Renewable energy sector to use broader range of risk transfer products

The renewable energy sector need to improve the way the way they manage risk and look to a broader range of alternative risk transfer products to mitigate growing financial and operational risks, according to a fascinating new report from the Economist Intelligence Unit and reinsurer Swiss Re. The report is based on a survey of 284 renewable energy executives, both operational and those in financing and investment, to uncover the perception of risk in financing, operations, construction and the risk management challenges they face.

The report, Managing the risk in renewable energy, shows that the renewable energy sector needs to get to grips with the best methods of managing risk and offloading those risks to other parties or it could face an uncertain future. 70% of the canvassed executives said they felt somewhat or highly successful at identifying risks, 61% at mitigating risk and just 50% said they were somewhat or highly successful at transferring risk to third parties. Those figures surely have to grow.

Worryingly, just 55% of those canvassed said they had used insurers as part of a risk mitigation strategy over the last three years. That suggests there is a massive opportunity for the re/insurance industry to get up to speed on renewables and help the sector plan and action risk transfer strategies.

Perhaps more worryingly, given the weather risk exposed nature of many renewables projects, just 32% said they had used weather protection providers (including weather hedging through weather derivatives) in the last three years. This despite a recognition that weather risks are one of the most pressing to the sector. When asked how they would rate the significance of specific risks to their business, 54% said that weather related volume risks (eg. lack of wind or sunshine) were a medium or high risk to their renewable energy projects. 45% of respondents acknowledged that weather related volume risk had materialised in their renewables business. 30% said that lack of awareness of weather hedging markets and solutions was a barrier to effective risk management while 15% said insufficient information on the magnitude of weather risks was an issue. The weather risk management market seems to have a PR job to do within the renewable energy sector.

On the plus side, 33% of respondents said that they used hedging of adverse weather conditions to mitigate financial and market risks associated with their renewable energy plants. So it’s not all bad as far as weather risk management education goes, but there is plainly much more to do for the renewables sector.

Where the data from report responses get’s really interesting is in the responses regarding what risk transfer mechanisms are used to offset risks within the renewable energy sector. The report is not particularly clear on one item of interest, the use of catastrophe bonds in this sector. We don’t know of any cat bond transactions involving renewable energy companies and yet the report repeatedly mentions catastrophe bonds as actively being  used as part of the risk transfer mix. We’re not sure whether this is indeed correct, or whether there is some confusion about what constitutes a catastrophe bond in this sector (perhaps these are just bond issues linked to performance?).

For example, the report lumps bonds and catastrophe bonds together as ‘alternative risk transfer’ as a response when respondents are asked what risk transfer mechanisms they use to address operational risk to which 25% respond ‘alternative risk transfer (bonds, catastrophe bonds). Plainly not accurate in the insurance-linked securities sense, so this has to include things like revenue bonds, performance bonds etc. We’d really like to know what percentage (if any?) of this sector are using what we know as catastrophe bonds? If you have any experience in this sector or knowledge of their use here, please let us know in the comments below.

It’s actually a shame that the report has been constructed this way as it’s a little misleading and it would have been nice to have a definition of each answer category, or to have split catastrophe bonds out.

Insurance is the most widely used risk transfer tool across most types of risk, with special purpose vehicles (again, a not very well explained response category) and financial derivatives also featuring highly.

Putting the confusion around the use of the term catastrophe bond in this report aside. What’s really important to take away from it is the fact that the renewable energy sector seem’s to be an area of promise for the risk transfer sector. The weather risk management market can have a major impact on this sector, particularly if it can be made easier to access customised solutions that address each type of renewable energies weather volume risks. Insurance linked securities, and catastrophe bond type structures, are also highly applicable to the renewable energy sector and there is likely a good fit for these tools to be used as a way to pass some of the performance risks associated with renewable energy projects to capital markets investors.

The major area the sector needs help with right now seems to be addressing the upfront financing risks associated with new renewable energy projects. The upfront costs are huge, construction can be costly and it often isn’t until the project is up and running that you have a really good idea how profitable it will be. This means investors take a huge risk when committing to new renewable energy projects and this is perhaps an area that insurance-linked securities could help to finance by transferring the risk of performance being lower than expected.

The confusion about the use and inclusion of the term catastrophe bond aside, this report is very interesting and pertinent for the re/insurance and weather risk markets as there is a very good fit between the products offered and the projects the renewables sector generates. The survey shows that there is a desire to broaden the understanding and the sources of risk transfer available to the renewables sector and an appetite to use alternative risk transfer techniques where possible.

You can access the full report here and read Swiss Re’s press release here.