The law behind… Energy

With the UK’s natural energy resources diminishing all too quickly the Government is continually looking at initiatives that will provide viable solutions to the problem.

Liquified Natural Gas

As the headlines mount about gas prices, security of supply and geopolitical worries, lawyers are working with energy companies to ensure that the world’s energy demand is met.

The gas industry has seen dramatic headlines in recent months: gas prices have been higher this winter than ever before, the UK’s indigenous stocks of North Sea gas are declining rapidly (the UK is expected to be 50 per cent dependent on imported gas by 2010 and 80 per cent dependent by 2020), and the Russian government appears to be using gas supplies as a means of exerting political pressure on its neighbours.

In response to declining North Sea supplies, the industry has been building capacity to import more gas into the UK: last year the Balgzand Bacton pipeline was commissioned between the UK and the Netherlands to add to the capacity between Continental Europe and the UK already provided by the Interconnector, a pipeline connecting the UK to Zeebrugge in Belgium. Additionally, a liquefied natural gas (LNG) terminal has been commissioned in the Thames Estuary, with an additional two being developed in brownfield sites in Milford Haven in South Wales.

LNG is seen as being a way of using gas reserves discovered far from markets to satisfy the developed world’s thirst for gas. As it is not supplied by a fixed pipeline, consumers can have a portfolio of suppliers and are therefore less vulnerable if a single supply is disrupted. LNG is produced by refrigerating natural gas to -161°C in a liquefaction plant close to the gas field. The LNG is then loaded into special tankers and transported to a terminal close to consumers, where it is unloaded and heated, converting it back into gas.

LNG projects are some of the most talked about in the energy world at the moment and are providing a lot of work for project finance lawyers.

Lawyers have several key concerns they must advise their clients about in relation to LNG and cross-border pipeline projects:

  • How do clients ensure they get paid? If the parties are happy to apply English law, then basic sales of goods law applies, and issues such as transfer of title, guarantees and letters of credit are used to ensure that the sellers are paid for the gas they deliver to market – an important consideration when each LNG cargo is worth more than $20m (£11.5m).
  • How do all the parts fit together? An LNG project involves the development of a gas field, a liquefaction project, a shipbuilding project and the construction of a terminal. In addition, the gas needs to be marketed and there is liaison with government entities concerning the importer and exporter states and funders. All of these activities need to be put into a contractual framework to ensure that if one piece of the jigsaw fails, the other pieces react in the appropriate way.
  • Environmental concerns. The LNG industry is seen as being relatively environmentally benign. Gas is cleaner than most other fossil fuels and does not produce so much carbon dioxide or cause slicks if spilt. Project lawyers liaise with non-governmental organisations and environmentalists to ensure that the project is executed in an environmentally sound manner. Projects that do not comply with the highest environmental standards risk damaging the reputation of the sponsors and run the risk that banks will refuse to provide funding.

    Ben Smith, associate, corporate practice, Herbert Smith


    LNG projects are challenging to finance because they involve the financing of several interdependent projects: the construction and operation of the gas field; the pipeline transporting the gas from the field to the liquefaction plant; the liquefaction plant itself; the acquisition and operation of LNG tankers to transport the gas to the regasification plant; and the construction and operation of the regasification plant. The extent to which a bank is willing to participate will depend largely on its assessment of the risks involved, the allocation of those risks and how they can be mitigated.

    Construction/completion risk is of vital importance to the project financier, since delays in the construction phase will inevitably lead to increased costs, which could put a strain on loan repayments and cause interest and debt to accumulate. As a result, financiers of LNG projects have traditionally required some form of completion guarantee to cover the additional costs incurred if completion of the construction phase does not occur by the required date.

    Financiers may also require other forms of protection, such as political risk insurance, which can provide cover for risks of war, revolution, imposition of exchange controls and breach by the host government of any undertaking given to it by parties involved in the LNG project.

    Wanda Tomaszek, associate, finance practice, Herbert Smith


    What protections are there in place to ensure that the energy company’s investment (a five-million tonne a year liquefaction plant costs approximately $1,000bn (£572.9bn)) is protected from state interference? Lawyers will advise on any bilateral investment treaties (BITs) or multilateral investment treaties (MITs) already in place. These are intended to encourage investment by providing certain legal protections for an investor from one signatory country making an investment in the other signatory country. The protections conferred by these treaties typically include protection against discriminatory treatment (for example, by the imposition of higher state taxes on non-domestic investors) and fair compensation for expropriation of property, including the compulsory acquisition or sale of an investment.

    State interference in an investment is just one of the many risks faced by an energy client committing to an expensive project. A whole range of contractual disputes can arise with contractors, suppliers and trading partners. It is unusual for any major infrastructure project to be completed without any disputes. Commercial clients are interested in whether they are entitled to damages for breach of contract if a section of pipeline has buckled, for example, or if they can claim liquidated damages because the project finished late.

    Craig Tevendale, associate, litigation and arbitration practice, Herbert Smith

    Nuclear Power

    World electricity requirements are predicted to double by 2030. At the same time, growing environmental concerns over carbon dioxide (CO2) emissions from coal and natural gas have led to international initiatives, such as the Kyoto Protocol, to cut CO2 emissions.

    Nuclear power currently accounts for 16 per cent of world electricity production and 20 per cent of the UK’s electricity supply. Despite growing demand, the majority of the UK’s nuclear reactors are scheduled to be decommissioned and closed over the next 20 years.

    In April 2005, the Government set up the Nuclear Decommissioning Authority, which has been given powers under the Energy Act 2004 to oversee the clean-up and decommissioning of 20 of the UK’s non-military nuclear sites. Decommissioning will open up competition for the contracts for the clean-up operations. The nuclear sector therefore presents legal, financial and technical advisers with an evolving market.

    A much-debated question is: how will the UK cope with the rising energy demand while at the same time filling the supply gap left by the closure of its existing fleet of reactors and meeting its commitment to reducing CO2 emissions?

    Over the past year or so, new nuclear build has been championed as the answer to this challenge. Its exponents argue that new nuclear reactors will assist in filling the energy gap; ensure that there is an uninterrupted supply of energy in the UK while reducing dependency on imported fuels; and enable the UK to meet its promise to reduce carbon emissions because nuclear power stations emit very little CO2.

    If new nuclear build does become a reality, lawyers will be called upon to advise contractors on building and financing new power stations, as well as in respect of the law that exists to regulate the nuclear sector including for instance the licensing requirements and liability and insurance regimes that exist under the Nuclear Installations Act 1965.

    Building a nuclear power station is an expensive undertaking and therefore the Government and the market will need to decide how the construction risks of the new build programme can be best managed. Not only does the build programme involve high capital cost, but getting to the stage where there is an operational power station that sells electricity and brings in money to pay off the upfront capital investment takes a long time. The timescales and uncertainties are seen as partly attributable to the intricacies of the UK’s regulatory and planning regime.

    In order to build or operate a nuclear reactor, the contractor must be granted a licence under the 1965 act. Under the present regime, station designs are looked at on a site-specific, case by case basis. The challenge for lawyers will be to work with the contracting community and the Government to advise on how the approvals process can be made to work efficiently, while ensuring that a rigorous safety regime is maintained.

    Because of the large capital investment and construction time periods, nuclear build is a long-term proposition. Conversely, the energy market that the nuclear station will supply is notoriously short term, and contractors and their lenders will want to ensure that the unpredictable nature of the electricity market does not jeopardise the achievement of returns on their time and money investment. Lawyers will have to work with the Government and the contracting community to ensure that, once the new power stations are built, there are mechanisms in place to minimise the risk of electricity demand not providing a steady return and to consider any state aid implications if any government assurances are offered.

    Caroline Powell, associate, corporate practice, Herbert Smith