5/5/2009

While the final rule did not vary significantly from MMS's July 2008 proposed rule,³ MMS did make some relevant changes in response to comments from industry and nongovernmental organizations.

Issuance of OCS Alternative Energy Leases

Leases will be assigned using a competitive format, unless no competitive interest exists. The final rule allows MMS to use one of four auction formats for each competitive lease: (1) sealed bidding, (2) ascending bidding, (3) two-stage bidding, and (4) multiple-factor auction. The new multiple-factor auction format allows for nonmonetary factors, like the use of innovative technology suited to a specific site, to be a determinative factor. The proposed rule mandated that any tie in the bidding process be broken through random selection. In contrast, the final rule provides that ties will be broken through an additional round of bidding.

Noncompetitive leases are awarded after a qualified entity requests a lease in an area not otherwise proposed for competitive bidding or excluded from leasing by statute. An unsolicited request will be considered after MMS issues a public notice of the request and determines that no competitive interest in the area exists.

Scope of Lease

Leases can be issued for both commercial production activities and for assessment or technology testing activities. Commercial leases have a preliminary term of six months to submit a Site Assessment Plan ("SAP") and then up to five years to conduct site assessment activities and submit a Construction and Operations Plan ("COP"). These preliminary lease terms are subject to automatic extension if necessary for MMS review and approval of necessary permits.

After the COP is approved, commercial leases have a standard operations term of 25 years, which will provide the access and operational rights to produce, sell, and deliver power on a commercial scale through spot market transactions or long-term power purchase agreements. As stated in both the proposed and final rule, the standard 25-year lease term for operations may be modified. An operations term longer than 25 years could be established under a particular lease. However, MMS declined comments requesting open-ended leases. MMS explained that open-ended leases could perpetuate the use of inefficient or obsolete operations.

Under the final rule, commercial leases can be renewed beyond 25 years, but only after MMS considers the (1) design life of existing technology, (2) availability and feasibility of technology employed, (3) environmental and safety record of the lessee, (4) operational and financial compliance record of the lessee or grantee, (5) competitive interest and fair return, and (6) effects of the lease on generation capacity and reliability in the regional electrical distribution and transmission system.

Limited leases are for periods up to five years and provide access rights to conduct activities, such as site assessment and technology testing,, that support production of renewable energy. A change in the final rule allows for operations on limited leases to interconnect with the transmission grid for commercial power sales.

The proposed rule provides that OCS sites would be leased in nine square nautical mile blocks. The final rule allows for leaseholds to be as small as 1/16 of a block or as large as multiple blocks depending on the project requirements.

Leases also include rights-of-way ("ROW") and rights-of-use and easement ("RUE") grants. ROW grants provide the lessee with the ability to use a portion of the OCS for the transmission of energy to the grid. RUE grants provide use of a designated portion of the OCS to support activities on a lease site. Alternate use RUEs can be awarded on a case-by-case basis.

Decommissioning timelines have also been extended. Lessees now have up to two years to decommission their facilities.

Conversion from Limited Lease to Commercial Lease

A number of parties commented that the OCS lease process should give limited lease holders site priority for subsequent commercial leases on the same site. MMS has declined to make any specific provisions in the final rule, due to the competition requirements of subsection 8(p) of the Outer Continental Shelf Lands Act. However, MMS stated in its responses to public comments that it may be able to provide limited lease holders extra weight in the competitive commercial lease process through the drafting of specific terms and conditions in the limited lease.

Financial Assurance Requirements

To minimize the risk of financial loss to the federal government, MMS is requiring that lessees provide sufficient financial security to ensure that their obligations can be fulfilled by a third party in the event of default. Just as in the proposed rule, lessees must post a grant-specific bond of $300,000 for limited leases, ROW grants, and RUE grants.

Commercial leases have financial assurance requirements at various stages. Before MMS will issue a commercial lease, the lessee must pledge one of the following types of assurance:

1. $100,000 lease-specific bond;
2. $115,000 in U.S. Department of Treasury securities;
3. $100,000 cash to be deposited and maintained by MMS in a federal depository account;
4. Certificates of deposit or savings accounts with minimum net assets of $500 million, a minimum Bankrate.com Safe & Sound rating of three starts, and Capitalization, Assets, Equity, and Liquidity ("CAEL") of three or less;
5. Negotiable U.S. government, state, and municipal securities or bonds having a market value of not less than $100,000 and maintained in a Securities Investors Protection Corporation insured trust account by a licensed securities brokerage firm for the benefit of MMS; or
6. Insurance to guarantee performance with an A.M. Best rating of "superior" or its equivalent.

Supplemental financial assurance is required after the approval of the SAP and COP. The amount of any supplemental bond (or its equivalent) will vary according to the proposed lease or grant obligations. In addition, the final rule allows for those bonds to be returned before decommissioning if the lessee provides a decommissioning bond.

A change in the final rule also allows for the bond requirements to be waived if the lessee, or a guarantor, is deemed to be of high financial strength and integrity. In determining financial strength and integrity, MMS will consider financial capacity substantially in excess of existing and anticipated lease and other obligations, five years of continuous operation and generation of renewable energy, credit ratings, and compliance with laws, regulations, and lease terms.

Lease and Grant Payments

The basic rent structure for OCS leases has not changed. The rent for a limited lease is $3 per acre per year, unless otherwise established in the Final Sale Notice and lease instrument. Limited leases will not be subject to any operating fee for the authorized sale of power.

The rent for a commercial lease is also $3 per acre per year, unless otherwise established in the Final Sale Notice and lease instrument. Unlike the proposed rule, the final rule provides MMS with the ability to waive portions of rent for commercial leases developed in phases.

In response to industry comments, the operating fee for the sale of power has changed. Only commercial leases will be subject to the operating fee for the sale of power. Of particular note, the final rule changed the fee formula so that operating fees are based on a calculation pegged to the wholesale power price rather than the retail power price as MMS had proposed last July. The fee formula is F = M * H * c * P * r, where "F" is the annual operating fee in dollars, "M" is the installed capacity in MW, "H" is the number of hours in a year (8,760), "c" is the anticipated capacity factor expressed as a decimal, "P" is the wholesale power price in dollars per MWh (in the state where the transmission line makes landfall), and "r" is an operating fee rate between zero and one to be set by MMS. Additionally, MMS will not charge an operating fee until the date of commercial generation of power. Further, MMS will share operating fee revenues with the state in which the transmission line makes landfall.

The rental fee structure for ROW and RUE grants is unchanged. The rental fee for ROW grants is $70 for each nautical mile that the ROW crosses plus an additional $5 per acre for use of the entire affected area if the ROW grant includes a site outside of a 200-foot-wide corridor. The rental fee for RUE grants is $5 per acre. Both ROW and RUE grants have a minimum fee of $450 per year.

Plans and Information Requirements

A General Activities Plan ("GAP") must be filed for limited leases and ROW and RUE grants. Commercial leases must have both an approved SAP and COP, which can be filed simultaneously. To comply with National Environmental Policy Act ("NEPA"), Endangered Species Act, Coastal Zone Management Act ("CZMA"), and other relevant laws, environmental reviews must be filed with each plan. However, if the SAP and COP are filed simultaneously then only one review is necessary. Furthermore, in competitive lease sales, MMS will prepare a NEPA document and consistency determination for the lease sale and site assessment activities, but a new NEPA/CZMA review is required if your SAP shows changes in impacts from those described in the lease sale NEPA document.

The proposed rule's requirement that a third-party contractor prepare the environmental reviews has been amended. The final rule allows for a case-by-case determination of whether a third-party contractor is required. Additionally, MMS can waive the requirement that a certified verification agent oversee facility construction at the site.

Similarly, MMS has also changed its position regarding approval of site surveys. Geophysical, geological, hazards, archaeological, and biological surveys do not need MMS approval. Instead, lessees can now obtain permit approval solely from the Army Corps of Engineers before or after lease grant.

The MMS has also removed its proposed rule to protect archeological resources. MMS has determined that archeological resource management is best handled by other agencies.

Submission of Proprietary Information

Numerous commentators to the proposed rule objected to MMS's lack of safeguards for proprietary information submitted with lease applications, SAPs, COPs, and GAPs. MMS has changed language in the final rule to reflect that it will use all mechanisms available under the Freedom of Information Act to protect appropriately designated proprietary information.

Assignment

OCS lessees can assign all or part of their lease or grant interest after MMS approval. In response to comments, the final rule added a statement clarifying the MMS position that mergers, name changes, and changes to business forms do not constitute an assignment. MMS must be notified of such change within 120 days.

Conclusion

These final rules represent the conclusion of an uncertain regulatory period for offshore renewables and the opening of a new frontier for offshore energy development. For developers, the choice between using the limited or commercial lease, in particular, will be a strategic one. While a limited lease may be a good choice for developers truly in a technology testing phase, those with tested technologies that are planning phased development may choose to pursue longer-term commercial leases that now provide for testing and construction time, have more flexible financial assurance requirements, and do not put site priority at risk.

For more information about the issues in this article, please contact:

John Laney at (206) 386-7559 or jslaney@stoel.com
Cherise Oram at (206) 386-7622 or cmoram@stoel.com
Michael O'Connell at (206) 386-7692 or moconnell@stoel.com
Barbara Brenner at (916) 319-4676 or babrenner@stoel.com
Eric Laschever at (206) 386-7614 or eslaschever@stoel.com
Dina Dubson at (503) 294-9675 or dmdubson@stoel.com

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¹ 30 CFR Part 285.
² Please note that, under a recent memorandum of understanding ("MOU"), it is agreed that MMS will issue leases, easements and rights-of-way for renewable energy projects on the OCS and the Federal Energy Regulatory Commission will issue licenses. Stoel Rives LLP issued an alert regarding the MOU on April 10, 2009. The alert is available at http://www.stoel.com/alerts/Ocean_April2009.html.
³ Stoel Rives LLP issued an alert regarding the proposed rule on July 23, 2008. The original alert is available at http://www.stoel.com/showarticle.aspx?Show=3037.