Offshore Transmission: Is it now too difficult to claim an income adjusting event?

On 5 June 2020, Ofgem issued its decision to Gwynt y Mor OFTO plc (the “OFTO”) confirming that it is not awarding an income adjusting event (“IAE”) for certain cable failures in 2015. This sends a clear message that there are significant hurdles to be overcome when claiming an IAE. However, we would query whether the hurdles are too high.

The IAE claims

Gwynt y Mor is a large offshore windfarm located off the coast of North Wales. The windfarm is owned and operated by Gwynt y Mor Offshore Wind Farm Limited (the “Generator”) and the transmission assets that link the windfarm to the national grid are owned by the OFTO.

In September 2015, two of the OFTO’s subsea cables suffered physical failures. The costs associated were significant, with £10.2 million for cable SSEC 1 and £14.2 million for cable SSEC 2. To recover some of these losses, the OFTO submitted claims to Ofgem for IAEs. IAEs are one of the few scenarios when an offshore windfarm transmission owner can claim for additional sums of money beyond its fixed, 20-25 year, revenue stream.

The OFTO’s claims for IAEs for each of SSEC 1 and SSEC 2 were for “an event or circumstance constituting force majeure under the STC” (“Force Majeure Claim”) or, in the alternative, “an event or circumstance other than listed [above], which in the opinion of the Authority, is an income adjusting event…” (“Discretionary Claim”). Ofgem rejected the IAE claim for SSEC 1.

For SSEC 2, in September 2017, Ofgem concluded that the OFTO would not have been able to effectively manage the risk and granted the IAE on the basis of the Discretionary Claim. Ofgem did not accept the OFTO’s arguments that the SSEC 2 was a Force Majeure Claim. However, this decision was quashed following judicial review in 2019 (pursued by the Generator), meaning that Ofgem had to consider the matter again.

https://www.bailii.org/ew/cases/EWHC/Admin/2019/654.html

On 5 June 2020, Ofgem issued its new decision on the IAE claim for SSEC 2 and rejected the claim in full.

Force Majeure Claim

Ofgem’s position has not changed significantly since 2017. The force majeure event must both (i) result in or cause the failure of that party to perform any of its obligations under the System Operator Transmission Owner Code (“STC”) and (ii) is beyond the reasonable control of the party.

Failure to perform obligations under the STC

The OFTO argued that it had been unable to perform two provisions of the STC: paragraph 2.1 of Part One of Part C (obligation to provide Transmission Services) and 4.1 of Part One of Part C (obligation to provide the Transmission Services in accordance with the Services Capability Statement).

However, in observing the cable failure constitutes a Service Reduction, Ofgem determined that there has been no failure by the OFTO to perform any of its obligations under the STC. This was on the basis that “there is no obligation on the Transmission Owner under the STC to provide Transmission Services where there is a Services Reduction”.

Ofgem commented that if the OFTO’s argument had been correct, then every Services Reduction caused by a fault or failure of plant or apparatus would constitute a breach under the STC and would invoke this force majeure provision. Ofgem states that this is not how the STC responds to “this commonplace occurrence” and that the force majeure provision is not (and need not be) engaged.

Whether the event is beyond the reasonable control of the party

The definition of force majeure under the STC includes the occurrence of “a fault or failure of Plant and Apparatus (which could not have been prevented by Good Industry Practice) …”. Ofgem therefore considers whether or not the fault in SSEC 2 could have been prevented by Good Industry Practice.

Ofgem concludes, with technical advice, that the Generator had not used Good Industry Practice. Further, since the STC definition of force majeure excludes performance/ non-performance by another Code Party (which includes the Generator), Ofgem determines that the event was not beyond the reasonable control of the OFTO.

Ofgem comments that there is a clear policy rationale for this approach, with the OFTO expected to rely on direct legal remedies against the Generator instead of pursuing IAE claims.

Discretionary Claim

The challenge to Ofgem’s assessment in 2017 of the Discretionary Claim related to whether or not a hypothetical insurer would have reduced the level of claim the OFTO could have had under a LEG3 policy prior to the SSEC 2 failure, as a result of the SSEC 1 failure, notwithstanding the OFTO had in place a LEG2 policy which offered reduced cover (the “Hypothetical Question”). Ofgem concluded that a hypothetical insurer would have reduced the level of claim under a LEG3 policy and agreed that the OFTO could not have managed the risk of the SSEC 2 failure (entitling the OFTO to an IAE).

However, in answering the Hypothetical Question in 2017, Ofgem was held in 2019 to have acted unreasonably and made material errors. The June 2020 decision reconsiders the Hypothetical Question.

Ofgem has now determined that an insurer under a LEG3 policy would not have been likely to have reduced the level of claim prior to the SSEC 2 failure. Furthermore, Ofgem’s view is that the OFTO made a commercial decision to put in place a LEG2 policy, not a LEG3 policy. Ofgem also considers other risk management arrangements that the OFTO could have put in place and refers to the OFTO’s unsuccessful claim against the Generator under a Cable Indemnity Agreement.

Ofgem comments that “the inability to pursue commercial recourse against the Developer only strengthened the need for the Licensee to ensure that it had full insurance protection in respect of those risks not covered through the commercial arrangements; the responsibility was on the Licensee to do so”.

Conclusion

The June 2020 decision by Ofgem makes it clear that there are high hurdles to overcome in order to claim IAEs. However, is it now too difficult to claim an IAE?

• If a fault or failure of plant, results in a Services Reduction, can it be said that the obligation to perform the Transmission Services as described in paragraph 2.1 of Part One of Part C is still being met in full? If it does, what then is the purpose of referring to fault or failure of plant in the definition of force majeure in the STC.

• Is it appropriate for a failure by a third party to perform in accordance with Good Industry Practice (which was not known about, nor could have been known about) to prevent a party from arguing that there had been a force majeure event under the STC.

• Has the ability to claim an IAE for defects on a discretionary basis been significantly narrowed? On the basis of this decision, it appears Ofgem expects any offshore transmission owner to have commercial recourse against the Generator and, failing which, have full insurance protection for risks not covered through commercial arrangements. Ofgem guidance suggests only if the risk subsequently become uninsurable would a discretionary IAE be granted.