Offshore wind in Australia - Detailed financial security requirements open for consultation

The Offshore Electricity Infrastructure Amendment Regulations 2024 (Draft Regulations) and a Consultation Paper have been released for discussion, which seek to operationalise the obligation in section 117(1) of the Offshore Electricity Infrastructure Act 2021 (OEI Act) to provide financial security to the Commonwealth in respect of the conduct of offshore wind projects. For an overview of the Draft Regulations, please see our previous blog post here.

We anticipate that the financial security aspects of the Draft Regulations will impact the return from offshore electricity projects. Industry should assess the implications of these measures. The consultation process closes on 12 May 2024.

Key takeaways

The key takeaways from the Draft Regulations include:

• The regime departs in a number of respects from traditional risk-based assessment of security assurance that is adopted in other industries / jurisdictions.
• The security to be provided is equal to the full amount of the future estimated costs of the decommissioning activities. Security is provided before commencement of construction or installation activities and maintained for the life of the project - 40+ years.
• A holder of a Feasibility Licence must provide security but it is unclear how the requirement would apply as permitted activities do not extend to the installation of infrastructure, though some monitoring equipment can be deployed in the licence area.
• Only cash or cash equivalents (e.g. bank guarantees) will be accepted. Parent guarantees are stated to be impermissible.

Requirement to provide financial security

Section 117(1) of the OEI Act requires licence holders to establish   financial security to protect the Commonwealth from exposure to costs, expenses and liabilities that may arise from the decommissioning of infrastructure, the removal of equipment and property, and remediation of licence areas.

By sections 117(2) to (4) of the OEI Act, regulations may provide for the calculation of security, types of acceptable security and when it must be provided.

The Draft Regulations therefore provide important detail concerning the obligation to provide security. In the paragraphs that follow, we comment on the key aspects of the Draft Regulations as they apply to the implementation of the financial security obligation.

Calculation of financial security

Calculation Methodology

Under section 87 of the Draft Regulations, a licence holder must describe in the management plan how it will comply with with section 117 of the OEI Act. The plan must set out the methodology for the calculation of the financial security amount and the verification process relied on. The method must identify and quantify the costs, expenses and liabilities that may arise as a result of:

• decommissioning of licence infrastructure;
• removing structures, equipment and property from the licence area;
• removing things from a vacated area that would be relevant structures, equipment or property if the vacated area was still part of the licence area of the relevant licence; and
• remediation of the licence area and other areas affected by licence activities.

Secured obligations

We consider that the Draft Regulations could add more detail on what is meant by ‘decommissioning of licence infrastructure’ and removing relevant ‘structures, equipment and property from the licence area’. Is it intended to refer to a process of severing structures from the seabed and their removal from the area or does it extend to the full decommissioning lifecycle, including dismantling and disposing of the infrastructure onshore? The answer will impact the amount and duration of the security.

The reference to ‘things from a vacated area’ in the third bullet point above is also unclear. If the security protects costs of removal of infrastructure and equipment, we wonder what additional ‘things’ might be the subject of the security?

Emergency costs

The method must also take account of costs, expenses and liabilities that might arise from emergencies or unexpected circumstances in relation to any of the above bullet points. The Consultation Paper characterises this as ‘the possibility of costs, expenses and liabilities arising outside a licence area (for example, for emergency situations or for situations where there is a need to rectify environmental damage)’.

We query whether financial security under section 117(1) of the OEI Act extends to such ‘emergency’ costs.

Costs of this nature are difficult to estimate, and these kinds of events seem remote when one has regard to the nature of the removal activity (being the removal of wind turbines).

Exposures to these types of risks are typically managed through insurances, which must be in place before works can commence. As insurance is prescribed as an acceptable form of financial security (see below), it may be the case that it is the Government’s intention that management plans provide minimum insurance requirements in respect of some events, with more traditional forms of security to respond to the cost of planned and approved activities such as decommissioning and removal. We suggest that this approach be clarified.

Verification requirements

By section 87(2)(b) of the Draft Regulations, the management plan must describe how the licence holder has verified the methodology used to calculate financial security.

The Consultation Paper states that licence holders may need to develop bespoke estimation tools or use methods developed in other countries. It also notes that the type of verification used should correspond to:

• the scale and complexity of the calculation method;
• the amount of financial security calculated; and
• the nature of the underlying project.

The Consultation Paper seeks comment on how verification should be approached in the regulations.

From our experience of similar practices within the oil and gas industry, it is evident that calculations of this nature will be an inherently complex exercise. In this context, it is made more complex by the need to calculate these costs many years (potentially decades) in advance of the date they are likely to arise.

This leads to the next fundamental question - when should verification be required? The level of assurance required in calculating costs, expenses and liabilities cannot be meaningfully understood until the nature of the project and the removal works are properly defined. It is difficult to see how verification methodologies can be defined and agreed in relation to these removal costs at the outset of the project, when these parameters will not yet be fully understood and will involve speculative elements. It is therefore our expectation that calculation methodologies will necessarily need to be reliant on the use of broad assumptions until realistic numbers can be developed closer to the time that decommissioning activities are forecast to take place.

Timing of provision of financial security

Timing

Following calculation of the financial security amount in accordance with the management plan, and after the Regulator is otherwise satisfied that the arrangements described in the management plan are appropriate, the financial security must be provided before any infrastructure is constructed or installed in the licence area.

Section 98 of the Draft Regulations allows for financial security to be provided in phases for particular licence infrastructure in accordance with a timetable set out in the management plan. However, the core proposition that financial security must be in place prior to construction or installation of the infrastructure, remains. The Consultation Paper expressly notes that a licence holder cannot defer provision of the financial security to a later time.

The result is that, in most cases, the full security for removal costs will need to be provided at the beginning of the project, despite that a typical offshore wind project may have a life of 40 years.

The costs of providing security will also be significant and may impact negatively on project returns. While the Consultation Paper acknowledges that projects may become commercially unviable without the ability to defer some amounts of financial security, it doesn’t appear that the deferral will be meaningful, as it is described in terms of a deferral tied to later established infrastructure.

We haven’t identified industries where financial security for a full removal cost is required to be posted prior to construction commencing and we note as a point of comparison that in the UK, security for this type of activity is progressively established over the project life.

Varying the amount of financial security

By section 53(2)(l) of the Draft Regulations, if the amount of financial security required to be provided increases, a licence holder must apply to revise their management plan to account for this increase as soon as practicable. The revision must be approved by the Regulator (section 53(1)) and an obligation to post more money arises.

If the amount of financial security that is required decreases, the licence holder may apply to revise their management plan under section 88 of the Draft Regulations. If the Regulator is satisfied with the evidence, it can approve the revision and by section 100, the Minister may then approve a reduction in the amount of financial security.

In circumstances where financial security ceases to be required because there will be no further costs, expenses, or liabilities in relation to the decommissioning, a licence holder may apply to revise their management plan to address the change. If the Regulator is satisfied with the evidence, it can approve the revised management plan and the licence holder is no longer required to provide financial security. Like the above, this also requires Ministerial approval (see section 99).

The Consultation Paper seeks comment on whether the revision of a management plan is the appropriate process for managing changes to financial security, or whether financial security adjustments should be administered through a separate process.

Form of financial security

The types of arrangements that are likely to be considered acceptable forms of financial security include (see section 102(1) and 102(3)):

• an amount received by the Commonwealth under section 119(3)(a) of the OEI Act;
• a cash deposit held by a financial institution;
• a credit facility with a financial institution;
• a guarantee from a financial institution; and
• an insurance policy with a financial institution.

This list is not intended to be exhaustive, as the Minister may determine that financial security in relation to a particular licence be provided in a particular form (see section 97 and Note 2 to section 102).

However, the following arrangements cannot be treated as financial security (section 103(1)):

• an arrangement involving self-insurance (i.e., a licence holder covering costs from its positive cashflow or balance sheet);
• an arrangement where the Commonwealth is a beneficiary of a trust; or
• a guarantee provided by a related body corporate of the licence holder.

Further, section 103(2) prescribes the minimum characteristics that an acceptable form of financial security must possess. An arrangement cannot be a financial security if:

• the arrangement does not limit the ability of persons other than the Commonwealth to recover amounts from financial security;
• it is not certain that the Commonwealth would be able to recover amounts under the arrangement when required; or
• the terms of the arrangement are unclear.

The above must be complied with by all licence holders regardless of their financial standing or credit rating.

For the life of a project, the above approaches will likely result in the lock up of cash or contingent liabilities recorded on licence holders’ balance sheets for those providing security, as well as associated banking costs to regularly renew and procure cash-like security.

The Consultation Paper seeks comment on the appropriateness of the list of arrangements which should and should not be treated as financial security, what definition of ‘financial institutions’ should apply and whether certain credit rating requirements should apply to financial institutions.

Next steps

We encourage industry to take this opportunity to review the financial security aspects of the Draft Regulations and provide comment, prior to consultation closing on 12 May 2024.

If you wish to discuss the Draft Regulations or other matters relevant to licensing and activities under the offshore electricity infrastructure regime, please contact us at our details below.

Written with assistance of Samantha Gates.