Offshore renewable energy: decommissioning guidance for Scottish waters

9. Financial security

Overall approach

9.1 The Scottish Ministers want to make sure that the responsible person has taken account of their decommissioning liabilities at the beginning of their projects and made adequate provision to ensure that sufficient funds will be available to meet their liabilities. The Scottish Ministers general approach is that the business responsible for the installation is best placed to manage and mitigate the costs and risks associated with decommissioning. The responsible person should take account of decommissioning obligations from the outset of the project, from the concept and design stage through to the contractual arrangements and warranties associated with construction and operation.

9.2 The Scottish Ministers also wish to seek to reduce, to an acceptable level, the risk of liabilities falling to the public purse in the event of default by the responsible person by requiring, and ensuring that appropriate securities are put in place. Certain securities will require approval by the Finance and Constitution Committee of the Scottish Parliament, which will take account of the particulars of the ask and the associated risk analysis.

Risk to the Scottish Ministers

9.3 Where a responsible person fails to carry out the decommissioning programme, it may fall to the Scottish Ministers as funder of last resort to decommission and (where necessary) to meet any outstanding costs of decommissioning. Taxpayer intervention will be in exceptional cases only and the Scottish Ministers will always explore where an associated corporate body such as a parent company, the landlord or administrator (or others) may potentially be in line to decommission before the risk passes to the Scottish Ministers and the taxpayer.

9.4 To mitigate against the risk to tax payers, the responsible person is required to:

• include details in their decommissioning programme of how they intend to finance their proposed approach to decommissioning; and
• put in place acceptable security arrangements to protect the taxpayer against the possibility of having to pay for decommissioning in the event the responsible person defaults on their obligations.

9.5 This guidance is not intended to be prescriptive as to how a responsible person reserves for or pays for the cost of decommissioning unless reserving is proposed as a form of security. There are many different ways for a company to make sure that the money is made available at the appropriate time. The preferred approach of the responsible person should be clearly set out in the decommissioning programme for review by the Scottish Ministers. This will provide reassurance to the taxpayer that the industry is financially well prepared to carry out the decommissioning programme at the end of its operational life, and that the funds will be available should the Scottish Ministers ultimately need to decommission.

9.6 For any security to be acceptable, appropriate arrangements must be in place to assure the Scottish Ministers that such funds will be available to the Scottish Government if needed. This may be through a financial agreement which ring fences funds, a trust arrangement or other mechanism depending on the type of security. The Scottish Ministers will not be able to accept securities, if there is not confirmation at the outset that funds will remain protected in the event of insolvency. If security is in the form of cash (upfront or accrual) once the cash has been put aside for securities, the responsible person needs to reflect the payment in their annual returns, so that any potential investors are able to clearly see that money is being put aside for decommissioning and that this capital cannot be accessed for any other purpose.

Financial security guiding principles

9.7 Under the Energy Act's decommissioning provisions, it is for the responsible person to submit details of the security they propose to provide with their decommissioning programme. To guide industry the Scottish Ministers have established the following principles to provide a policy framework against which financial security decisions can be taken:

a) the responsible person is expected to meet the costs of decommissioning and be responsible for the liabilities they have created (the "polluter pays" principle).

b) the Scottish Ministers have a duty to ensure that the taxpayer is not exposed to an unacceptable risk of default in meeting costs associated with decommissioning.

c) the Scottish Ministers will expect to see evidence that the financial securities are in place and that effective and transparent arrangements are in place to ensure that decommissioning programmes are carried out.

d) if decommissioning obligations are not met, the Scottish Ministers will consider the viability of recovering expenditure incurred in carrying out a decommissioning programme (see Annex A on Energy Act powers).

Examples of acceptable security

9.8 There may be a number of acceptable forms of security. The type of security likely to be acceptable will depend on a number of factors, including but not limited to the maturity of the technology and the financial strength of those responsible for decommissioning. The timing of security arrangements will be dependent on similar factors including revenue certainty over time and acceptable subsidy period. The undernoted securities would generally be satisfactory, however each programme will be assessed on the matters presented in individual cases.

i) Upfront cash deposit

9.9 In the case of pre-commercial projects where the risks to the taxpayer are the greatest, upfront cash security paid into an escrow account or direct to a Scottish Government account, only accessible by the Scottish Government prior to commencement of construction, is likely to be the most acceptable form of security.

ii) Cash accrual

9.10 In the case of more established technologies, cash security paid into an escrow account only accessible by the Scottish Government is likely to be acceptable. The securities would have to be fully accrued by the end of any support mechanism subsidy period, or equivalent guaranteed income stream, subsidy period with actual amounts set aside agreed following the Scottish Ministers review of the responsible person's financial model.

9.11 Cash would need to be held in an account where deductions could not be made without the prior approval of the Scottish Ministers, or officials on their behalf (the Scottish Ministers cannot pay interest on funds held).

9.12 Where the owner of a project has provided cash (either upfront, or through accrual) as security to the Scottish Ministers, the withdrawal of funds to pay for the costs of decommissioning will be on the production of evidence that the funds are being used for decommissioning costs, and on the basis of satisfactory evidence that the remaining cash balance covers the residual cost of the (e.g. provision of invoices / signed contracts for decommissioning). The Scottish Ministers may hold back a limited proportion of funds pending a successful post-decommissioning report (in case further works are required) on a case-by-case basis according to the risks of each project.

iii) Irrevocable draw down letters of credit / bank guarantees / performance bonds

9.13 A standby letter of credit, bank guarantee or a performance bond are all broadly similar instruments, and it is the substance rather than the precise form which is relevant. These should be fully accrued by the end of the subsidy period, with actual amounts set aside agreed following the Scottish Ministers review of the financial model. The letter of credit / performance bond must be renewed annually. A number of circumstances, including for example the operator not fulfilling its liability to annually renew or the bank's rating falling below a given level, will give the Scottish Ministers the right to draw on the letter of credit / performance bond and put the guarantee amount in the bank as security for future possible liability for decommissioning.

9.14 If the letter of credit or surety bond cannot be renewed, then the Scottish Ministers will draw down all sums and hold this as a cash security against decommissioning costs.

9.15 The key features expected of any proposed security include:

a) the beneficiary of the proposed security must be the Scottish Ministers.

b) the security is issued by either (i) the UK branch of a bank established in an OECD country, or (ii) a UK authorised insurer (i.e. regulated by the Prudential Regulation Authority) or European Economic Area ("EEA") authorised insurer operating in the UK.

c) the issuer has a long term rating of at least either A- or better by S&P Global Ratings (Standard & Poor's) or A3 or better by Moody's Investors Service or an equivalent rating by another recognised ratings agency. The security can be drawn in full if the issuer fails to maintain the required credit rating.

d) the security is irrevocable and payable upon demand of the Scottish Ministers.

e) the security is for a fixed term either for the full duration of the decommissioning obligations or for a shorter term (typically 1-3 years) with a 'pay or renew' provision.

f) notwithstanding the above expected features, the security must in any case be issued by an entity acceptable to the Scottish Ministers as appropriate in the circumstances.

9.16 As further guidance the Scottish Ministers would also generally expect (i) payment of any demand to be made within no more than five business days (ii) the form of demand notice to be provided (iii) partial and multiple demands to be allowed (iv) the expiry date and renewal provisions to be clear (v) the security amount to be denominated in GBP (vi) the security proposed is subject to the latest relevant rules^[12]; (vii) security to be governed by and construed in accordance with the law of Scotland; (viii) the parties submit to the exclusive jurisdiction of the courts of Scotland in respect of any dispute without recourse to arbitration.

Term and renewal

9.17 In order to ensure continuous renewal of the security with no lapse, each security shall be required to be extended or replaced at least one month in advance of its expiration date.

9.18 Decommissioning obligations need to be discharged before the expiry date set out in the marine licence. Therefore there is a synergy between the licence, the decommissioning programme and the security provision. It is the responsible person's responsibility to ensure that these instruments are aligned.

9.19 As set out in Chapter 7, the owner should submit a post-decommissioning report within a timescale agreed with the Scottish Ministers, following completion of decommissioning works. The Scottish Ministers will then review the report and decide whether to accept it as evidence that decommissioning has been carried out in accordance with the decommissioning programme. Security must remain in place until the Scottish Ministers confirm that the decommissioning programme is accepted as being complete.

Timing of securities

9.20 Securities will generally be expected to be paid up front of the commencement of construction for pre-commercial and short-term projects. Short-term projects would include parts of longer term projects which will only be constructed for a limited period of time.

9.21 For large scale commercial deployments that receive a predictable revenue stream (such as from a Contract for Difference ("CfD") or OFTO fixed term revenue stream) and involve a proven technology with low operating risk, a secure, segregated decommissioning fund that accrues by the end of the subsidy period is acceptable. The earlier payments are made and completed, the better the Scottish Government is insulated from risk, since reserving would occur when there is a guaranteed revenue stream. A decommissioning programme which accrues late into the operating life of the installation will not be acceptable.

9.22 The Scottish Ministers will consider the timing of securities on the matters presented in individual cases, taking into account the guiding principles set out in paragraph 9.7 above, and the risk profile of the individual project. Whilst the following should not be taken as a definitive list, considerations will include:

• whether there is a reliable long term (e.g. 15 or 20 years) income stream in place for the project, such as a CfD or OFTO fixed term revenue agreement
• the financial strength of the company and its linked parent / group (the Scottish Ministers may require financial information to be submitted to help inform their considerations)
• whether there is evidence to suggest that technology has a proven track record of operating reliably on a commercial, post-testing basis; and
• whether the project has the necessary lease, consent and/or licence in place covering the full time period up to the proposed decommissioning date

9.23 Each project will be considered according to its individual circumstances, but if the above criteria are not met, it is unlikely that a segregated decommissioning fund that accrues during the middle of the life of a relevant object ("mid-life accrual") will be acceptable to the Scottish Ministers. Where these criteria are not met, there is more likely to be a requirement for payment upfront of installation, or no later than three months from the approval of the decommissioning programme.

9.24 The table below summarises when a mid-life accrual of securities, if considered acceptable, should commence based on the revenue support a particular offshore renewable project might receive:

9.25 Security covering the entire cost of decommissioning the relevant objects ("full security") must be maintained from the end of any subsidy period until after the Scottish Ministers have reviewed the post decommissioning report and confirmed that the programme is accepted as being complete. Full security will need to be maintained if final decommissioning is deferred for whatever reason (for the avoidance of doubt this includes scenarios where there is an extension of the asset life or repowering).

Draw-down on securities for decommissioning

9.26 Where the owner of a project has provided cash as security with the Scottish Ministers, any withdrawal of funds to pay for the costs of decommissioning will be on the production of evidence that the funds are being utilised for decommissioning costs, and on the basis of satisfactory evidence that the remaining cash balance covers the residual cost of decommissioning remaining infrastructure (e.g. provision of invoices for draw-down, and contractor estimates setting out the remaining decommissioning costs for anything still to be removed). As stated above, the Scottish Ministers may hold back funds pending a successful post-decommissioning report (in case further works are required) according to the risks of each project.

Examples of unacceptable security

9.27 The following would normally be unacceptable:

i) Parent Company Guarantees ("PCGs")

9.28 PCGs are not normally accepted as a primary source of security. However,- they may be required as a secondary form of security to provide Scottish Ministers with additional reassurance that the taxpayer is being suitably protected.

ii) Insurance schemes

9.29 In general, insurance will not be an acceptable security for decommissioning liabilities.