President Trump’s Executive Order on US Bulk Power System Electric Equipment: Questions and Analysis

On May 1, 2020, President Trump issued an Executive Order (EO) prohibiting certain transactions involving “bulk-power system electric equipment” developed, manufactured or supplied by a “foreign adversary” if the Secretary of Energy, in consultation with the heads of other agencies, determines that the transaction raises significant national security concerns. The EO is ostensibly aimed at addressing the threat that foreign adversaries could exploit vulnerabilities in the US electrical grid to malicious effect. However, the EO could have far-reaching implications for both the renewable and conventional power industries if the EO prevents the import of certain critical equipment for new power or existing power projects or, in certain circumstances, prevents the sale of any interests in those projects (including tax equity interests).

Energy industry participants, including sponsors and developers of energy projects, construction contractors and energy project investors, are asking questions regarding the implications of the new EO on the US bulk power system and what the order means for their projects under development and construction (and existing energy projects). For stakeholders in the power sector, the breadth of the EO raises a number of key questions and concerns, which will hopefully be clarified in forthcoming guidance. Below are some of the initial issues raised by the EO.

ANALYSIS OF ORDER:

What countries are implicated by the EO?

The EO applies to bulk-power system electric equipment “designed, developed, manufactured, or supplied, by persons owned by, controlled by, or subject to the jurisdiction or direction of a foreign adversary.” The term “foreign adversary” is not defined, and no particular country is specified in the EO. However, because Chinese companies are key suppliers of equipment to the US power sector, and the Trump administration has consistently targeted China as a trade adversary and threat to US national security, many observers believe the EO intends primarily to curtail Chinese access to, and Chinese industrial equipment sales serving, the US bulk power system. The new EO follows a series of Trump administration trade actions against China, including the imposition of tariffs on virtually all imports from China under Section 301 of the Trade Act, prosecution for trade violations of major Chinese companies including Huawei and ZTE, export restrictions thwarting involvement of those Chinese companies in the US telecom industry, and concerted focus by the Committee on Foreign Investment in the United States (CFIUS) on US national security interests affected by Chinese investments in US businesses.

To what equipment does the EO apply?

While the EO specifically refers to “bulk-power system electrical equipment,” there are really two definitions at play here. The first is “bulk-power system,” which, as outlined below, is a system necessary to maintain interconnected transmission systems and maintain reliability. The definition of “bulk-power system electrical equipment” is electrical equipment necessary to maintain the “bulk-power system.” The examples of such equipment could appear to go beyond equipment merely needed to maintain the transmission system and ensure reliability, however.

• For purposes of the EO, “bulk-power system” is defined as “(i) facilities and control systems necessary for operating an interconnected electric energy transmission network (or any portion thereof); and (ii) electric energy from generation facilities needed to maintain transmission reliability.” The definition includes transmission facilities rated 69 kV or higher, but excludes electric distribution facilities.
• “Bulk-power system electric equipment” potentially subject to the EO includes “items used in bulk-power system substations, control rooms, or power generating stations, including reactors, capacitors, substation transformers, current coupling capacitors, large generators, backup generators, substation voltage regulators, shunt capacitor equipment, automatic circuit reclosers, instrument transformers, coupling capacity voltage transformers, protective relaying, metering equipment, high voltage circuit breakers, generation turbines, industrial control systems, distributed control systems, and safety instrumented systems.”
• The EO’s definition of “bulk-power system” is substantively identical to the definition of that term under Section 215 of the Federal Power Act, which gives the Federal Energy Regulatory Commission (FERC) jurisdiction over electric reliability matters affecting the bulk-power system. It is perhaps noteworthy that, notwithstanding FERC’s responsibilities in this area, FERC’s chairman is not identified as one of the agency heads to be included in the Task Force. Nor is FERC identified as an agency with which the Secretary must consult in implementing the EO.
• The EO does not apply to distributed generation facilities (such as commercial or residential solar or storage projects).

Does the EO apply to utility-scale wind, solar or battery storage projects?

While distributed solar or wind is not covered by the order, the issue becomes whether the language is broad enough to include utility-scale wind or solar or large-scale energy storage projects. Nothing in the EO suggests that it applies to these projects. On a close reading of the definition, with the possible exception of substation equipment, neither wind equipment, solar equipment nor large-scale batteries should be included. However, the inclusion of the terms “generating power stations” and “generation turbines” creates some uncertainty. Further, the statement in the EO that it only applies to generation facilities that are necessary to “maintain transmission reliability” could be a vague reference to generation sources other than wind and solar (since those technologies have been challenged by coal and nuclear interests as “less reliable”). That said, it would be surprising that such a large proportion of new-build power projects in the United States would be categorically exempt from the EO.

To what type of transactions does the EO apply?

The EO applies to the “acquisition, importation, transfer, or installation” of any bulk-power system electric equipment designed, developed, manufactured or supplied by persons owned by, controlled by, or subject to the jurisdiction or direction of a by foreign adversary that threatens national security. In other words, the EO could apply broadly not only to equipment supply purchases directly from original equipment manufacturers, but also to any downstream purchases or incorporation of such equipment in power projects. It could even apply, for example, to transfers in connection with establishing a tax equity partnership for renewable power transactions.

• Implementation of the EO will require inter-agency coordination, rulemaking and procedures. The EO directs the Energy Secretary to coordinate with the US Departments of Homeland Security, Commerce and Defense, among others, which may involve new requirements and focus on targeted imports (customs rules), exports and transfers (trade controls), and foreign investments in US bulk-power equipment businesses (CFIUS reviews).

What considerations will the US Department of Energy use to determine whether equipment supply poses a threat to US national security?

US “national security,” which also underlies the Trump administration tariff action on steel and aluminum under Section 232 of the Trade Expansion Act and all reviews by CFIUS, remains undefined. Instead, as in the CFIUS and Section 232 contexts, “national security” is framed as a series of factors to be considered. Thus, the EO directs the Secretary of Energy, in consultation with other department heads, to determine one of the following in order to impose the applicable prohibitions: the transaction must pose (1) “an undue risk of sabotage” to the operation or maintenance of the US bulk-power system, (2) an undue risk of “catastrophic effects” on the security or resiliency of US critical infrastructure or economy, or (3) an “unacceptable risk” to US national security. As in the CFIUS and Section 232 contexts, these factors allow significant discretion to the Department of Energy for imposing the prohibitions.

What is the effective date of the EO?

This is unclear. The EO states that it applies to “transaction[s] . . . initiated after the date of this order,” although another part of the EO states that it applies “notwithstanding any contract entered into or any license or permit granted prior to the date of this order.” This suggests, for example, that new purchase orders placed under master supply contracts that are already signed and downstream sales of projects incorporating prohibited equipment already installed could both be blocked.

Will the EO just apply to new equipment orders?

One troubling aspect of the EO is that it instructs the Energy Secretary to “develop recommendations on ways to identify, isolate, monitor, or replace” targeted equipment, meaning that, depending on the scope and nature of forthcoming regulations, projects that have incorporated target equipment could have to replace such equipment in the future. Parties would do well to think about these potential implications when negotiating contracts with counterparties to appropriately allocate risk of future replacement (and costs and delays associated with such replacement).

NEXT STEPS TO BE TAKEN BY SECRETARY OF ENERGY:

The Department of Energy provided an initial overview of the EO, which can be found here.

The EO directs the Secretary of Energy, in consultation with other relevant department heads, to identify “as soon as practicable” bulk-power system electric equipment that would raise the national security risks mentioned in the EO.

The Secretary of Energy, in consultation with the heads of other agencies, is also allowed to publish a list of pre-approved equipment vendors.

The EO establishes a task force, headed by the Secretary of Energy or the Secretary’s designee, that will produce a set of energy infrastructure procurement policies for the US government and will produce an annual report summarizing its findings.

The Secretary of Energy is directed to publish rules and regulations implementing the EO by September 28, 2020.

WHAT NEXT?

While the industry waits for the Secretary of Energy to publish rules and regulations implementing the EO, the industry must live under this cloud of uncertainty. It would seem difficult, but not impossible, to later challenge good faith attempts to comply with the EO. Therefore, in the meantime, we would expect that many developers and owners will stay the course on building and operating existing projects. On new projects or those where changes in equipment suppliers can be made, we would expect to see some international manufacturers avoided. We may also see extra diligence applied in purchase and sale transactions for projects that could include equipment that may be later determined to be prohibited by the EO. While the EO refers to new transactions, it is not completely clear that existing projects are exempt. Hopefully, the Secretary of Energy’s regulations will properly clarify this issue.

The team at McDermott is monitoring these issues and addressing client-specific inquiries as well, including providing advice regarding structuring transactions and allocating risks associated with the EO. We will continue to provide updates on the implementation of the EO regulations as they are developed.