Emissions Guarantees…..Make Good Obligations…..Fair or Foul?

Published: July 19, 2022

For many gas fired power plant operators in today’s market, technology selection is not just down to criteria like capital and operational expenditure over time or power output and efficiency but prudent operators must also ensure that the impact of their power plants on the environment is minimized. For gas fired power plants, emissions can take on a myriad of forms that affect the environment ranging from combustion products, waste heat, wastewater, and noise. Our bone of contention here however is the disturbing trend OEMs are beginning to adopt in an effort to address air emissions limits such as CO and NOx post build – during the service period of the power plant.

Emissions legislation in different countries are often based on the best available emissions control technology. To that effect, environmental permits are handed out to operators who employ technologies that comply with emission limits set out in local legislation, there is typically no form of derogation permitted, either operators comply, or they cannot operate. To that effect there are a various technical solutions available on the market today ranging from dry low NOx burners to water /steam injection solutions and SCR systems. Most of the known and reputable OEMs offer these technical solutions.

In the not-so-distant past, if a power plant operator entered into a service agreement with an OEM, they would be offered “not to exceed emission guarantees for CO and NOx”. The intent of these guarantees was to line up contractual guarantees with the emissions limits set forth in an operator’s environmental permit and ensure compliance. Operators would be obliged by the OEM to comply with a number of restrictions such as adhering to a prescribed fuel specification (in an attempt to limit the harmful components of exhaust gases), limited operation on liquid fuel and generally operating the units within logic settings and temperature constants established by the respective OEMs (typically no peak firing).

Now what happens if an operator adheres to all these limits and due to no fault of theirs the power plant exceed said limits? Well typically OEMs would have make-good obligations as their sole and exclusive remedy. This means that at their cost, OEMs would remedy the defect and ensure the plant complied with the limits and returned to service. Unlike other performance parameters such as power output or heat rate, if a power plant does not comply with environmental permits, in most developed electricity markets they have to cease operation until they are compliant. This is why OEMs have historically provided make good guarantees as sole and exclusive remedies because the resultant effect of non-compliance on an operator’s availability and finances (loss of profit etc.) are dire to say the least.

Chimneys and dark smoke over factory at sunset

Sounds fine and dandy right, so what is the issue? What has changed? Service business especially long-term service business, even though highly profitable for OEMs and Independent Service Providers is risky business. So much so that some OEMs who offer operation and maintenance contracts sometimes create a hold separate company that is an entirely separate legal entity from the rest of its businesses (e.g., new build power plants) in an effort to contain this portfolio of risk. If their service business fails, the intent of their hold separate structure is to contain the failure. To that end, what we have observed recently in the marketplace with some OEMs is that they are transferring some of this inherent risk back to the power plant owners and one particular area where they are transferring risk is with emissions. OEMs are still offering make-good guarantees when the plants within their care are exceeding contractual emissions limits, however they have now employed a mechanism whereby they cap their make good obligations to a monetary value. Typically, the cap has two components, there is a monetary cap per event and an overall monetary cap per year. OEMs defend these caps as with a rationale that they are endeavoring to employ commercially reasonable efforts to address the power plant owners’ issues. Anything in excess of these commercially reasonable caps will be at the owners’ account. Some of the more aggressive OEMs have actually linked this monetary cap for emissions to the monetary caps for collateral damage. The implications for an owner could be damning to say the least. In the event that an owner has an emissions issue, due to no fault of theirs and the OEMs or service providers remedy the situation albeit exhaust the “commercially reasonable” monetary cap in doing so in a given year, owners are then left with no risk coverage if there is further collateral damage on their plant within the same year. They would have the cover the damage out of their own pockets (typically with insurance coverage) and strangely enough OEMs profit from these situations because they typically offer to remedy the damage at exorbitant rates. So, this brings us full circle, is the predicament we find ourselves in fair or foul?

Well, it depends what side of the fence you sit on. If you are an OEM or service provider, obviously lowering your risk profile whilst increasing shareholder value is where you want to be. The power market OEMs find themselves competing in today is dynamic and challenging at best, OEMs are not only being pushed to develop cleaner and efficient technology but also flexible technology as market dynamics and the onset of renewables has many heavy-duty plants turning to a cycling regime. This effect has resulted in a plethora of gas turbine operators in today’s market clamoring for low load operation products to reduce their start-up costs and start-up time so they can essentially park their plants whilst still being emissions complaint. As a result, OEMs are pushing their technologies to the limit and logically they want their customers to share a bigger portion of the risk. Makes sense, right? Here is the issue though, emissions are unlike any other performance criteria. If there is a shortfall in power output or efficiency the contractual remedies are generally straightforward, the OEMs pay liquidated damages subject to a monetary cap and this is treated as the sole and exclusive remedy and the plant can continue operation unimpeded. This remedy unfortunately does not fly for emissions limits, if a plant does not adhere at a minimum with what is in their environmental permit, in a functioning market the plant cannot be operated and the consequential damage depending on the downtime would result in a loss of profit that is significant to any plant owners bottom line.

This worrying trend of OEMs and service providers now attempting to employ a “commercially reasonable” financial cap on their emissions compliance make-good obligations is not a suitable remedy for a technology provider as the bulk of the risk has shifted to the power plant owners and at worst, they will be left footing the bill through no fault of their own. Compliance is compliance and OEMs and service providers who rope plant owners into expensive service agreements under the guise that “we are here to share the risk” cannot be allowed to shirk their responsibilities going forward. So how can we ensure that readdress this risk imbalance? What contractual mechanisms can power plant owners put in place to provide them some modicum of protection? These are some of the issues that we here at SS&A Power Consultancy seek to address with our clients and if you are having similar issues in your service contracts, you are not alone. Reach out and we will be happy to help.


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