Energy sector Construction Dispute Resolution

Energy sector disputes are the pinnacle of construction and engineering disputes in terms of complexity, commerciality, political intervention and persuasion. Generally, when energy sector construction projects go wrong, there is the potential for massive, headline-grabbing disputes that need to be approached with specialist knowledge of the industry, the players and the political environment. More than anything, however, there must be an awareness that nothing happens in isolation. Every design error, or badly welded joint, risks leading to a cascade of claims.

Energy sector construction disputes are typically linked with common themes of complex and sometimes new technology, low tolerance of defects and high thresholds for contractual and regulatory compliance. As one would imagine, projects in the energy sector include:

• laying of pipelines (buried subsurface, sunk beneath hundreds of metres of water, and across land with vast variances in natural features);
• construction of power transmission infrastructure;
• construction of power plants (ranging from traditional coal to nuclear power projects, but also more sustainable options, such as hydroelectric and ‘energy from waste’ plants);
• construction of refineries;
• construction of liquefied natural gas (LNG) liquidation and regasification facilities;
• development of port facilities for the loading and unloading of oil and LNG;
• construction of offshore platforms and supporting facilities (storage tanks, processing facilities, pipes, etc.); and
• development of solar and wind farms.

Each of these types of project presents its own individual technical challenges. Given their scale, many involve additional challenges, such as crossing international borders or involving construction in inhospitable environments, such as remote areas or offshore.

The regulated and political environment, coupled with development in technology, expand the breadth of the challenges further still. In the United Kingdom, for example, the energy-from-waste industry has successfully contributed to a reduction in the amount of biodegradable household waste sent to landfill over the past 20 years or so. Energy from waste, however, is not truly a source of renewable energy in the same way as solar or wind.

The ease with which household waste can be treated through these facilities has also affected recycling rates. Incinerating otherwise recyclable materials to generate electricity discourages efforts to preserve resources and potentially even creates a disincentive to generate less waste. It is no surprise, then, that there are links between the pressure to utilise these facilities and reduced recycling rates.

Design and engineering

The design and engineering of an energy project can be a highly complex area. In large energy projects, it is commonplace for there to be a detailed front-end engineering design phase prior to an investment decision being made.

The primary purpose of this stage is for a basic engineering design to be developed, from which an indicative cost package can be prepared to allow an owner to make a decision on investment; however, this phase can be fertile ground from which points that feature heavily in subsequent construction disputes may be harvested.

Decisions made during the design stage have perhaps the most impact, positive or negative, on the later progress of the project. Typically, designers will define the functional requirements: how the facility is to perform and under what operating conditions.

From this point, generally the design is developed, materials and components are selected, operator requirements are integrated and other factors, such as design life, are taken into consideration. In parallel, detailed costing scenarios are developed to ensure the design of the facility will fit with the owner’s costing and financing arrangements. Most technical challenges are identified and managed during this stage.

It is not uncommon for the eventual contractor (usually an engineering, procurement and construction contractor) to work hand in hand with the owner to develop and refine the front-end engineering design. Although this has the advantage of collaboration, the contractor’s interests are not always aligned with the owner’s.

For example, contractors may be forced to adopt working methodologies they would not select if the choice were entirely their own, probably as a result of pricing pressure, brought to bear to ensure the project can be completed within certain cost constraints. Depending on the pricing methodology for the construction work, these issues tend to simmer for a good while, bubbling to the surface at a later stage.

Construction

One hallmark of construction disputes in the energy sector is the duration of the construction, with time typically being measured in years. The scale of these projects alone brings inherent complexity in supply chain, access, logistics and workforce management. Challenges will also arise if projects are being undertaken in inhospitable locations, such as offshore or in remote or developing regions.

As touched on above, construction disputes are almost invariably founded on the balance in the contracting framework. Timely performance is often a central cause, and likely to lead to significant financial consequences. Like most traditional construction disputes, claims that stem from delay or disruption include, on the one hand, increased build costs, exposure to liquidated damages or reductions in any contractual incentive regimes, and on the other, claims arising from losses to production, breach of ancillary agreements and those relating to the financing arrangements. Given the importance of energy projects, disputes are also likely to bring with them the added pressure of government influence and publicity.

In addition to timely performance, the cost of performing the work, and changes thereto, is another key root for disputes. There is no fixed approach to payment in construction contracts, which can range from a lump-sum turnkey approach right through to a hybrid of payment methods over different stages of the performance of the work.

Of course, payment is closely associated with risk allocation, and just because a contracting arrangement is traditional or straightforward does not mean that disputes will not arise. Indeed, disputes arising from traditional lump-sum contracts have the same propensity to arise as those in which the parties have carefully allocated risk and reward between them.

Environmental concerns during the construction phase are also commonplace, and can be problematic for owners and contractors alike. Taking wind farms as an example, these represent a new source of impact and disturbance for birds. This can manifest itself as a direct effect from bird strikes to more subtle effects, such as changes in breeding and migration patterns. Depending on how and when these issues arise, both parties could face delays and claims for additional costs, as well as possible sanctions.

As with other types of construction projects, ongoing energy construction projects have also been affected by general supply chain issues and inflationary pressures on labour and financing costs in recent years, as well as on shipping and construction materials.

The International Renewable Energy Agency (IRENA) has reported that the supply chain constraints that began in 2020, and the general commodity price inflation beginning in 2022, are now being felt in project costs much more widely than in 2021, at least for onshore wind.

Commissioning and start-up, and operation and maintenance

Following construction is the critical phase of commissioning and start-up. It is during this phase that risks associated with materials, workmanship and quality tend to arise. The range of risks that can arise span those that relate to snagging and other contractual non-conformances (such as in respect of materials and workmanship), right through to ‘failure’ scenarios, where the asset fails to meet performance level requirements, for example.

Needless to say, the consequences of such a range of issues can be equally broad in scope. Even if a plant passes the start-up steps, quality-related issues can still arise during the operation and maintenance phase.

Key players: significance of the state

Many of the instantly recognisable global entities (whether or not they specialise in the energy sector) will appear as contractors, construction managers and material suppliers in construction projects within the energy sector. Often, those sitting on the owner’s side of the table are not such familiar faces – there are relatively few owners with multiple truly large-scale energy projects on their ledger.

Profit and energy generation are generally the key motivators for new projects. Owners are faced with the challenge of trying to design and build in an environment where the justification for doing so can evaporate at the drop of a hat if, for example, there is movement in a commodities index. In a world of US$100/barrel oil, projects can afford grand designs, ‘nice-to-haves’, multiple levels of redundancy and the use of the very best materials.

However, volatility in the oil price can lead to an entirely different dynamic, causing owners to seek to engage in ‘value engineering’, or to vary the timing (either by accelerating or delaying) to catch an anticipated market upturn, or to get out of capital costs as quickly as possible. This can radically alter the dynamic between owner and contractor, shifting a successful project relationship towards one that is operating under extreme pressure.

Recent years have shown strong trends towards ever more interventionist host states in this regard, with projects being audited to ensure that no ‘gold plating’ is occurring. This often occurs when audit bodies, designed to root out corruption and check for black-and-white compliance with procurement regimes, are unleashed. One may be forgiven for assuming that this applies more to projects undertaken in developing nations, but it is also applicable in first world developments, particularly where margins are tight.

It should be noted, however, that this approach can sometimes ignore real-world dynamics of how construction decisions are taken during the course of a project, or what normal industry practice is in the energy sector (with its belt-and-braces approach to safety and reliability, and the constant conflict between using expatriate expertise and complying with requirements to use local resources).

Perhaps not surprisingly against this backdrop, contractors are more astute than ever as to their contractual and legal rights, particularly in emerging and developing markets. Indeed, contractors are becoming ever more sophisticated in their understanding of local laws and how those laws may affect or drive their ability to make claims against an owner.

Claims for ‘equitable rebalancing’ are becoming more prevalent in these markets and present particular concerns for owners who typically operate in common law jurisdictions. The nature of large energy projects dictates that contractors, designers, subcontractors and suppliers, more often than not, have a diverse range of nationalities and backgrounds, bringing an added legal and social complexity to the working environment.

Issues beyond employer–contractor disputes

Construction disputes in the energy sector can also be at the mercy of international and domestic politics, primarily as a by-product of the importance of natural resources to sovereign and other international actors. Determining entitlement to natural resources often requires recourse to international law, as many reserves lie in areas to which claims of ownership are disputed. This is particularly true of offshore assets, including production facilities and pipelines.

As noted above, construction projects in the energy sector are also distinguished from general construction projects by their sheer scale and scope, which invariably warrant international cooperation. Pipe-laying, for example, often requires passage through multiple nations or seas. When a project is contemplated, the initiating country may have a choice of routes through different states – a decision that may be guided by existing international relations, and with the potential to have a considerable effect on future international relations.

Clearly, the presence of energy construction projects is of great importance to national leaders, owing to the international recognition and associated foreign investment. It is important, therefore, to see construction projects in the energy sector against the backdrop of turbulent international relations, as such projects may assume a pivotal role in the maintenance, progression or deterioration of relations between sovereign actors – a factor that is beyond the control of the contractor, and that may also be outside the influence of the owner, unless investments have been carefully structured to give access to protection under a bilateral or multilateral investment treaty (such as the Energy Charter Treaty), which may provide access to a remedy via an international tribunal.

Recognition of the reliance on, and significance attributed to, natural resources can present other complications for construction projects in the energy sector. Indeed, the energy sector itself is an obvious target when there is disagreement among nations.

Construction projects in the energy sector may, therefore, be subject to a greater risk of complications as the energy sector may be ‘held hostage’, as a means of trying to coerce another nation to adopt, or cease, a particular course of action.

Construction and energy specialists in dispute resolution

As to the conduct of these disputes themselves, many of the same issues arise as in any construction arbitration. It is clearly desirable (depending, perhaps, on the strength of the case) to find arbitrators who have experience in both construction and energy matters. Potential sources of information about such individuals include the Permanent Court of Arbitration (which maintains lists of experienced energy arbitrators and energy expert witnesses) and the International Centre for Dispute Resolution’s Energy Arbitrators List, which is freely available online.

As ever, market reputation remains an invaluable resource. In addition to experience, availability will be a factor worth particular consideration. Energy construction disputes are typically highly document-heavy, involve multiple sub-issues and often are resolved over the course of years rather than months. Good availability, running far into the future, is obviously key, but a common problem for the most sought after and desirable candidates.

The multiplicity of parties and multiple related disputes (with interlocking contracts) also gives rise to the issue of whether or not consolidation of disputes is possible, or even desirable. While always a case-specific question, anecdotal evidence suggests that despite ever greater access to consolidation mechanisms via the latest editions of the various institutional rules, parties in this sphere often prefer to keep each step in the dispute chain separate. This can, and does, lead to the danger, and reality, of inconsistent results and contractual gaps.

Given the political and environmental dimensions of these cases, energy construction disputes can also see attempts by third parties to intervene. This is particularly the case where arbitrations are being fought in the World Bank’s International Centre for Settlement of Investment Disputes mechanism, where there are trends to permit both greater visibility in what is normally a confidential world, as well as active intervention by way of amicus curiae briefing and interjection.

At best, such interventions delay awards and increase cost. At worst, they take otherwise private disputes in different directions from those that either of the original parties would intend or desire.

Concluding notes - The allocation of the risk of these claims as between the owner and the contractor, and as between the contractor and the subcontractor, will be key to the issue of who is dragged into the fight, and who will be left carrying the can – and that is before the effect of third-party interventions from states, public interest groups and other concerned parties is felt.

- courtesy Global Arbitration Review.