Target practice – target cost contracts in renewable energy projects

As renewable energy projects grow in scale and technical complexity, traditional construction contracting models are increasingly being questioned. In particular, the suitability of fixed-price, lump sum contracts in an environment characterised by cost volatility, design development and programme pressure is under scrutiny.

Against this background, target cost contracts are playing an increasingly prominent role in the delivery of renewable energy infrastructure. When used appropriately, they offer a structured way to share risk, promote collaboration and incentivise cost efficiency. However, they also demand careful legal and commercial structuring to avoid disputes and unintended outcomes.

What is a target cost contract?

At its core, a target cost contract is a cost-reimbursable model with a risk-sharing mechanism. The parties agree an initial target cost, typically based on an open-book estimate prepared with contractor input. The contractor is paid its actual defined costs as they are incurred, together with an agreed fee for overheads and profit.

At completion, the final outturn cost is compared to the target cost:

• If the final cost is below the target, the saving is shared between the employer and contractor in agreed proportions (the gainshare).
• If the final cost exceeds the target, the overspend is similarly shared (the painshare), often subject to a cap on the contractor’s liability.

In the UK, this mechanism is most commonly associated with NEC4 Option C (Target Contract with Activity Schedule), though target cost principles can also be incorporated into bespoke contracts or adapted versions of other standard forms. The first JCT target cost contract was launched in 2024.

Why target cost contracts are gaining traction in renewables

Renewable energy construction projects can present a distinctive risk profile that often sits uncomfortably with lump sum contracting.

Design evolution and ground risk

Many renewable projects proceed with incomplete design. Offshore and onshore wind developments, battery storage facilities and grid connection works frequently involve ongoing design development as site conditions, grid requirements and environmental mitigation measures become clearer. Attempting to fix price too early can result in inflated contingency allowances or adversarial disputes when reality diverges from assumptions.

Target cost contracts allow projects to commence on a realistic commercial basis while accommodating controlled evolution of scope.

Supply chain volatility

Global supply chains for turbines, cables, transformers and steel remain volatile. Price fluctuations, long lead times and geopolitical factors introduce uncertainty that contractors may be unwilling – or unable – to absorb under a fixed-price model. A target cost approach enables risk to be shared more transparently, often resulting in more competitive pricing.

Programme and regulatory pressures

Renewable projects are frequently driven by immovable milestones, such as subsidy deadlines, grid connection dates or power purchase agreement obligations. Early contractor involvement under a target cost model can support faster mobilisation and improved planning for the construction phase, reducing the risk of delay.

Alignment of incentives

Unlike traditional contracts, where each party’s commercial interests often diverge, target cost contracts align incentives. Both employer and contractor benefit from cost savings and are exposed to overspend, encouraging collaboration, innovation and efficient problem-solving.

Key legal and commercial considerations

While target cost contracts offer flexibility, they are not “light touch” arrangements. They require detailed drafting and proactive management.

Defining allowable cost

One of the most common sources of dispute is the definition of allowable cost. The contract must clearly identify which costs are recoverable and which are excluded. Particular care is required around:

• Head office overheads and corporate costs
• Subcontractor pricing and management costs
• Plant, logistics and preliminaries
• Inefficiency, rework and delay-related costs

For renewable projects involving specialist subcontractors and complex logistics, ambiguity in cost definitions can quickly undermine trust.

Setting a robust target cost

The success of a target cost contract depends heavily on the credibility of the initial target. Unrealistically low targets may encourage adversarial behaviour and claims, while overly generous targets dilute the incentive effect.

Best practice typically includes early contractor involvement, transparent estimating, risk workshops and, in some cases, independent cost validation.

Pain/gain share mechanisms

The sharing ratios for savings and overruns need careful calibration. Employers will seek meaningful downside protection, while contractors require confidence that exposure is proportionate and insurable. Caps on contractor liability are common and may be essential for market acceptance.

Managing change

Change is inevitable on renewable energy projects, whether driven by planning conditions, grid operator requirements or environmental constraints. The contract must clearly distinguish between:

• Changes that justify an adjustment to the target cost
• Risks that remain within the contractor’s share of pain.

Poorly defined change mechanisms can lead to disputes that simply replace arguments over variations with arguments over target cost adjustments.

Governance and culture

Target cost contracts demand a different behavioural approach. Open-book accounting, regular cost reporting and transparent governance structures are essential. Without a genuine commitment to collaboration, the model can quickly revert to defensive cost management and mistrust.

The funder perspective

Historically, funders have been wary of target cost contracts due to perceived cost uncertainty. However, attitudes may be evolving. With appropriate safeguards – such as cost caps, contingency arrangements, step-in rights and robust reporting – target cost models are increasingly viewed as compatible with project finance structures, particularly for construction-only risk periods.

For renewable projects where risk cannot realistically be priced with confidence at contract award, a well-structured target cost contract may offer funders greater long-term certainty than an artificially fixed price that later unravels.

When target cost contracts may not be appropriate

Target cost contracts are not a universal solution. For projects with well-defined, repeatable scopes – such as standardised solar installations with minimal ground or interface risk – a lump sum contract may still deliver better value and simplicity.

The key is aligning the contracting strategy with the project’s risk profile, complexity and the parties’ appetite for collaboration.

Key takeaway

Target cost contracts are becoming an increasingly important tool in the delivery of renewable energy infrastructure in the UK. When properly structured and managed, they can address the realities of cost uncertainty, encourage early contractor involvement and promote collaborative behaviour that benefits all parties.

However, they are not appropriate for all projects. Success depends on careful drafting, realistic cost setting, clear governance and a genuine commitment to transparency. For developers, contractors and funders alike, the real question is not whether target cost contracts can work in renewable energy projects but whether the project team is prepared to use them properly.

How we can help

If you are considering a target cost approach for a renewable energy project, or would like to review your existing contracting strategy, please contact Martin Whiteford at martin.whiteford@andersonstrathern.co.uk.