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DoD Moves Forward with Stricter Sourcing Requirements for PV Devices

Posted in Department of Defense, Government Contracts

Earlier this week, the Department of Defense (“DoD”) issued a proposed rule to revise (and make stricter) the unique sourcing requirements applicable to certain photovoltaic devices that are used in the performance of DoD contracts.  Specifically, unless an exception under the Trade Agreements Act applies or a contractor secures a waiver based on public interest or unreasonable cost, the proposed rule would require photovoltaic devices provided under a covered contract to be both manufactured in the United States and made “substantially all” from components or materials that are also mined, produced, or manufactured in the United States.  DoD contracts covered by the proposed rule involve the provision of photovoltaic devices that are—within the United States—either (i) installed on DoD property or in a DoD facility or (ii) reserved for the DoD’s exclusive use for their full economic life.  Although the proposed rule does not apply to contracts under which the DoD directly acquires photovoltaic devices as end products, it does extend to energy savings performance contracts and power purchase agreements under which the DoD effectively acquires electricity produced by photovoltaic devices that are installed and managed by contractors.  As we have previously discussed, these contracts represent significant opportunities, especially given the DoD’s continued focus on securing sources of renewable energy.

The proposed rule implements new sourcing requirements set forth in the National Defense Authorization Act for Fiscal Year 2015, which overlap with existing requirements established in the National Defense Authorization Act for Fiscal Year 2011 that are contained largely in DFARS 252.225-7017.  Although the new requirements are largely consistent with existing requirements, which make the Buy American Act applicable to photovoltaic devices provided under similar contracts, the new requirements contain key differences that may complicate existing supply chains.  Importantly, the DoD has interpreted the new requirements to foreclose existing exceptions and waivers on which contractors may currently rely to provide photovoltaic devices that are manufactured outside the United States or made from foreign components.  In addition, whereas existing requirements apply only when both the DoD has reserved the exclusive use of a photovoltaic device and the device is to be installed on DoD property or in a DoD facility, the new requirements apply when either condition is satisfied.  As a result, a number of contracts will suddenly be subject to new sourcing requirements under the proposed rule, including contracts under which the DoD does not have an exclusive right to power generated from a photovoltaic device installed on DoD property or in a DoD facility, such as when a contractor is authorized to export power produced by such a device to a commercial grid, as well as contracts which have a term that is less than the full economic life of such a device.

The proposed rule mirrors existing requirements in that the primary effect of the current application of the Buy American Act to covered photovoltaic devices is to require contractors to ensure that the devices are manufactured in the United States.  Although existing requirements also technically require covered photovoltaic devices to be made “substantially all” from components or materials that are mined, produced, or manufactured in the United States, this requirement has been waived under existing regulations, as described below.  The proposed rule also mirrors existing requirements in that it recognizes a significant exception to contractors’ obligation to ensure that covered photovoltaic devices are manufactured in the United States by making the proposed rule’s application subject to the Trade Agreements Act, which provides an exemption from the Buy American Act’s requirements under contracts valued above certain dollar thresholds and requires contractors to provide photovoltaic devices that are “substantially transformed” in an authorized country, such as Canada, the United Kingdom, or Italy.  The application of the “substantial transformation” test under the Trade Agreements Act dramatically increases the number of available sources of supply as it focuses on the point at which a photovoltaic device is transformed into a new and difference article of commerce rather than the origin of its components or its final point of assembly.  Thus, under both the proposed rule and existing requirements, without considering other limitations on imports, a contractor could provide a photovoltaic device that is substantially transformed in an authorized country—such as the United Kingdom—from components manufactured in an otherwise unauthorized country—such as Malaysia.  DoD’s previous clarification that the relevant test focuses on the final place of substantial transformation remains unaffected by the proposed rule.

However, because the National Defense Authorization Act for Fiscal Year 2015 merely imposes key obligations from the Buy American Act and, unlike existing requirements, does not make the Buy American Act directly applicable to covered contracts, the proposed rule does not recognize other exceptions that currently apply to existing requirements.   In particular, the proposed rule does not recognize the waiver of the Buy American Act for components of commercially available off-the-shelf items, which the DoD has interpreted to apply to components of all photovoltaic devices covered by existing requirements.  Thus, in circumstances in which the Trade Agreements Act does not apply, contractors will be forced to trace the origin of the components of each photovoltaic device to ensure that “substantially all” of the components—which has been interpreted to mean more than fifty percent of component costs—have been manufactured in the United States.

More importantly, as the Trade Agreements Act will likely apply to the majority of covered contracts given the relatively high value of energy savings performance contracts and power purchase agreements, the proposed rule does not recognize general exceptions to the Buy American Act for (i) photovoltaic devices manufactured in other countries with which the United States has reciprocal defense procurement agreements, such as Turkey and Egypt, (ii) other foreign photovoltaic devices that are available at a cost that is less than the cost of domestic photovoltaic devices after a fifty percent adjustment to the foreign devices’ cost, and (iii) photovoltaic devices that are substantially transformed in the United States but potentially assembled in another country or made with foreign components in circumstances in which the Trade Agreements Act applies.  Although the proposed rule provides the DoD with authority to effectively implement these exceptions on a case-by-case basis, contractors will need to be cognizant of the circumstances in which a waiver can be requested and ensure that they actively pursue waivers when required.

The proposed rule will likely have a minimal impact on contractors that source photovoltaic devices through relatively uncomplicated supply chains that involve countries covered by the Trade Agreements Act.  However, contractors that have supply chains that source items from other countries or rely on existing exceptions to the Buy American Act should consider the impact of the proposed rule on their existing practices, especially considering complications that can arise in determining the origin of photovoltaic devices that include wafers, cells, and modules manufactured or assembled in different countries.

Comments on the proposed rule are due on or before July 27, 2015.

What the Home Battery Could Mean for Africa

Posted in Africa, Energy Storage

The African continent is revolutionizing itself as the place where no infrastructure is no problem.  This began in the telecommunications field:  Africa lacks a robust system of landlines, which traditionally enable better access to desktop computers, online services, and financial institutions.  But the emergence of cellular telephony has allowed individuals across Africa to bypass this infrastructure deficiency.  Today, the Pew Research Center estimates that over two-thirds of Africans own cell phones, with adoption nearing 90% in some countries.  Now, Africa may be on the path to revolutionizing itself in a second field:  electricity.  Decentralized energy storage options, like those announced by Tesla, General Electric, Samsung, LG Chem, and others, could play a significant role in enabling that revolution.

Currently, Africa’s energy situation mirrors its former telecommunications situation.  Over 600 million people live without access to electricity in Sub-Saharan Africa.  While 13% of the global population lives on the continent, they currently constitute less than 5% of global energy demand.  And the continent as a whole is rich in renewable energy resources:  the Sahara Desert provides unparalleled sunlight access, the Rift Valley contains geothermal reserves, and the coasts and interior have strong wind streams.  But at present there is no way to harness or store these energy sources effectively.

Hence the potential significance of distributed generation.  By day, a home battery can be charged on renewable sources; by night, it will continue to provide power despite the setting sun or calming winds.  Most manufacturers of decentralized storage appear to provide scalable batteries—one battery could power a home or small business, and many batteries could power a town.  Home battery costs have decreased 14% since 2007, as many manufacturers currently list their home batteries at around $3,000.  Moreover, costs to consumers will likely continue declining because of the many manufacturers competing in the marketplace and Tesla’s promise to place its home battery specifications in the public domain.

When Tesla CEO Elon Musk unveiled his company’s home battery on April 30, 2015, he noted its potential value for Africa.  The alternative—installing and upgrading traditional grid infrastructure on the continent—is highly expensive.  For instance, South Africa’s government-owned utility company estimated it would cost $22 billion to improve the grid enough to meet current demand.  Decentralized energy storage that is affordable will increase the feasibility of on-site energy generation and reduce the need for a fully-developed transmission grid.  Analysts project the market for microgrids reaching $20 billion in 2020, and on-site generation of solar power becoming comparable to or cheaper than grid-supplied power.  Just like how cell phones enabled access to the internet and microfinancing, distributed generation and on-site storage could light up homes, increase technological innovation, and change the look of the African economy.

Whether a home battery built by Tesla, General Electric, Samsung, LG Chem, or another company becomes the premiere energy storage solution in Africa, distributed generation has the potential to revolutionize electricity and power throughout the continent.

Calvin Cohen is a summer associate in Covington’s Washington D.C. office and a student at Vanderbilt University Law School.

FERC Outlines Its Role in Implementing EPA’s Clean Power Plan

Posted in EPA, FERC

Earlier this year, FERC held four technical conferences to discuss the implications of state, regional and/or federal plans for compliance with EPA’s proposed Clean Power Plan (CPP) rule to set carbon emission limits for existing electricity generating units.  A major issue raised was the impact of the CPP on electric grid reliability as coal-fired generators are retired to meet compliance requirements.  As noted in a previous post on this blog, what has been unclear is the action – if any – FERC may take to address the concerns regarding a rulemaking over which the Commission lacks jurisdiction.  A recent exchange of letters between EPA and FERC provides some clarity.

In a May 6, 2015 letter to FERC Chairman Norman Bay, EPA’s Acting Assistant Administrator for Air and Radiation Janet McCabe noted that EPA will be “intently focused on the issue of reliability,” that it is incumbent on EPA to craft a rule that “provides sufficient time, flexibility and latitude” for states, utilities and reliability entities to take actions to ensure reliability, and that EPA is reviewing suggested mechanisms for addressing reliability concerns.  The letter also said that staff members of FERC, EPA and DOE are planning for the agencies to coordinate their activities regarding reliability after the CPP rule is issued and are developing a working document to guide those efforts.

In response, a May 15, 2015 letter to EPA signed by all five FERC Commissioners discussed how FERC can fulfill its responsibility on Bulk-Power System reliability after EPA releases a CPP final rule, and focused on two mechanisms suggested at the conferences.

Reliability Safety Valve.  This would be a process for modifying compliance obligations when unforeseen delays in implementation efforts could risk harm to grid reliability.  If EPA adopts this mechanism, FERC could review a claim that unforeseen or emergency conditions would result in a violation of a FERC-approved reliability standard, identify issues, and evaluate any proposed mitigation to determine whether it would resolve the problem.  FERC’s letter advised that “in this narrow role,” the Commission will not opine on other issues that EPA could consider, such as whether the applicant or EPA should pursue different options.  FERC offered its staff to help EPA on the information needed for a FERC review.

Reliability Monitoring and Assistance.  This would be a process for reviewing state compliance plans for their impacts on reliability.  FERC says reviewing state plans for reliability concerns should rely primarily on existing processes by planning authorities such as the RTOs, ISOs and regional reliability coordinators.  The Commissioners did offer a limited set of functions FERC could perform, including reviewing others’ analyses, suggesting additional analyses or in limited cases performing its own analyses, providing input on a particular plan if requested by EPA, and conducting outreach activities.

The Commissioners tempered this offer with a note of political caution.  The letter noted that FERC’s role in reliability is limited by its statutory authority to approve and enforce reliability rules and by how its rate jurisdiction affects reliability.  It pointed out that reliability also depends on factors beyond FERC’s control, such as state authority over local distribution and integrated resources planning, and that the Commission “is not seeking to alter this balance of Federal and state roles or to assert authority over state plans.”

FERC’s letter did not calm the controversy over whether the proposed CPP rule would compromise reliability.  According to a post on the Governors’ Wind Energy Coalition site, Robert Dillon, a spokesman for Senator Lisa Murkowski, chairwoman of the Senate Energy and Natural Resources Committee, called the letter a “positive step, and it’s good to see the commission responding to the concerns it heard during the recent round of technical conferences.  Now we expect EPA will cooperate with the agency responsible for actually ensuring the reliability of the grid.”  However,  David Weiskopf, an attorney for NextGen Climate America, said there is sufficient technical analyses that have found no cause for reliability concerns, adding “[t]hat’s why, rather than recommending any new procedures or endorsing any utility requests for less protective emissions reduction targets, FERC has instead offered to assist EPA as the Clean Power Plan is finalized and implemented, in case any of these industry claims are eventually found to have genuine merit.”

EPA’s website says the proposed CPP will be finalized by mid-summer.

CFTC Officials Outline Commission’s Policy Positions at Energy Risk Summit USA 2015

Posted in CFTC

Chairman Timothy Massad and Commissioner J. Christopher Giancarlo of the Commodity Futures Trading Commission (the “CFTC”) delivered speeches at the Energy Risk Summit in Houston this week, providing a roadmap for the CFTC’s current and upcoming rulemaking as well as a policy perspective on the CFTC’s proposed position limit rules.

In remarks to the conference on May 12, Chairman Massad addressed a number of proposed CFTC rules pertinent to commercial end users, including CFTC proposals to clarify the status of contracts with embedded volumetric optionality for purposes of the swap rules and to reduce reporting requirements for trade options and illiquid swaps.  Massad also discussed the need to complete any outstanding rulemaking required under the Dodd–Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”).  Massad indicated that the position limit rules were a priority, but that the CFTC needed to carefully evaluate hedging strategies and estimates of the “deliverable supply of a commodity” when considering the final form of such rules.  Massad also identified the posting and collection of margin on uncleared swaps, as well as swap dealer dollar-amount thresholds (the de minimis threshold) as targets for potential rulemaking in the near-term.  Specifically, Massad noted that the CFTC would be undertaking a study related to the potential change in the swap dealer de minimis threshold.  This is a significant issue for energy companies because if this threshold is lowered, additional energy companies may have to register as swap dealers.

Massad also discussed the CFTC’s perspective on recent enforcement actions, specifically with respect to benchmarks and automated trading.  Massad stressed the need for benchmark integrity, but noted that the U.S. system does not provide a government-sponsored supervisory regime for benchmarks as in Europe.  In addition, in response to the recent CFTC-Department of Justice action against an individual in connection with the 2010 Flash Crash, the CFTC is evaluating the need for additional regulation regarding automated trading.

Commissioner Giancarlo used his keynote address to the conference to deliver a strong critique of the CFTC’s position limits proposals.  In his address, Giancarlo stressed the need for quantitative, data-driven investigations to justify any proposed rules in this area, stating at one point that:

“[T]he only way to [determine whether position limits are necessary or appropriate] is to draw upon current and accurate data and confirm that any final rule will facilitate price discovery, maintain liquidity and not unduly disrupt markets that by all accounts are functioning fairly well . . . .”

In this vein, Giancarlo pointed out the lack of data showing that movements in commodity prices such as oil prices are necessarily the results of excessive speculation.  Giancarlo also alluded to liquidity challenges that are making it increasingly costly and harder to hedge that, according to the CME and ICE, are due to widening bid-ask spreads in certain commodity markets.  If anything, according to Giancarlo, there is not enough speculation in certain commodities markets.  Giancarlo proposed (1) the adoption of position accountability as a potential substitute for bright-line position limits and (2) a definition of “deliverable supply” that would more accurately reflect the deliverable supply for a regulated commodity like natural gas or electricity.  With respect to position accountability, Giancarlo noted that exchanges currently require position accountability reporting, and such reporting already reduces the potential for overly risky positions.

Giancarlo also took issue with the CFTC’s proposed exemption from position limits for bona fide hedging.  The proposed rules, if adopted, would unduly hamper legitimate hedging strategies such as those undertaken in connection with storage transactions and merchandising transactions, as well as cross-commodity hedging (e.g. using ultra-low sulfur diesel futures contracts to hedge jet fuel prices).

The recent speeches by Chairman Massad and Commissioner Giancarlo demonstrate that energy market participants must continue to follow developments at the CFTC, particularly those related to position limits and establishing best practices related to enforcement cases.

Focus on Infrastructure

Posted in NEPA

Infrastructure Week is underway in Washington, DC, and across the country, highlighting the importance of investing in and modernizing America’s aging infrastructure.  The emphasis is on the essential role infrastructure plays in our economy.

Covington & Burling, together with Common Good, the Bipartisan Policy Center, and the National Association of Manufacturers, co-hosted an event on Tuesday bringing together experts to discuss the infrastructure approval process, and ways to improve or reform the current system to increase efficiency.  The half-day forum presented new perspectives and a conversation on why an overhaul is needed.  Boosting the economy and improving environmental outcomes can move in tandem but current structures and regulatory barriers prevent such paradigm shifts.  The forum also included a presentation of best practices from other countries and opportunities created by consolidating decision-marking and early consideration of environmental impacts.  Philip Howard, founder of the Common Good and partner at Covington & Burling, convened the event, acknowledging on Tuesday that “No one designed the system we have now – it just grew.”  The forum’s goal was to explore bold proposals for simplifying, accelerating, and improving the infrastructure approval process.  Red tape must be cut if America wants to reap all the benefits of new infrastructure projects—enhanced competitiveness, millions of jobs, and a greener environmental footprint.

Deputy Secretary of Transportation Victor Mendez was the keynote speaker, remarking on the new Department of Transportation (DOT) “Beyond Traffic” survey that accounts for current infrastructure and transportation needs and forecasts future trends.  The most recent survey, Beyond Traffic: Trends and Choices 2045, predicts a population increase of 70 million people by 2045 and demographic shifts across the country.  Mr. Mendez acknowledged that our current infrastructure will not be able to sustain that growth.  He stated that our infrastructure will not get better by itself.  He believes we can improve the current system to provide for more efficiencies, starting with the passage of a long-term surface transportation authorization from Congress.  Should Congress continue to pass only short-term fixes, Mr. Mendez believes infrastructure stakeholders and the American public should begin considering mechanisms to keep innovation occurring outside of legislative action.

The first panel, moderated by Covington & Burling’s Gary Guzy, brought together international and domestic experts to discuss how the U.S. infrastructure approval system compares to that of other countries.  Nick Malyshev, head of the Regulatory Policy Division at OECD, observed that while the U.S. has a great system for instituting laws and regulations, we could do a much better job of evaluating the regulations in place.  He and the other panelists, John Porcari of Parsons Brinckerhoff and Shawn Denstedt of Osler, Hoskin & Harcourt (Canada), discussed how Canada, Australia, and many European Union countries are light years ahead of the United States in terms of their regulatory framework and approval processes.  Mr. Denstedt discussed how Canada in particular revamped its environmental review process in 2012 to make it more consistent and timely and the outcomes more predictable.  All of the panelists remarked on how the convoluted approval process, not necessarily the substance of projects, is dragging down the infrastructure system here in the United States, and how there must be better coordination between federal and state entities to reduce overlap and inconsistencies.

A second panel discussed the environmental review process and the devolution of the National Environmental Policy Act (NEPA).  While the original intent of the act was to balance interests and understand the consequences of different choices in infrastructure projects, panelists remarked on how the process has become cumbersome, with overlapping oversight authority and review processes that have resulted in delays, escalation of costs, and an overall burden on the American economy.  Attendees were reminded that the law was only 7 pages when enacted in 1970; several panelists commented that it is time to go back to the law’s original intent.  There was also a consensus among panelists that there needs to be more of an evidence-based discussion around environmental review.  There is little analytical data on NEPA policy, but a better model could exist that is based on metrics and outcomes that can better inform decisions.  Covington & Burling’s Don Elliott discussed the judicial review process under NEPA, which he said has become a process for stopping projects, rather than facilitating how a project gets done.  One fix he noted was for preliminary injunctions to be done away with and for CEQ to issue guidelines for judicial standing.

The final panel discussed the challenges and bright spots in the current permitting process.  Joann Papageorgis of the Port Authority of New York and New Jersey discussed the Bayonne Bridge navigational clearance project as an example of how complicated the review process can be and how inefficiencies can be solved.  This project in particular required approximately 50 permits from 20 different agencies.  They found the complicated regulatory review contained multiple duplicative regulatory processes and conflicting federal requirements.  She outlined several strategies and recommendations based on the experience of this project, many of which were echoed by the other panelists, including how important it is to enforce early coordination and synchronization between agencies, and to work on a schedule.  Shoshanna Lew from DOT agreed there is no reason certain processes cannot happen simultaneously, and multiple agencies could participate as part of the same review, rather than duplicating it multiple times.

There was broad consensus across these three panels and participants that all parties should work toward permanent solutions that increase efficiencies, improve outcomes, and balance interests to advance our infrastructure systems and meet the current and future demands of our country.

Anatomy of a Nigerian Oil Scandal: Audit of National Oil Company Fuels Momentum for Sectoral Reform

Posted in Africa, Oil

After months of speculation and mounting pressure, it’s finally here: the government of Nigeria has released the long-awaited PricewaterhouseCoopers (PwC) forensic audit of the Nigerian National Petroleum Corporation (NNPC), the country’s national oil company. It’s not often that the release of a highly technical accounting report makes the headlines—much less grabs the attention of millions—but this isn’t just any audit, either. The allegations that the report examines cost the central bank governor of Nigeria his job, and may even have played a role in unseating President Goodluck Jonathan this past March.

A little background is in order. In late 2013, then-Central Bank Governor Lamido Sanusi accused NNPC of failing to remit tens of billions in oil revenue to the Nigerian treasury—revenue sorely needed for the country’s macroeconomic stability. President Jonathan brushed off the claims and rapidly sacked Sanusi. This move was widely condemned, especially given Sanusi’s track record on combating corruption and in steering the country through its 2009 banking crisis. To quell growing public outcry, the government commissioned PwC in June 2014 to carry out a forensic audit of the state oil company. PwC submitted its final report in February 2015, but the Jonathan administration had until now chosen not to make it public, releasing only a one-page summary. The government fended off calls to release the full audit report, with Petroleum Minister Diezani Allison-Maduekwe claiming the report would not be released so as not to politicize the elections. Regardless, Major General Muhammadu Buhari handily defeated the incumbent president in late March, capitalizing on the electorate’s frustration with the Boko Haram insurgency and the perceived rampant corruption plaguing Nigeria—and still, the report was not released. Finally, after President-Elect Buhari stated last week that his administration would make the report public when he took power, President Jonathan relented and released the full audit on April 27.

The now-public report provides a bleak depiction of NNPC’s operations, and even then does not reveal the full picture. PwC was blocked from accessing the data and people it needed to conduct a full audit, and so, in an unusual move, the accounting firm warned that it could not vouch for the reliability of its report, which was not conducted in line with generally accepted auditing standards and is not to be relied upon. Overall, however, PwC’s main conclusions are in line with Sanusi’s allegations of at least serious mismanagement. (The audit does not mention the role of corruption in getting the NNPC to these dire straits, but many Nigerians believe corruption is an endemic problem in the institution.) The audit found that NNPC owed at least $1.48 billion to the treasury  as a result of accounting and computation errors. The report also cautions in uncharacteristically strong language that NNPC had been given a “blank cheque to spend money without limit or control,” warning that its operations are unsustainable and need to be urgently remedied. Over the January 2012 to July 2013 period covered by the audit, nearly half of the oil proceeds went to covering NNPC’s operational costs and on kerosene and oil subsidies; these latter subsidies, while nominally pro-poor, have long been seen as a wealth transfer to kerosene retailers instead. With oil prices tumbling dramatically over the last year, PwC warns that if the state oil company continues on the same spending trajectory, it would be unable to cover its own costs, much less remit anything to government coffers.

While PwC’s report is proving to be political poison for President Jonathan’s administration—most recently with the Minister of Finance distancing herself from the audit—it further strengthens President-Elect Buhari’s mandate to reform the oil sector. The Major General has indicated his priorities upon taking office on May 29 would be to end fuel subsidies, crack down on corruption, and reform the NNPC, while tax reform for the oil sector would take a back seat. The incoming Buhari administration may also provide the necessary momentum to get the long-pending and controversial Petroleum Industry Bill passed, which would establish a fiscal, legal, and regulatory framework for the sector. International oil companies have been keenly watching the taxation provisions of the pending bill. Uncertainty over the taxation of the sector has allegedly caused billions of dollars of foreign investment to be withheld, and Buhari’s signaling that oil taxation will not be a policy priority is likely to only increase this uncertainty. But one thing is clear: Buhari is inheriting a petroleum sector in crisis, and the effectiveness with which the President-Elect tackles the problem will determine not just the trajectory of the Nigerian oil industry for years to come, but the success of his administration as well.

Global Infrastructure Investment — Getting Investors Off the Sidelines

Posted in Asia

Power shortages in India, transportation costs in Africa, the poor grades given to US infrastructure, pollution in China, and the devastation to old and sub-par infrastructure in places like Nepal when disaster strikes are clear reminders that the world needs more and better infrastructure.  Infrastructure is the talk of governments, of bodies such as the G20 and international organizations including the World Bank, the OECD and the IMF.  The need is real and there is enough cash in global markets to make it happen.  Yet, private investment in infrastructure has fallen despite calls to ramp it up as a way to spur inclusive growth, productivity and job creation.  So, why isn’t it happening and is help on the way?

Experts estimate the shortfall in global infrastructure debt and equity investment to be at least US$ 1 trillion per year.  Governments (which typically fund  infrastructure) do not have the financial headroom, and infrastructure projects are complex to manage  and prone to corruption and failure.  That is especially true where competition and capacity are weak, and laws and regulations not geared to ensuring that such investments succeed over their life-cycle — a.k.a. in most of the world.  Sovereign risk is a key predictor of infrastructure investment.  Global infrastructure needs cannot be met without private capital and know-how.  Insurance and pension funds have invested less than 1% of their $80 trillion in assets in infrastructure, mostly in advanced economies.  Private investors — including long-term investors such as pension funds, insurance companies and sovereign wealth funds — say they are hard-pressed to find bankable projects in which to participate.[1]

Despite unmet and fast-growing demand for infrastructure services, the high transaction costs, poor capacity, political and governance risks, and policy and regulatory barriers found in most emerging markets make investment returns too low to attract private investment.  The pipeline of well-prepared projects is small; there is a lack of appropriate financial instruments of sufficient liquidity (e.g. project bonds) to mobilize global investors;  daunting inconsistencies persist in contracts, concessions, bidding documents, procedures and purchase agreements  (e.g. fuel and power) and critical underlying cost recovery and cash flow challenges plague sectors that need private investment.  So billions of people go without reliable access to basic services such as electricity, clean water and transportation; and investment fails to materialize while global growth remains slow and uneven.

A number of international initiatives have been launched to get global capital and private investors off the sidelines and into infrastructure investment.  In October 2011, the MDB Working Group on Infrastructure[2] submitted an Infrastructure Action Plan to the G20.  It focused on specific initiatives to unlock private funding with technical assistance and targeted financial support (including for regional projects) and to make multilateral banks procedures more amenable to public-private partnerships.  Key among its recommendations were the need to improve the transparency and success of infrastructure procurements and projects, including by ramping up the number of countries supported via the 2008 Construction Sector Transparency initiative (CoST) and launching the global Infrastructure Benchmarking Initiative (IBI) to assess the quality and performance of infrastructure spending.

Building on this work, in the Fall of 2014, the G20 and the World Bank launched the Global Infrastructure Facility (GIF) with the support of major asset management and private equity, donor governments and other prominent multilateral institutions for a three-year pilot.  It aims for formal collaboration via an Advisory Council made up of international institutions, governments and private investors to prepare and structure complex projects involving public-private-partnerships (PPPs) transparently and efficiently.  Up to $200 million in downstream co-financing resources for the GIF is envisioned once the upstream work has taken hold.  The GIF is also expected to identify and help to improve legal, regulatory and institutional conditions, to provide new risk mitigation and credit enhancement tools and to help mobilize and finalize financing packages.  It is to provide a comprehensive approach with operational activities in both Washington DC and Singapore to develop a diverse portfolio of projects with complexities that might otherwise deter investment, but with a high potential to leverage diverse investors and lasting development impacts.

The G20 and their business advisors, the B20, also agreed in November 2014 to establish a Global Infrastructure Hub in Sydney, Australia to help advance the G20’s infrastructure goals, including to drive increased consistency in project documents and processes, to promote more transparent procurement practices, to highlight global best practices and important challenges, to establish a data base to help match investors (including pension funds and insurance) with projects and to identify and encourage innovative financing models.  It also envisions work to provide more efficient ratings of infrastructure projects in particular country and regional contexts (e.g. enforcement risks, policy and regulatory risks, transaction costs, counterparty risks).

The OECD and World Bank are also working on a joint checklist for key steps and best practices on Public-Private Partnerships and Project Preparation.  A major G20/OECD project analyzing government and market-based incentives for long term investment financing (such as the new tax credits for infrastructure being discussed in the U.S. Senate) is ongoing.  It aims to examine a wide range of options and instruments to facilitate institutional investors participation in infrastructure projects, and to focus on new forms of investment – e.g. partnership and co-investment models between banks and institutional investors –  as well as on risk mitigation mechanisms.  The aim is to create an agreed framework of instruments and incentives to facilitate the development of infrastructure as an asset class, so as to leverage private capital.  The IMF and OECD will also continue work to ensure efficient sovereign debt sustainability and crisis management, which also is key to mobilizing infrastructure investment.

Recognizing infrastructure as a critical need and an opportunity to build its global presence and prestige, China launched a new Asian Infrastructure Investment Bank (AIIB) in Beijing in October 2014.  Despite questions raised by the United States, Japan and others about the governance and efficiency of the AIIB, some 58 countries (including 18 European countries, most of the G20 and the majority of the Asian economies) have already signed up as founding members.  The World Bank and Asian Development Bank plan to work cooperatively with the AIIB, which is expected to be fully established this year with up to $100 billion in capital.  Although the United States has yet to sign on to the AIIB, President Obama said last week that he is “all for” the AIIB, if it maintains high standards and adopts best practices.  Japan, which also has yet to join, this week announced at the annual meetings of the Asian Development Bank an initiative on “quality infrastructure” investment, while the ADB also rolled out plans to streamline project approvals and increase flexibility to draw from various capital sources to finance regional infrastructure.

This year will be critical to whether international efforts to assess creatively and de-risk, facilitate and co-finance private investment in much-needed infrastructure can begin to produce efficient investment and help to spur growth and job creation.  Like the so-called “natural resource curse”, there is an infrastructure “curse” that also requires transparency, capacity and independent monitoring finally to unlock private investment.  This may be the year it finally happens.

____________________

[1] Adrian Blundell-Wignall and Caroline Roulet.  Infrastructure Versus Other Investments in the Global Economy and Stagnation Hypotheses:  What Do Company Data Tell Us?   OECD Journal Financial Market Trends — Volume 2014/2; OECD 2015.

[2] Comprised of the African Development Bank (AfDB), the Asian Development Bank (ADB), the European Investment Bank (EIB), the Inter-American development Bank (IADB), the Islamic Development Bank (IsDB) and the World Bank Group (WBG).

DLA Energy Plans to Make Utility Privatizations More Effective and Streamlined

Posted in Department of Defense, Government Contracts

Last week the Defense Logistics Agency (DLA) Energy issued a statement on DLA’s website about its plan to “increase the productivity, efficiency and effectiveness of [the] Air Force’s utility services contracts” – a plan that dovetails with the Department of Defense’s (DOD) Better Buying Power 3.0 initiative (BBP 3.0).  This should be good news for utility service providers seeking opportunities in and currently performing under the Air Force’s (and the Army’s) utility privatization program.  Pursuant to 10 U.S.C. § 2688, the Air Force and the Army may (a) convey a utility system (water, wastewater, electric and/or natural gas) through a bill of sale to a utility service provider (i.e., the contractor) and (b) enter into a long term agreement (between 10 and 50 years) with the contractor for utility services on the conveyed system, which generally includes the operation, maintenance, repair and modernization of the system.  DLA Energy is the contracting agent for the Air Force and Army utility privatization programs.

Over the last 10 years or so, some of the issues we have seen with utility privatization contracts – both with respect to competitions and contract administration – have been ameliorated.  This is due, in part, to the evolution of the standard utility privatization RFP.  Nonetheless, there is still room to grow, and it now appears that DLA Energy is proactively taking the next step.  In the DLA statement, Martha Gray (DLA-E Utility Services Director) notes that DLA Energy recently has examined pre- and post-award issues for the purpose of “revamp[ing] the time-to-award strategy to more accurately reflect utility privatization timelines and gain efficiencies.”  Ms. Gray explained that “[o]ne of the chief inputs from the Air Force was that our solicitation process took too long, and that the milestone schedule in place at the time was unrealistic.”  As a result, DLA Energy has adjusted its internal milestones and “built a realistic milestone schedule that identifies not only the major procurement milestones, but the necessary tasks to accomplish each one.”  On the post-award side, DLA Energy considered a variety of concerns raised by the Air Force – e.g., records management, the conveyance of assets, the development of performance metrics and the development of a process to identify execution year funds.  Ms. Gray indicated that DLA Energy’s review of these matters have “led to more streamlined contract management and a clearer path forward on critical issues.”

Only time will tell if DLA Energy’s recent efforts will increase the productivity, efficiency and effectiveness of the Air Force’s and the Army’s utility privatization contracts.  We plan to closely monitor and report on these developments.

FERC Staff to Measure Grid Investment Effectiveness

Posted in Electricity

The Department of Energy recently released a Quadrennial Energy Review that identified a pressing need for new electricity transmission facilities, among other infrastructure issues.  Encouraging new transmission investment has also been a decade-long priority policy goal of FERC reflected in the Energy Policy Act of 2005 and FERC’s seminal Order No. 1000.  In furtherance of this priority goal, FERC staff recently announced that it is developing quantitative metrics regarding transmission investment adequacy and the impact of FERC’s policies.

The metrics under development would help the Commission to assess the adequacy of transmission infrastructure and the effectiveness of FERC policies in achieving appropriate levels of transmission investment needed to meet reliability, economic and public policy concerns.  At the recent FERC meeting, staff described specific metrics for which adequate data are available.  The metrics fall into three broad categories.

Metrics to assess the adequacy of transmission infrastructure.  Staff will identify persistent costly line congestion as a measure of inadequate transmission investment.  One metric, to be used for facilities not under the control of a regional grid operator, will look at the number of incidents where the grid operator needed to take action to address congestion problems, weighted by the quantity of end-user, or retail, load.  For facilities under the control of a regional grid operator (Regional Transmission Operators or RTOs, and Independent System Operators, or ISOs), staff will identify persistent price differentials between locations on the grid.  This different metric is needed for RTOs and ISOs because they operate markets that place a price on congestion and thus do not rely on operator actions for congestion management such as curtailment.

Metrics to measure relative transmission investment.  Staff will develop three metrics:

  • Circuit miles of transmission added to the grid, divided by retail load.
  • Investment in new capital additions to the grid, divided by retail load.
  • Circuit miles of transmission added, divided by the associated investment dollars.  The resulting metric, circuit miles per dollar of investment, measures the effectiveness of investments.

Metrics to evaluate key goals of Order No. 1000.  Staff identified only one metric in this category: the percentage of transmission project proposals made by nonincumbent (i.e., non-utility) transmission developers.  One of the major goals of Order No. 1000 is supporting competition in transmission development.  This metric measures the participation of nonincumbent developers in regional planning processes. 

Staff indicated that it will consider whether additional metrics would be helpful.

New FERC Chairman Norman Bay told staff “This is important work that you’re doing.  The metrics presented by staff today will allow the commission and its staff to better see what works and what needs further improvement,” according to RTO Insider.

Risk and Reward in the UK Continental Shelf: Key Developments in Q1 2015

Posted in Oil & Natural Gas

Our 2014 series on risk and reward in the UK Continental Shelf (UKCS) outlined the challenges being faced by the UKCS oil and gas industry to remain competitive. A consistent theme emerging from industry stakeholders is that significant fiscal and regulatory reform is required to secure the industry’s long-term future. This post highlights key fiscal and regulatory developments during the first quarter of 2015.

2015 Budget: Welcome fiscal reforms

In the last Budget before the May 2015 general election, the UK Government announced oil and gas sector fiscal reforms, including:

  • A new “investment allowance” to simplify the existing system of offshore field allowances;
  • A reduction in Petroleum Revenue Tax from 50% to 35%; and
  • A reduction in the Supplementary Charge on company profits from 30% to 20%.

Almost simultaneously, the Office for Budget Responsibility published statistics showing that tax receipts from the UKCS were at their lowest in 40 years. The UK Government expects the measures in the Budget will encourage further investment in the UKCS, leading to over £4 billion of additional investment and a 15% increase in oil production by 2019. Oil & Gas UK — the trade association for the offshore oil and gas industry — welcomed the fiscal reforms contained in the Budget, commenting that the Government’s actions were “both sensible and far-sighted”.

Developments in the implementation of the Wood Review recommendations 

As reported in our November 2014 series, the Secretary of State for Energy & Climate Change commissioned Sir Ian Wood to conduct an independent review of offshore oil and gas recovery in the UKCS in June 2013 (the Wood Review). The Wood Review published its final report in February 2014. One of the Wood Review’s recommendations was to establish an arm’s length regulatory body with powers to implement a new strategy for maximising economic recovery from the UKCS (the MER UK Strategy).

In July 2014, as part of its response to the Wood Review, the UK Government announced that it would create the Oil and Gas Authority (the OGA). On 1 April 2015, the OGA was established as an Executive Agency and it will transition into a Government Company by summer 2016.

In March 2015, the Government published its response to the November 2014 Call for Evidence from interested parties concerning the implementation of the Wood Review recommendations. The Government’s response outlines the key regulatory powers of the OGA, which are to include:

  • The right to attend industry meetings as an observer, including meetings between operators within a joint venture and meetings between licensees.
  • Sufficient powers to gather relevant data and information from non-licensee parties captured by the MER UK Strategy.
  • A non-binding role in the resolution of disputes that relate to licence terms or that impacts, or has the potential to impact, on the MER UK Strategy. The OGA will have information-gathering powers and the ability to set timeframes for the provision of information to speed up the resolution process.
  • The power to impose sanctions where parties within the scope of the MER UK Strategy do not comply with the key powers exercised by the OGA, as well as other breaches of the MER UK Strategy and non-compliance with licence conditions. The Government has proposed a statutory limit of £1 million on individual financial penalties, with a reserve power to increase this limit to £5 million, subject to consultation and Parliamentary approval. Although the financial sanctions may be considered relatively modest, the reputational impact upon sanctioned parties is potentially significant.

The Government considers it appropriate for the oil and gas industry to pay the costs of the OGA, consistent with the user pays principle, through a combination of the existing fees and charges regime and a new levy. The Government intends for the costs falling under the levy to initially relate to Offshore Petroleum Licence holders only, and to begin collecting the levy from October 2015. A consultation on the design of the proposed levy is open from 23 March until 20 April 2015.

The Department for Energy & Climate Change is currently preparing a bill for the first session of the new Parliament in summer 2015, which will implement the measures establishing the OGA. However, this timeframe is expressly subject to the will of the new Government and necessary Parliamentary procedures. The outcome of the UK general election on 7 May 2015 could, therefore, have an impact upon the MER UK Strategy and the implementation of the OGA, as well as the UKCS’s broader outlook.