There are many contractual considerations besides price that an EDC should consider in the course of negotiating power supply agreements
Clients are typically, and understandably, focused upon price when evaluating proposals for the purchase of electric power from a supplier other than the local electric utility. However, price is only one of several considerations that an edge data center (EDC) purchaser should consider.
Since electricity is a significant cost line item, it is prudent to compare potential sources in light of the location and needs of the existing or proposed EDC facility. Options may include full or transportation service from the local electric utility, a power supply contract, an onsite electric generator or colocation with an electric production plant.
This article generally discusses electricity procurement and focuses primarily upon contractual and negotiation considerations relating to procuring electric energy from a third-party source such as an energy services company (ESCO). For convenience, in this article, suppliers are generally included under the term “ESCO.”
Preparation for Effective Power Procurement Negotiations and Contracting
Know thyself. It is gospel in the energy sector that a purchaser’s in-depth knowledge of its facilities and equipment together with the characteristics of its power needs should primarily drive the source and type of the power supply. Other necessary information includes an understanding one’s own legal framework and possible limitations. For example, covenants with one supplier or utility tariffs may constrain an EDCs ability to procure power from another source. And, organizational structures may impede effective contracting. For instance, power procurement in an organization was handled by a different department than capital construction. The procurement department negotiated a power purchase agreement for a facility’s entire load without realizing that the construction department was negotiating for the installation of a cogeneration system to provide baseload power to the facility.
Determining the Projected Usage of EDC Facilities. Sourcing and negotiating for individual or multiple EDCs’ power supply should be conducted in conjunction with an analysis of the EDCs’ history of (or projected) usage. If multiple EDCs are involved – such as modular, containerized units – consideration should be given to collective usage curves. In addition, as small, localized, self-functioning, data centers that perform IT deployments for cloud services, the power requirements of EDCs have much in common with those of telecommunications facilities such as microwave or cellular telephone monopole towers which require distributed data center support.
Procuring for multiple EDCs or multiple accounts for a single, significantly sized EDC can provide a negotiation advantage both in bargaining power and quality of usage. Since an EDC is likely to have to have a relatively flat load curve and 24/7 demand, this is a desirable customer from a utility or ESCO viewpoint.
An EDC should ascertain its own projected power requirements and reduce these to an accurate, written description. Important elements of this description include the answers to the following questions. What are the load curves and operating characteristics of the facility? Does it have dual energy source capabilities (i.e. for a combination of gas for self-generation and procured power)? If so, does it have synchronous on-site generation able to handle the demand on-peak or during interrupted periods? What are its metering and monitoring capabilities? What are the capabilities of purchaser’s staff to administer complex supply contracts? The answers to these questions have a significant bearing upon the drafting of the power supply contract.
Location. Any analysis of power procurement includes an evaluation of the elements of the location and usage of the EDC. Since EDCs are typically located within the vicinity of end users and their devices that use applications and data, some of these locations can be remote. Remote locations can bring their own issues. For example, whether purchasing full service from a utility or having a distribution utility deliver power purchased from an energy services company, if the necessary transmission or distribution lines are not constructed or are insufficient, the EDC may have to pay the utility to construct a line extension. These construction costs can be significant, particularly if the EDC is the first customer on the line extension. Those construction and supply costs must be weighed against the cost of installing and operating on-site generation which can raise reliability issues.
Sources of Power. Depending upon the location of the facility, there may be several supply and delivery options from the local electric company to ESCOs to on-site or co-located electric generation. Within those categories, there are further options. As discussed above, the primary methods of obtaining or generating power are from:
- A local electric distribution utility under its full-service tariff;
- An ESCO in a deregulated state which power is distributed by the utility;
- Facility owned on-site equipment and utility stand-by; and
- On-site generation owned by a third party or colocation with an adjacent electric generator and power provided under a power supply agreement.
Power Supply Agreements
In contracting with an ESCO or other supplier, following are negotiating and drafting points that an EDC should bear in mind:
Obligations are imposed by state requirements upon ESCOs. Since deregulation differs among the states, purchasers should become generally familiar with the legal and regulatory requirements for ESCO relationships with commercial customers. State agencies will often have a website which provides information on the standards applicable to ESCOs and lists qualified ESCOs. Regulations can also include uniform provisions which must be included in energy sales contracts with retail customers. Regulators may impose disclosure requirements upon ESCOs covering areas such as billing, customer deposits, obtaining and protection of confidential information received from the purchaser, purchaser rights and obligations, termination, switching providers, and complaints which are incorporated into the contract. These protections are important and, if not included in the contract by regulatory requirement (or example, if regulatory requirements apply to residential but not commercial customers), the purchaser should make certain that such protections are included in the contract language.
Function of Local Distribution Utility. An electric utility will distribute power that is provided to it by ESCOs at transmission points at the perimeter of the utility’s system and deliver it to the utility meter(s) for the EDC customer accounts. The customer will be charged based upon the applicable service classification within the utility’s transportation tariff. In some cases, the tariff will provide that the utility and customer must enter into a separate agreement for the delivery of power. This may be an opportunity for the EDC to negotiate with the utility for as favorable terms as the EDC is able to achieve.
ESCO Contractual Formats. ESCOs will have contract forms which are typically required to be filed with state regulatory agencies. These forms vary and can be called power purchase agreements or PPAs. One typical format would be a fixed or variable price electricity supply contract containing:
- A “customer disclosure statement” that sets forth terms such as price(s) – including a basis for calculating variable prices if applicable – duration, early termination (with and without penalty), amount of early termination fee, late payment fees, expected kWh consumption and identity of accounts;
- Variable pricing with a specific reference for calculating prices throughout the entire term of the contract. Contracts with set variable pricing with a cap for the first year subject but not in subsequent years should be avoided;
- Early termination provision, which can be unrealistically burdensome: ESCOs can be expected to seek to collect the early termination fees and even resort to collection lawsuits to do so;
- A requirement to notify the ESCO in the event of anticipated changes in power requirements and the imposition of charges in the event that the customer fails to do so; and
- General Terms and Conditions. These may be considered by some as “boilerplate” and hardly worth reviewing. Sales personnel may assure EDCs that these are standard. From an experienced energy attorney’s perspective, the word “standard” can cover a multitude of sins in energy commodity sales and close attention should be paid the general terms and conditions.
Contractual provisions between the ESCO and the distributing electric utility. The distributing utility’s relationship with the ESCO is partially governed by the contract between the ESCO and the utility. A purchaser may be billed by the ESCO or by the utility on behalf of the ESCO under what is called a purchase of receivables (POR) agreement, or by both.
Request for proposal (RFP) process. An RFP process should be used to select an ESCO. Without such a uniform process, it can be difficult to compare ESCO proposals.
The ability of the ESCO to meet its contractual obligations to the purchaser rests not only upon its strength but also upon the type and strength of the upstream companies and the quality of the supplier’s contracts with them. It is key for the purchaser, by questioning or requiring information to be provided in response to an RFP, to obtain as much information as possible about the upstream sources upon which the ESCO is relying. Following are examples of the questions purchasers should ask:
- Does the ESCO have its own generation? If so, what is its source of fuel? If the ESCO does not have its own generation, how will the power be supplied?
- Does the ESCO have long term source contracts? If not, how does the ESCO plan to purchase power? What arrangements will it have with the independent system operator (ISO), if applicable?
- Is the ESCO affiliated with a fuel supplier such as a pipeline and storage operator? What arrangements has the ESCO made to provide transmission?
My preference is to use a comprehensive RFP which seeks detailed information regarding the facility and its needs. Where appropriate, I also recommend including the proposed contract in the RFP and asking the bidders to either entirely accept the terms and conditions of the proposed contract or to indicate which portions are not accepted.
The ESCO’s credit. Purchasers should investigate an ESCO’s ability to financially perform. Despite regulatory protections and imposition of financial requirements by utilities and ISOs upon non-utility ESCOs (such as the posting of letters of credit), a purchaser should perform its own due diligence and assessment. Is the price of the electricity sufficiently below other market prices (e.g., to gain market share) that the ability of the ESCO to deliver an offered price (particularly a fixed price) is questionable in light of ESCO’s finances? Is the ESCO a credit risk? The answer to the last question is crucial because, if the ESCO is unable to provide electricity when required under the contract, an important purchaser’s recourse is the ESCO’s credit. Considerations related to the question of whether ESCO is a credit risk may include (to the extent that these can be determined) are the ESCO’s cash position, the ESCO’s credit line, and whether any sale of ESCO as an entity contemplated and, if so, why.
There have been significant ESCO bankruptcies within the past 12 months. In such a situation, the failing ESCO may attempt to sell its business and move its contracts to another ESCO. If it is unable to sell its business, the ESCO may have no choice but to “drop” its customers – meaning that they become full-service utility customers. In such a situation, the EDC would lose the benefits of any favorable fixed price contract it might have with ESCO. Alternatively, the EDC might be able to enter into a new contract with another ESCO at the best price it could gain at that point.
How should non-performance provisions be limited? Purchasers should closely examine the contractual justifications for non-performance. What justifiable reasons are there for either ESCO’s or purchaser’s non-performance under the contract? Does the ESCO have the right to suspend delivery in the event of supply-related problems? A purchaser should attempt to keep provisions which justify non-performance by the ESCO to a minimum.
Remedies. For events of justified non-performance by the ESCO, the purchaser should bargain for a contract which provides itself with the flexibility to cover by procuring alternative power supplies without jeopardizing its rights under the contract. For individual events of unjustified non-performance, the EDC should bargain for the right to immediately secure power from another source (including, of course, the distributing utility) and charge any overage in price back to the ESCO.
Contract cancellation in the event of bankruptcy. Purchasers should make certain that they are able to terminate the agreement in the event of the ESCO’s bankruptcy. Ironically, an ESCO may be stronger in the event of a Chapter 11 in which the company continues to run its own business (since it does not have to pay many of its obligations) so the EDC may not wish to terminate a favorable contract. Having said this, it is important to consult a professional in the event of a bankruptcy by the ESCO.
The right to adequate assurance. The agreement should include a right for either party to ask the other for reasonable, adequate assurances that the other party can perform the agreement when it appears that the other party will be unable to perform. In the event that adequate assurance of performance is not forthcoming, the requesting party may have the right to terminate the agreement. This is important if a party has reason to believe that the other party may not be able to perform the contract. For that reason, it makes sense to incorporate such a provision in your agreement. It should not be necessary to wait for a default (and compromise to the requesting party’s position) to take action. This is also a remedy under the Uniform Commercial Code (UCC) which and is applicable to electricity sales in certain states.
Consequential damages. The agreement should include a mutual waiver of consequential and indirect damages. The reason for such language is that the parties cannot financially anticipate the burden of each and every risk in the chain of causality which ensues from a failure to perform.
Guarantees and other financial protections. Certain power supply agreements provide that the variable price will always be lower than that of the local utility. In order to protect an EDC purchaser, the agreement must have a clear mechanism for determining the local utility’s costs and identify any and all costs used to determine the cost of utility power. Utility tariffs are complex and the contract language should be specific as to the method for determining the utility benchmark.
“Standard forms.” A prospective EDC purchaser might receive a document which is characterized as a “standard form” agreement. Unless it is a well-established, industry-wide standard form or the form is mandated by regulation, no form should be regarded as standard. Although there is move towards standardized electricity purchase forms, there remains considerable variety to the form of contracts which an ESCO may provide to a purchaser. As a general matter, there are advantages to industry standard forms (as opposed to company standard forms), but they can offer false comfort if they are used without an understanding of their terms. Such forms offer convenience, are typically available in electronic format and can be modified to suit individual transactions.
However, standard forms can also be complex and require careful review especially where the purchaser does not have prior experience with the form. A lawsuit in which this attorney represented a party was complicated by one of the parties’ use (to its disadvantage) of an industry standard form without modifying it to the specific needs of the transaction.
As discussed above, there are many contractual considerations besides price that an edge data center should consider in the course of negotiating power supply agreements. The intent of this article is not to cover all the possibilities, but rather to set out a general outline of certain important points.
This article is meant to provide general information and should not be regarded as legal advice.
Peter Funk is a partner at Funk & Zeifer LLP where he practices in the area of energy law with a focus on energy generation and energy management/conservation projects. Funk's column Legal Perspectives discusses legal issues pertaining to energy generation and conservation.