District cooling projects – a few things to know
Real Estate & Construction and Hotels & Leisure Focus
Euan LloydPartner, Head of Construction & Infrastructure
District cooling projects are becoming increasingly prevalent across the Middle East (particularly in Saudi Arabia) as more and more large-scale commercial and residential developments ramp up, requiring a controlled and certain cooled environment (particularly between April and October).
In this article, we provide a brief overview of some key issues concerning the niche area of the procurement of district cooling facilities.
One option is for a Developer to implement a district cooling project (“Project”) on a ‘traditional’ basis – in other words, the Developer engages an EPC contractor to construct the Project before either operating and maintaining the Project itself or engaging a third party to do so, with the Developer owning the Project throughout.
However, Projects are increasingly procured on a build, own, operate (“BOOT”) basis, thus ensuring single point responsibility throughout both the build and operations phases.
Under this integrated model (and as the name suggests), the Developer engages, typically through a competitive tender process, a Service Provider, on an exclusive basis, to design and build the Project before operating it for a pre-agreed term (i.e., of 25 years). Upon expiry of the term, title to the Project transfers to the Owner.
As BOOT structures are typically project financed, the Service Provider will usually be a SPV, incorporated specifically for the Project in question and a BOOT contract (“BOOT Contract”) can be compartmentalized, from a high-level, perspective as follows:
In basic terms, a Project comprises: (i) a district cooling plant (“DCP”)(i.e., the plant that produces chilled water); (ii) a district cooling network (“Network”) (i.e., that distributes, through piping, the chilled water produced by the DCP to the buildings receiving the district cooling, before returning the chilled water to the DCP); and (iii) a heat exchanger (i.e., a facility that extracts heat from the recipient building’s natural environment, to prevent the temperature of the chilled water increasing).
The build phase largely replicates the requirements typically found in any design and build/EPC construction contract (albeit in relative shorthand), including:
a design review and approval process;
the construction phase (where site related access, interface and coordination issues (i.e., with the main works contractor) as well as defects liability should be addressed);
a variations mechanism;
risk allocation (including in respect of ground conditions and authority related delays etc.);
detailed completion criteria, including performance tests;
a fixed time for completion and accompanying extension of time and delay liquidated damages regimes. However, it is not unusual for the Owner to have, in the event of the Service Provider’s culpable delay, the option to require that the Service Provider provides temporary facilities (at the Service Provider’s expense) so cooling services commence, in lieu of levying delay liquidated damages (i.e., as the commercial operation of the development is likely to be far more valuable in real terms than the receipt of delay liquidated damages;
performance security (typically in the form of an on-demand performance bond);
insurance (in respect of which various policies (such as insurance for the Project, third party liability insurance and force majeure) will straddle both the build and operations phases);
design and construction related warranties; and
subcontracting requirements - these are significant as the Services Provider will typically engage an EPC contractor and an operator as subcontractors on terms that are ‘back to back’ with the BOOT Contract and the Owner may wish to have these key subcontractors novated to it if the BOOT Contract is terminated.
In contrast to the traditional approach, no payments will be made by the Owner to the Service Provider during the design and construction phase on account of the project financed nature of the project.
BOOT Contracts for district cooling projects are multi-faceted, nuanced and complicated documents – however, if properly drafted and negotiated, they can satisfy the requirements of all stakeholders, providing an efficient solution to the crucial issue of the provision of air conditioning.
The operations phase commences upon the completion of the build phase (but without prejudice to the Service Provider’s responsibility to correct construction related defects), whereupon the Owner pays, typically on a monthly basis, the Service Provider the tariff, comprising a capacity charge and consumption charge (determined by a sealed metre) in consideration for receipt of district cooling services. Depending on the creditworthiness of the Owner, the Service Provider may seek a payment guarantee (i.e., in the form of a letter of credit or bank guarantee) to ensure payment of the tariff.
However, the tariff will be subject to reductions to the extent that KPIs are not achieved (i.e., in respect of availability, temperature of the chilled water, efficiencies (including in respect of electrical and treated sewerage effluent discharge).
Additionally, the tariff will typically be subject to periodic escalation throughout the term (i.e., based on CPI or benchmarking), while the BOOT Contract will often prescribe specific circumstances that may trigger an increase to the tariff (or, alternatively, trigger an extension of the term). Either way, these grounds tend to be negotiated (and may be subject to monetary thresholds), but may include such things as unforeseen ground conditions/the discovery of antiquities, acts of prevention, change in law and the occurrence of events of political force majeure.
The Owner will typically reserve a right of set-off so that it can recover entitlements it may have against the Service Provider (i.e., in respect of KPI related penalties or indemnities), although the Owner may also require additional security in the form of an operations phase on-demand performance bond.
Throughout the Operations Phase (and of direct relevance to the KPI regime)), the Service Provider will be required to: (i) maintain the DCP and the Network (including pursuant to an annual maintenance plan while a thorough audit of the condition of the DCO and Network is usually required every 5 years); and (ii) provide temporary facilities in the event of any outages (whether planned (which should be during winter months) or otherwise), failing which the Owner will usually have the right to step-in and provide temporary facilities at the Service Provider’s cost.
At the end of the term (which may be extended), the Project is handed over to the Owner and the BOOT Contract typically sets out a detailed hand over criteria. The handover process starts 6 months prior to the expiry of the term and may include the provision of a dilapidation report (which may trigger a right for the Owner to claim if the Project has not been adequately maintained), the provision of training and will almost certainly prescribe the handover of documents.
Termination and its consequences are key issues with relevance to both the build and operation phases.
Although the grounds for termination tend to be usual (i.e., in respect of material breach (including in the event of prolonged outages), insolvency, the exhaustion of a cap on delay liquidated damages, for the Owner’s convenience etc.), the consequences of termination require particular consideration on account of the project financed nature of the Project and the corresponding requirements for funders to recover their investment – it is therefore important that the Owner is familiar and comfortable with the financial model, as this will directly impact the termination payments.
While there is inevitably a degree of negation, it is not unusual for debt, equity as well at direct consequences of termination (including breakage costs) to be recoverable in the event of termination of the BOOT Contract on account of the Owner’s breach, or in the event of termination by the Owner for convenience. If, on the other-hand, the Owner terminates on account of the Service Provider’s breach, the Service Provider will typically only be entitled to recover the outstanding senior debt (subject to claims that the Owner has against the Service Provider).
Termination in the event of prolonged force majeure (which is typically divided into political and natural force majeure) is further ground for termination, which usually allows for the recovery of the outstanding debt as well as the a degree of a return on equity – however, the availability of insurance in respect of force majeure needs to be noted, as events of political force majeure can be uninsurable in various jurisdictions, thus potentially significantly increasing the Owner exposure.
Aside from the above, various other issues should be addressed in the BOOT Contract, including:
Property issues regarding the Project, as may be addressed in a lease/sub-lease.
Expansion of the Project.
The right of the Owner to ‘on-sell’ the cooling services.
Limits of liability (which may differ between the build and the operations phases).
Funders’ direct agreements (and step-in rights).
Refinancing.
Carbon credits/cap and trade schemes.
Governing law and dispute resolution.
For further information,please contact Euan Lloyd.
Published in June 2025
