Hot issues in district cooling
In this article, Martin Preston* sets out some of the issues that need to be considered in the procurement or provision of district cooling.
01 March 2012
DISTRICT cooling is a means of providing cooling from a central plant to one or (usually) more buildings.
One of the advantages for developers is that by having the district cooling sited outside the buildings making up a development, it provides a greater lettable area due to the ability to dispense with air-conditioning units within those buildings.
There are two district cooling models used in the Middle East – central plants and captive plants. Central plants are developed by the district cooling provider at his own risk with the aim of selling district cooling services to developments within the vicinity of the plant. Captive plants serve a particular development or developments following the grant of a concession from the master developer to the district cooling provider for the provision of district cooling to the development(s). There are, however, issues that need to be considered in the procurement or provision of district cooling.
Demand risk is a key issue for district cooling providers. In deciding whether it is feasible to construct a central plant or whether to enter into a concession agreement for a captive plant, a district cooling provider will need to decide whether there is, or is likely to be, sufficient demand for district cooling. This was a particular issue during the downturn as developments were scaled down, postponed or cancelled and demand for district cooling was affected as a result.
District cooling providers of captive plant will look to mitigate this risk in their concession agreement. This may be done by seeking an undertaking from the master developer that the latter will assume some of the demand risk, ensuring that the district cooling provider is not required to commence construction of the district cooling plant until a minimum number of end-user agreements have been entered into and/or ensuring that end-users are required to ascertain that any subsequent purchasers are obliged to purchase district cooling from the district cooling provider.
Collection risk is another key issue on district cooling projects. Payment for district cooling can be made either by the master developer or by residents of the developments (end-users). Typically, when supplying district cooling to a development, a district cooling provider will not wish to invoice end-users directly but will prefer to invoice the developer who will pass these costs onto the end-users through the service charge. In considering whether to accept payment by the developer, the district cooling provider will need to satisfy itself as to the ability of the developer to pay the district cooling charges and, if necessary, seek some form of credit support such as a parent company guarantee or letter of credit.
If the district cooling provider takes the risk of collecting charges from the end-users, it will need to build in safeguards to ensure that it is able to do so. This may involve appointing a facilities manager to assist with collection, in which case the latter may be incentivised to collect the payments by having all or a portion of its payment being dependent on the collection of the district cooling charges from end-users.
The district cooling provider will also want to ensure that the end-user agreements contain rigorous succession obligations so that subsequent purchasers are required to enter into an agreement with the district cooling provider for district cooling and/or to take an assignment of the original end-user agreement. The district cooling provider may also, if it is permitted by local laws, look to include rights to cut off the supply of district cooling for non-payment.
On a number of district cooling projects there is a split between the reticulation network (through which the chilled water passes) and the district cooling plant itself. Often, the master developer will construct the reticulation network and attempt to sell it to the district cooling provider. This approach creates a number of risks. For example, a district cooling provider may not be prepared to accept the risk associated with a reticulation network it has not designed or constructed and the parties will need to agree how defective design and/or construction will be addressed. For example, if the district cooling provider is taking end-user collection risk but is unable to supply chilled water due to a defect in the reticulation network, it will want to be compensated by the developer. Another issue that may arise with this approach relates to the cost of the reticulation network as the two parties may have differing views as to how much it should cost.
A master developer letting a district cooling concession will be concerned to safeguard its reputation by ensuring that it selects a recognised district cooling provider with a strong balance sheet. In addition to this, various requirements can be included in the concession agreement to encourage good performance by the district cooling provider such as key performance indicators (KPIs) against which the district cooling provider’s performance is measured and against which penalties may accrue.
Ultimately, failure to achieve an acceptable level of KPIs may trigger termination of the agreement for district cooling provider default. In order to ensure that charges are in line with the market, the agreement may also contain benchmarking provisions which require the district cooling provider to demonstrate that its charges are in line with the market and are competitive.
In addition to these considerations, typical contractual provisions need to be considered by the parties such as force majeure remedies for breach, termination and the consequences thereof.
* Martin Preston is partner at Norton Rose (Middle East) LLP Dubai office. Norton Rose Group is a leading international legal practice with offices in Europe, Asia Pacific, Canada, Africa and the Middle East, and Latin America and Central Asia.
The group has had a presence in the Middle East for 30 years and has advised developers, lenders, and contractors in relation to the legal aspects of a wide variety of construction and infrastructure projects in the region.
With a combined team located in the Abu Dhabi, Bahrain and Dubai offices, Norton Rose (Middle East) LLP is able to provide both contentious and non-contentious support to financiers, developers, contractors and specialist contractors in the region.
Legal queries related to the construction sector can be addressed to Norton Rose (Middle East) LLP through Gulf Construction magazine at editor@gulfconstructionworldwide.com.
