Trump bulk-power system order: Market reaction
Market reaction to the Trump bulk-power system order has been mixed.
Some tax equity investors and lenders moved quickly to require sponsors to fund any future costs to replace foreign adversary equipment that the government decides poses a threat to the US electricity grid. Not every tax equity investor or lender has done so.
Some construction lenders are requiring sponsors to do special cyber-security audits to help show that the project is following best practices in case of government scrutiny.
The question has been showing up on diligence lists in both financings and M&A transactions whether any equipment that is manufactured or designed by Chinese suppliers will be used in projects.
Companies that were on the verge of signing equipment supply agreements with Chinese suppliers have been thinking carefully about whether to move forward with such arrangements. It is too early to tell how much, but some level of pullback in the short term from Chinese equipment seems inevitable, especially for equipment like transformers or batteries that is closer to the grid than other equipment like solar panels.
US Department of Energy officials seemed to feel that the reaction among renewable energy developers was overblown and went out of their way in calls to industry trade associations and interviews soon after the order was issued to downplay concerns that equipment might have to be ripped out and replaced. A list of frequently-asked questions put out by the department said, “As of today, no equipment is prohibited . . . . As such, any immediate steps by owners or operators would not only be premature, but may be unnecessary.”
President Trump issued an executive order on May 1 that imposes an immediate ban on the purchase, use or transfer of as-yet unidentified foreign adversary equipment that might be used to harm the US power grid.
The order bans the “acquisition, importation, transfer, or installation” of transmission and electric generating equipment designed, manufactured or supplied by any company that is “subject to the jurisdiction” of a country that the US considers a “foreign adversary.”
The order leaves more questions than it answers.
There are four broad questions.
One is who are the foreign adversaries. The order seems directed at China. Russia, North Korea and Iran are not large suppliers of equipment for the US power sector.
Mark Menezes, the deputy energy secretary-designate, confirmed the list of adversaries in comments on May 21.
Another question is which power projects are affected. The order applies only to equipment used in the “bulk-power system,” defined as not only “facilities and control systems necessary for operating” the transmission grid, but also “generation facilities that are necessary for system reliability.”
The order does not apply to distributed energy or distribution system equipment.
Key phrases appear to have been drawn from section 215 of the Federal Power Act, including the phrases “generation facilities needed to maintain transmission reliability” and “facility used in the local distribution of electric energy.”
The Federal Energy Regulatory Commission, which administers the Federal Power Act, draws the line on the bulk-power system at 100 KV. The Trump executive order draws it at 69 KV.
DOE officials say it is too early to know to what extent the department will follow FERC precedent to decide what equipment is considered used in the bulk-power system.
President Trump has said repeatedly at rallies that intermittent renewable energy is an unreliable source of electricity. However, any possibility that the order does not cover wind and solar facilities was dispelled by comments by the White House trade adviser, Peter Navarro, who had a hand in writing the order. “To those who have concerns,” Navarro said on May 5, “I would simply say work in good faith with the process. And unless you intend to use foreign components that may pose a risk for the bulk-power system, including flawed batteries or inferior solar or wind turbine systems, you have nothing to worry about.”
A third broad question is how the ban is supposed to work in practice. The Department of Energy must determine one of three things about a transaction before the prohibition applies. The transaction must either pose an “undue risk” of “sabotage or subversion of” the US bulk-power system or of “catastrophic effects” to critical US infrastructure or the US economy or pose simply an “unacceptable risk” to US national security. Given how broadly the Trump administration has invoked national security concerns in other contexts, this does not draw a very clear line for the market.
Finally, the effective date of the ban is confusing. The order says in one place that the order applies “where the transaction is initiated after the effective date of this order.” It says in another place that the prohibitions in the order apply “notwithstanding any contract entered into or any license or permit granted prior to the date of this order.”
US intelligence agencies have warned in the past that the US electric system is vulnerable to attack. The executive order says that “foreign adversaries are increasingly creating and exploiting vulnerabilities” in it, including through cyber activities.
A DOE intelligence official said that although the main focus is Chinese equipment, the timing had nothing to do with current tensions with China over the coronavirus. The order has been in the works for a year. It just happened to get through the process on May 1. It is possible there may be some ripping and replacing of equipment in the future, but it will not happen quickly.
The order reads like a similar order that President Trump signed on May 15, 2019 dealing with the US telecom network. The US Department of Commerce is charged with administering the telecom order. Commerce took six months, until November 27, 2019, to issue proposed implementing regulations.
The order applies not only to projects in the United States, but apparently also to projects outside the United States undertaken by US persons. It applies to a transaction “by any person . . . subject to the jurisdiction of the United States.”
The Department of Energy can propose measures that would mitigate the national security concerns in order to let a transaction move forward.
Sales of projects into tax equity vehicles are potentially affected to the extent the order covers renewable energy. The order bans any “transfer . . . of any [proscribed] bulk-power system electric equipment (transaction).” Read literally, it applies to purchases of development rights to projects where a foreign adversary company has signed a contract to supply equipment.
The Department of Energy is supposed to identify equipment that is potentially a problem “as soon as practicable” and make recommendations for how to “identify, isolate, monitor, or replace” such equipment in the US power system. This creates risk that the government might require replacing any equipment in the future that it identifies as a potential threat.
Mark Menezes said FERC is working on a plan to compensate utilities that must remove equipment considered a security risk.
The order also directs the Department of Energy to set up an inter-agency task force that will report within a year on model procurement policies for federal agencies to follow in the broader US energy sector to address national security concerns. The task force will also focus, among other things, on the potential for attacks on the electricity supply to originate through the distribution system and will engage distribution system industry groups in that effort.
Bruce Walker, the assistant energy secretary responsible for administering the order, said in a briefing on May 7 that DOE plans to establish a pre-qualification system for suppliers of bulk-power system equipment. DOE will issue a request for information first to vendors and other stakeholders for input that it will then use to put out instructions for companies that want to be considered for pre-qualification. He said it will take five months for DOE to work out a pre-qualification process.
DOE will be working separately with the US intelligence agencies, FERC and the North American Electric Reliability Corporation, NERC, to identify existing equipment that may pose security risks. Where risks are identified, DOE will come up with strategies to monitor and mitigate risks and work with asset owners to replace equipment, if necessary.
The Wall Street Journal reported in late May that federal officials commandeered a large Chinese transformer made by Jiangsu Huapeng Transformer Company when it arrived by ship in Houston last summer and took it by truck under federal escort to the Sandia National Laboratories in New Mexico. The transformer was purchased for use in a substation owned by the Western Area Power Administration.