Structuring a Successful Co-location Project
Co-location is not a novel concept. Since the dawn of human economic activity, we have recognized the convenience and efficiency of locating one economic activity in close proximity to a related activity. Today, the benefits of co-location can be measured quite clearly at the bottom line.
Examples of co-location are limitless: a smelter, refinery or other processing facility next to a mine, wellhead or hydroelectric facility; an ethanol or biodiesel plant on the site of a grain elevator or soy crush facility; chemical products operations a short pipe length away from a petroleum refinery. Any input to product relationship can suggest an opportunity for co-location.
While the concept is simple, establishing a successful co-location relationship can be quite complex. If the ownership of both the primary and secondary facilities is the same, the advantages of co-location can be realized readily. But, often the owners of co-located facilities are different, not only in their views of the economics of the relationship but also in their capabilities to establish and operate their respective facilities.
A simple co-location relationship might require only a contract for the supply of a feedstock or other input. The most complex could be documented with a master or joint venture agreement that spells out the major terms of the relationship and is supplemented by agreements for feedstocks, energy, utilities, transport, off-take, site ownership or lease, management, other services, labor, equity and debt finance, and government subsidies. In any case, the agreements will need to address the endgame: what happens when the agreement expires or is terminated, if the benefits of co-location cease or if one party is sold, goes bankrupt or dissolves.
This can be critical where two or more parties co-locate on a site owned by one party. The lease will need to deal with the term, renewals, rent or other payments, changes for market conditions, and ownership or disposition of plant and equipment upon termination. The rent could be $1 per year, market rate or variable depending on the success of the venture. The lessee would want both renewal rights at a predictable cost and termination rights with minimum liability. The site owner will have an interest in preserving the integrity of the property and assuming ownership of the fixed assets at termination.
Where the co-located facility is essentially in the business of commodity processing, the supply and off-take arrangements will be critical. Pricing on both ends could make or break the venture. One answer might be a tolling arrangement, where the co-located facility is paid a processing fee that is not tied to the market price of either the inputs or production. Where the downstream producer has a market for a product that is not so sensitive to price, it may take more market risk with respect to inputs.
Joint arrangements for utilities and transportation can be a major cost reduction benefit of co-location. Shared electric and natural gas sources and even a jointly owned power plant should be considered. Water source, recycling and disposal should be common. Road access and rail service should be shared. The agreements will need to identify which party will control these relationships and own the related real estate and fixed assets.
Co-location may also involve special management and labor sharing arrangements. Thus, management, employment and various operating services agreements may be used to reduce operating costs.
Financing sources, including equity and debt investors in either party to a co-location arrangement, will take a great interest in assuring the integrity and durability of whatever arrangement and agreements are made. Lenders particularly will look for assurances on the supply and off-take sides to support the viability of the facility or company being financed.
Risks and liabilities will need to be considered when co-locating facilities. An incident at one facility could damage the other. Indemnification and insurance will need to allocate risks and provide protection that is adequate in scope and amount.
Realizing the benefits of co-location will depend on sound planning and structuring. The parties will rely on engineering, operations, procurement, marketing, finance and legal resources to bring the project from conception to success. Outside advisors will bring expertise to the table to support each of these tasks.
Author: Dean R. Edstrom
Partner Attorney, Lindquist & Vennum PLLP