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Good deal structure tactics reduce cost

Cheaper wind turbines and balance-of-plant hardware are only two elements of bringing down the cost of wind energy. Much can also be gained by improving transportation and installation logistics and paying attention to financing arrangements. Less obvious a means of cost cutting is the fine-tuning of legal structures: getting the deal structure right for bulk purchase of wind turbines greatly reduces the transaction costs per unit.

Bulk purchase of wind turbines through master agreements has many additional benefits beyond reducing the transaction costs per unit bought. The initial expense of a complex legal structure can pay for itself in considerable added value in the long run

 

Cheaper wind turbines and balance-of-plant hardware are only two elements of bringing down the cost of wind energy. Much can also be gained by improving transportation and installation logistics and paying attention to financing arrangements. Less obvious a means of cost cutting is the fine-tuning of legal structures: getting the deal structure right for bulk purchase of wind turbines greatly reduces the transaction costs per unit.

As wind projects have grown, so have orders for wind turbines. In response to the limitations of traditional wind turbine supply agreements, wind power developers are turning to "master purchase agreement structures," big orders made well ahead of when they are needed, yet attuned to the complexities of large scale procurement. Wind developers who have used the master agreement approach have improved efficiencies and lowered overall transaction costs substantially.

The desire to buy in bulk has been driven by the shortage of turbines. Despite rising demand, manufacturers have not ramped up their production capacity to keep pace, pointing to the perennial uncertainty surrounding the tax credit for wind generation in the United States, the world's largest wind market, as a major disincentive to investment in more factories. In a turbine-constrained world, wind project developers want to lock in supply and are increasingly buying turbines on a multiple project basis and in larger numbers, long before project identification is complete.

When buying so many turbines early in the procurement process, developers need the flexibility to modify, store and redirect turbines as necessary. Traditional wind turbine supply agreements, which have tended to address the purchase of turbines project by project, lack the flexibility to respond to the complications posed by the merging of large project pipelines and long lead-time procurement.

Just the bare details

Modelled after master agreements commonly used for commodity and derivatives transactions, the master turbine supply agreement -- usually referred to as a framework agreement in the wind industry -- sets out the legal terms and conditions from purchase to delivery to the end of the warranty for all subsequent turbine purchases. Buyer and seller then enter into individual transactions, using the master agreement as the governing document. Setting out legal terms ahead of time makes execution of multiple transactions over a long period easier, minimising the time required for each. Costs drop.

This kind of purchase order typically includes only the basic commercial terms, namely turbine quantity, manufacture date and price. Often, a pricing formula is hardwired into the terms of the master agreement, providing an element of price certainty. Supplier and purchaser may execute any number of purchase orders over time under a single master agreement. Both firm and conditional purchase options may also be set out in the master agreement.

Wiggling room

The master agreement can give a buyer flexibility with respect to in-land transportation and installation. After the execution of a purchase order, a master turbine supply agreement puts into motion a number of mechanisms and timelines, including engineering and storage parameters and the option to combine turbines from separate purchases in a single project.

Once a project has been designated, previously established warrantee and service agreements attached to the master agreement are executed automatically. Delivery schedules and other guaranteed dates operate on a formula basis related to factory location, shipment port and project site.

This agreement structure provides a number of benefits over and beyond lower transaction costs per unit. It gives developers greater manoeuvring room to respond to weather conditions, construction schedules and permitting delays, or to incorporate the latest turbine models and updated designs as well as new options under standing legal terms and conditions. With minimised transaction time and costs, developers can make more purchases in a shorter period of time. Having a single, long term channel of communication with a turbine supplier helps a developer build a long term relationship and creates incentives to resolve short term problems. Confidence in the terms of delivery enables it to better integrate balance-of-plant terms.

There are practical limitations to the master agreement structure. Though transaction costs per unit will ultimately be much lower, due to the encompassing nature of the master agreement, initial transaction costs may be high. Furthermore, some suppliers may need to know regional or project designations at an early stage to avoid costs. Mechanical specifications appropriate to a project in one region may not apply elsewhere, curtailing flexibility. Storage may have physical limitations or be costly and there may be constraints on any supplier's transport, installation, commissioning and support capabilities.

Regardless of these limitations, though, wind power developers can benefit most by tailoring a master purchase agreement structure to their own circumstances, limitations and goals.

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