
The EPCm Model:
In cases where no main contractor can assume the EPC role, the technology provider may act as an EPCm consultant, coordinating project contractors without assuming responsibility for timely and on-budget completion. The fees of the EPCm contractor often include a contingent element, incentivizing successful project completion. This model allows for the allocation of risks across different contractors, reducing the likelihood of a single contractor taking on excessive or unmanageable risks.
Bridging the Gap: Supporting Innovation and Funding:
To facilitate innovation and ensure the smooth progress of energy transition projects, various initiatives and support mechanisms have emerged. Organizations such as the Net Zero Technology Centre and ORE Catapult provide assistance to innovators through technology verification, research, and acceleration programs. These initiatives help drive early success and bridge the gap between early-stage projects and the large-scale investment required for a successful energy transition.
Conclusion:
The allocation of technology risk in energy transition projects is a complex challenge that requires careful consideration of funding sources and contractual structures. Balancing the burden between contractors and other stakeholders is essential to avoid supply chain disruptions and contractor insolvency. Equity participation and the EPCm model offer potential solutions, aligning interests and distributing risks effectively. However, further efforts are needed to facilitate innovation and ensure adequate funding for the energy transition to meet its ambitious goals.
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