On May 1, 2020, the President issued Executive Order 13920, “Securing the United States Bulk-Power System” (“E.O. 13920”) to address what the Trump Administration considers to be national security threats to the U.S. bulk-power system. (See our prior client alert.) The order has engendered concern and confusion among participants in U.S. power project development, including sponsors, investors and equipment suppliers. Pending E.O.13920’s implementation months from now, this article focuses on what is known today about risks that the order presents for these parties and potential mitigation approaches in project contracting.
E.O. 13920 prohibits the “acquisition, importation, transfer, or installation of any bulk-power system electric equipment (‘Transaction’)” by any person, or with respect to any property, subject to U.S. jurisdiction, that is “designed, developed, manufactured, or supplied, by persons owned by, controlled by, or subject to the jurisdiction or direction of a foreign adversary,” if the Department of Energy (“DOE”) determines that a Transaction poses certain undue or unacceptable risks. DOE, working with other federal agencies, is tasked with administering E.O. 13920 and issuing implementing regulations by September 28, 2020.
Under E.O. 13920, “bulk-power system” encompasses:
(i) facilities and control systems necessary for operating an interconnected electric energy transmission network (or any portion thereof); and (ii) electric energy from generation facilities needed to maintain transmission reliability. For the purpose of [the] order, this definition includes transmission lines rated at 69,000 volts (69 kV) or more but does not include facilities used in the local distribution of electric energy.
This expansive definition and the terms “bulk-power system electric equipment” and “foreign adversary,” discussed below, are central to the scope and expected administration of the order. How each term is applied in forthcoming regulations will be critical to determining how far-reaching the order’s impact will be.
E.O. 13920 is part of the Administration’s broader strategy to address perceived national security concerns related to China and U.S. critical infrastructure that has been reflected in changes to, among other things, the jurisdiction and role of the Committee on Foreign Investment in the United States (“CFIUS”). CFIUS has broad authority to review and, potentially, prohibit, impose conditions on or order divestment of, foreign investments into the United States, even retroactively. Increasingly, CFIUS’s attention has been directed at foreign investment into U.S. businesses or projects that generate electricity fed into the U.S. bulk-power system. CFIUS’s focus overwhelmingly has been on China in recent years.
However, CFIUS’s disposition of transactions is statutorily limited to foreign investments into and acquisitions of U.S. businesses or certain real estate. Absent a connection to foreign investment in a U.S. business, CFIUS does not have the authority to review or prohibit the procurement of foreign manufactured bulk-power system electric equipment by a U.S. business. E.O. 13920 is intended to address the lack of a mechanism to screen the foreign sourcing of U.S. bulk-power system equipment.
Contracts that directly or indirectly involve procurement of equipment that may be subject to E.O. 13920 will likely need to address potential scenarios for implementation of the order, including the impact that restrictions or prohibitions on certain equipment procurement will have on the timing and cost of importing such equipment or finding alternatives. In some circumstances, implementation of E.O. 13920 may make a contract impossible or impractical to fulfill.
II. Project and Equipment Scope of E.O. 13920
While the scope of E.O. 13920 is uncertain in several respects, certain broad contours are evident. As a threshold matter, E.O. 13920 excludes from its coverage transmission lines with a voltage below 69 kV and facilities used in the local distribution of electric energy.
A second critical scoping aspect of E.O. 13920 is its definition of “bulk-power system electric equipment,” which includes:
items used in bulk-power system substations, control rooms, or power generating stations, including reactors, capacitors, substation transformers, current coupling capacitors, large generators, backup generators, substation voltage regulators, shunt capacitor equipment, automatic circuit reclosers, instrument transformers, coupling capacity voltage transformers, protective relaying, metering equipment, high voltage circuit breakers, generation turbines, industrial control systems, distributed control systems and safety instrumented systems.
The definition is focused on equipment that can be manipulated to affect volumes of power that are produced or that are supplied to the grid.
While E.O. 13920 empowers DOE to apply the order to equipment that the order does not identify explicitly, DOE is expected rarely if ever to do so. For example, conventional photovoltaic (“PV”) modules are not identified in the definition of bulk-power system electric equipment, and DOE is not expected to interpret the order as covering PV modules. However, it is difficult to predict with certainty which types or sizes of electric equipment will be included within the definition, and it may include other equipment which typically is used along with PV modules for solar generation projects.
In implementing its mandate under Section 215 of the Federal Power Act, which similarly relates to the U.S. bulk-power system, the North American Electric Reliability Corporation (“NERC”) determined that the definition of “bulk-power system” in the legislation, which is identical to the definition in E.O. 13920, was too vague. Accordingly, NERC developed a definition of “Bulk Electric System” with clear criteria specifying the size and types of facilities that are subject to its reliability standards. The NERC definition of Bulk Electric System generally includes transmission systems operated at a voltage of 100 kV and above and generating facilities connected at 100 kV and above with a gross individual nameplate rating of at least 20 megawatts (“MW”), or an aggregate nameplate rating greater than 75 MW.
It is not clear if DOE will follow NERC’s lead in setting minimum size criteria for generation resources subject to E.O. 13920. However, it seems unlikely that the DOE would diverge from NERC so significantly as to include generating resources connected to a distribution system with a voltage below 69 kV. For those generating resources connecting at 69 kV or above, the DOE rules implementing E.O. 13920 would be expected to cover only generating facilities that contribute to transmission reliability.
As noted above, NERC set thresholds of 20 MW for individual generating facilities and 75 MW for aggregate generating facilities. Not all generating facilities subject to the NERC reliability standards necessarily contribute to transmission reliability. For example, in establishing its latest version of cybersecurity standards, NERC developed criteria for identifying Bulk Electric System cyber systems that could have a low-, medium- or high-impact on the reliability of the grid. Cyber systems designated as low impact are not expected to have a significant impact on transmission reliability. Such low-impact facilities include cyber systems associated with generating facilities with an aggregate capacity of less than 1,500 MW, including blackstart resources, unless a planning coordinator or transmission planner deems them to have a greater impact. Generation and energy storage projects are more likely to contribute to transmission reliability if they are designated as reliability-must-run units or if they are located in load pockets where access to replacement generation capacity is limited by transmission constraints (e.g., New York City). In addition, energy storage projects that are used by utilities to mitigate transmission constraints are likely to be deemed to contribute to transmission reliability. Although DOE might not include such bright-line tests in interpreting the scope of bulk-power system equipment, the NERC criteria offer some guidance on what we expect might be included in and excluded from this definition.
III. Country Nexus
E.O. 13920 defines “foreign adversary” as “any foreign government or foreign non-government person engaged in a long‑term pattern or serious instances of conduct significantly adverse to the national security of the United States or its allies or the security and safety of United States persons.” The order does not identify any particular “foreign adversaries,” and it is unknown whether DOE will identify any in the implementing regulations. Given the United States’ current adversarial relationship with China and China’s importance to the bulk-power system electric equipment supply chain, China—or certain Chinese companies—are likely to be classified formally, or possibly informally within DOE, as foreign adversaries. The same may also be the case with Russia or certain Russian companies.
Importantly, E.O. 13920 does not limit the designation of a foreign adversary to solely a nation state. DOE may target foreign companies as “adversaries.” Further, if, for example, China were designated a foreign adversary, non-Chinese subsidiaries of Chinese companies would come within the scope of the definition.
IV. Implementation of E.O. 13920
A. Outright Ban Versus Other Remedies
E.O. 13920 provides for remedies short of Transaction prohibition. DOE is authorized to establish a review process and impose mitigation conditions akin to CFIUS’s practice. Recent DOE guidance (the “DOE Guidance”) indicates that mitigation measures may include testing components and addressing vulnerabilities or inspecting manufacturing plants. The order also authorizes DOE to establish criteria for pre-qualifying equipment and vendors in the bulk-power system electric equipment market, create a list of pre-qualified equipment and vendors and implement a licensing process.
The DOE Guidance indicates that DOE is working closely with its federal and industry partners to develop a mechanism to pre-qualify equipment and vendors for the bulk-power systems supply chain, thereby removing such pre-qualified equipment and vendors from the prohibitions imposed by E.O. 13920.
B. Potential Retroactive Effect
E.O. 13920 tasks the Secretary of Energy with developing recommendations on ways to identify, isolate, monitor or replace bulk-power system electric equipment found to be subject to the order as soon as practicable, taking into consideration overall risk to the bulk-power system. However, the DOE Guidance clarifies that equipment installed prior to May 1, 2020 is not currently prohibited and that any immediate steps by owners or operators to rip and replace existing equipment would not only be premature but may be unnecessary. As a general matter, experience with CFIUS’s negotiation of mitigation arrangements for screening of power production equipment vendors suggests that DOE would not commonly apply E.O. 13920 to disturb existing vendor contracts.
V. Risk Assessment Factors
As U.S. companies assess the risk of adverse action against a sourcing arrangement, they should try to determine the cost differential associated with procuring bulk-power system electric equipment from sources that are likely—versus unlikely—to be deemed connected to any foreign adversary. They should also consider how disruptive it would be to a particular project if the source of equipment had to be changed. It will also be important to determine the risk, from a cybersecurity and critical infrastructure point of view, of specific bulk-power system electric equipment to the bulk-power system. As indicated, some CFIUS mitigation agreements have provided for U.S. government screening of equipment vendors, and it is expected that DOE may follow a similar approach with respect to mitigation measures in implementing E.O. 13920.
In assessing risk, DOE is expected to consider how easily specific equipment can be manipulated via cyber or supervisory control and data acquisition (“SCADA”) systems such that supply of power to the grid could be disrupted. Equipment that has known flaws or vulnerabilities and originates from China is most likely to be prohibited by DOE. Additionally, projects located near sensitive military installations, training ranges or with large power production supplying a metropolitan area should be prepared to face enhanced scrutiny of their procurement of bulk-power system electric equipment found to be subject to the order.
VI. Impact on Contracts Potentially Subject to E.O. 13920
E.O. 13920 has introduced uncertainty regarding contracts that directly or indirectly involve procurement of equipment from sources that are considered to be connected to a foreign adversary, including offtake, procurement and construction contracts. Until regulations are issued, parties to existing contracts, negotiating contracts or planning projects that will involve these contracts are seeking ways to plan for and decrease the risk due to uncertainty relating to implementation of E.O. 13920. The order may be implemented to prohibit the procurement and installation of bulk-power electric equipment manufactured in China (from which a large percentage of equipment incorporated into new U.S. power projects is sourced), introduce a CFIUS-like screening process, or impose other testing or screening processes that could add cost, time and uncertainty to procurement of the equipment needed to build U.S. energy projects.
Almost all offtake, procurement and construction contracts for energy projects include force majeure provisions that excuse performance when events occur that a party could not anticipate and over which it had no control. Sometimes these force majeure provisions expressly include a change in law, or sometimes change in law is excluded from force majeure and handled separately. These force majeure and change in law provisions are the primary focus of parties attempting to contract around the range of possible effects of E.O. 13920.
Broadly speaking, there are two types of relief afforded if the force majeure or change in law clause in a contract is triggered. The first extends relief for performance to a particular schedule under the contract, including guaranteed dates that can be associated with delay liquidated damages, termination rights or other remedies. The second is cost relief allowing the party claiming the force majeure or change in law to pass through to the other party the marginal additional cost of the event. Most contracts provide for a finite amount of schedule relief, whereas cost relief is present only in some contracts or is limited.
Under power purchase agreements (“PPAs”) and other offtake contracts, the seller of the energy or other energy-related service is rarely afforded cost relief for force majeure or change in law. Even schedule relief in PPAs and other offtake contracts is often granted in narrower circumstances than under construction or procurement contracts. For any projects using equipment that potentially will come under E.O. 13920, it is recommended that owners negotiate an express right to schedule relief due to the potential effects of E.O. 13920. For projects with a higher likelihood of falling under E.O. 13920’s restrictions, it would be advisable for the parties to consider special extended relief for the effects of E.O. 13920, as most force majeure and change in law schedule relief provisions have an outside date after which the contract can be terminated. These projects would include those that provide power or energy services to defense infrastructure or provide grid reliability (including energy storage systems), which plan to source key equipment (inverters, energy management systems, SCADA systems, etc.) from China or another potential foreign adversary. Also, expressly including the implementation of E.O. 13920 as a force majeure or change in law will reduce uncertainty as to whether implementation will be considered a preexisting event dating back to the issuance of the order.
Procurement contracts, and construction contracts that include procurement, for equipment that may be subject to E.O. 13920 will need to address both cost and schedule relief. Many owners, equipment suppliers and construction companies are wrestling now with the proper allocation of the cost and schedule impacts of E.O. 13920 that may cause delays in importation of key equipment or, in the case of a prohibition, may require a change in the source of the equipment entirely. The latter risk is of particular concern, as a new source may not only take longer to procure and be more expensive, but may also require significant redesign of a project, leading to a cascade effect on other equipment, permits and schedule.
An owner can, of course, mitigate its risk under E.O. 13920 by sourcing its equipment from vendors and jurisdictions unlikely to be subject to the order, but this may be impractical for projects that have been bid and awarded based on prices quoted, and design specifications provided, by Chinese suppliers, which is quite common. Assuming this is not practical, the parties will need to agree to a process by which they can evaluate the effect of E.O. 13920 potentially imposing some sort of restriction on equipment intended to be used in the project and make informed decisions about how to move forward without giving one side or the other undue leverage to dictate a solution. For example, many contracts that do not expressly account for E.O. 13920 afford the contractor cost and schedule relief for change in law, meaning that if a piece of equipment the contractor intended to procure becomes illegal to import (to use the extreme scenario), which may give the contractor too much latitude to take whatever actions it deems reasonable, such as securing another source, and pass on to the owner all of the cost and schedule impacts of the change, including redesign costs and impacts on other equipment. Such a change order could significantly impact, or even jeopardize the viability of, a project.
Thus, it is recommended that owners and contractors/vendors consider contract provisions that afford an owner the right to weigh in on how to accommodate the possible effects of E.O. 13920. If the solutions available to a particular contractor or vendor are incompatible with the viability of a project, the owner would benefit from an off-ramp from the contract at a pre-negotiated cost. If the owner can tolerate some schedule delays due to, for example, a CFIUS-like screening process (particularly if owner has negotiated for schedule relief from E.O. 13920 in its offtake contract), or moderate cost increases due to finding alternate sources, it would likely be in both parties’ interest to avoid a termination. The starting point for negotiating the cost of a termination would not necessarily be recovery of a contractor/vendor’s costs (for materials, manufacturing, etc.) or “lost sale” type of damages, but perhaps a structure that reflects a sharing of this known risk. Of course, each project has its own unique set of circumstances and relative bargaining positions between the parties, so these mitigation plans will end up running the full spectrum. Regardless, it is recommended that parties negotiating contracts for equipment potentially subject to E.O. 13920 address the uncertainty it presents head-on rather than relying on a traditional force majeure or change in law provision.
E.O. 13920 has the potential to have a significant impact on U.S. power project development. Although it will be months before the order is implemented, it is not too soon for participants in the industry to consider and take steps to address the risks the order poses. Parties to offtake, procurement and construction contracts for U.S. energy projects that may be subject to E.O. 13920 should proactively address how the parties will handle delays or restrictions in the import of equipment planned to be used in the project, and in the extreme scenario affording the project owner an off-ramp from the contract should such delays or restrictions jeopardize the viability of the project. In addition, industry participants should take the opportunity to engage with DOE during the rulemaking process, as the DOE Guidance pledges that the agency will work with stakeholders to address and clarify outstanding issues.