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Newsletter 09/2014

Construction/Property Updates | Introducing district cooling agreements

 

District cooling agreements are unsurprisingly common in this region. They are often complicated arrangements, given the long duration over which the terms of the agreements apply to each party.

An unavoidable consequence of being a projects lawyer in a large firm in this region means that from time to time, I am asked to draft, review and negotiate these agreements. One is forced to gain at least some expertise in district cooling issues!

District cooling is the centralised production and distribution of chilled water to end users for air conditioning.  This method of cooling is commonly used in large residential projects across the GCC and replaces the need for individual air conditioning units or traditional in-building chillers.

A key advantage of district cooling is the small space of the central cooling facility relative to the area this facility services (increasing the total sellable/lettable area), not to mention the aesthetic benefits. Water and energy use is less than alternative forms of air conditioning, which has both pricing and environmental benefits.

Environmental benefits are significant as it is estimated that around 70% of demand for energy in the UAE is down to air conditioning during summer months. Given the popularity of district cooling as a means of cooling large developments in the this region, together with rapid population growth, this note touches on some of the key issues in a typical district cooling agreement for a large project.

The GCC’s district cooling industry is subject to little law or regulation. This means that rights and obligations of stakeholders need to be addressed in a clear and integrated contractual framework. Due to the high cost of constructing a district cooling plant and the associated pipe network and infrastructure, district cooling services are normally procured under a long-term agreement that authorises the provider of the district cooling to exclusively provide cooling services to a development for an agreed period of time (say for 25 years), based on benchmarks and standards, including quality and availability of the cooling.

Key performance indicators are especially important as the exclusivity of the cooling services prevents end users from procuring air conditioning from an alternative source if they are dissatisfied with the provider’s performance. To incentivise performance, financial penalties are often levied against a provider if it fails to comply with stated parameters, while the agreement may provide a right to terminate for persistent breach.

To avoid this, providers must diligently operate and maintain both the plant and network.A key risk in a district cooling arrangement is demand. It is imperative, from the provider’s perspective, that end users in the relevant project are contractually required to enter into agreements for the provision of cooling and that this obligation is rigorously policed.

Allocation of demand risk is a matter for negotiation between the developer and provider, however, the provider often seeks that the master developer underwrites a portion of demand (the developer will generally only agree to this if a considerable portion of end user agreements have been entered into). Master developers, however, do not like to provide any demand guarantee. This subject is normally a key element of negotiation in these types of agreements.

Closely connected to demand is the issue of billings and collection. Payments can either be made to the provider by the developer (as a single point of collection for all end-users) or by each end-user. Providers unsurprisingly prefer that they are paid by the developer, which avoids the time and expense of seeking payment from each individual end-user (which can be considerable if there are many end users i.e. individual unit owners in a high-rise tower). If the developer is responsible for the collection of district cooling charges, a provider may require the developer to provide security to guarantee these payment obligations and, as a last resort, the provider typically seeks a right to disconnect service if non-payment passes a particular threshold.

A hefty penalty is usually charged for reconnection. Although there is no independent regulator of the district cooling industry, tariffs usually consist of a connection charge, an availability/capacity charge and a consumption charge.

Given the length of district cooling agreements, tariffs are typically subject to periodically applied adjustment mechanisms to allow the charges to vary on account of such things as the fluctuating cost of providing district cooling services (i.e. water, power and labour), inflation and the consequences of changes in the law. The benchmarking of the tariff regime is obviously a subject that parties carefully negotiate when entering into long-term agreements.

Adam Balchin

Regional Head of Construction and Infrastructure at Al Tamimi & Company and ABCD member

Al Tamimi & Company

a.balchin@tamimi.com

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