The World Bank has completed a $450 million weather and oil price insurance transaction for a Uruguayan state-owned hydro-electric power company, with the risk being offset with reinsurance by Allianz, through its partnership with Nephila Capital, and Swiss Re.
The novel transaction provides Administración Nacional de Usinas y Transmisiones Eléctricas (UTE), the Uruguayan state hydro-power company, with $450m of protection over an 18 month period against drought and high oil prices, both of which have had negative financial impacts on the company in the past.
The clever transaction fends off two risks which impact the hydro-electric generation firm at the same time. A lack of rainfall reduces the water levels in reservoirs, forcing UTE to turn to thermal generation which costs more and requires oil purchases. The costs go up even higher during drought if oil prices are high as well, causing a burden on the Uruguayan government budget.
So protecting UTE against a lack of rainfall and oil price spikes in the same transaction can mitigate much of the impact of this risk for the hydro-electric power generation firm.
Uruguay’s Minister of Economy and Finance, Fernando Lorenzo, commented; “Uruguay is vulnerable to climate and oil price volatility, we need to manage these challenges and do it in a creative way. This transaction is a positive step forward since it helps us to manage risks which have a big impact on individual consumers, on businesses, and on the public accounts.” Lorenzo added that; “This transaction is complementary to the Energy Stabilization Fund Established in 2010.”
“This transaction, which is one of the largest the market has seen, is unique.” commented Madelyn Antoncic, Vice-President and Treasurer of the World Bank. “Combining protection against the risk of drought and high oil prices is something that works particularly well for hydropower companies, and it’s the first time we have seen a public utility use this type of tool. This transaction is a good example of how we can focus our financial and technical expertise, combined with experiences in other countries, to deliver solutions that meet specific client needs.”
Rainfall data is measured at 39 weather stations spread throughout the river basins of the Rio Negro and the Rio Uruguay, which provide much of the water required by UTE. The transaction features a trigger based on the measured rainfall levels, with data collected daily compared to a pre-determined level set as the trigger for the contract.
If the measured rainfall level is lower than the trigger, the contract will pay up to $450 million. The transaction pays out on a sliding scale, depending on the severity of the drought, and on oil price levels. This is attractive to UTE as it helps to mitigate both a lack of rainfall and a full-blown drought. If oil prices are high, any payout will be larger to offset the high cost of UTE’s fuel purchases.
The World Bank said that the contract size is large because the cost to UTE of a drought can be significant. In 2012, water shortages forced UTE to purchase other sources of energy. In that year alone the costs of supplying demand for electricity reached a record of US$1.4 billion, far exceeding UTE’s original projections of $953 million. The gap in financing was covered by borrowing funds from the market, drawing down on Uruguay’s US$150 million Energy Stabilization Fund, and increasing electricity prices for consumers.
So this weather risk and oil price insurance aims to smooth pricing for the end using customers, by protecting UTE against lack of rainfall and mitigating the oil price spikes that may occur, with the hope of preventing the firm needing to pass on additional costs to consumers or borrow from the government.
“This coverage is for three semesters, because once other sources join the system, such as wind and combined cycle natural gas, the vulnerability of the overall power system will go down,” commented UTE’s President Gonzalo Casaravilla “While the likelihood of cost overruns continues to exist, they will be lower, and the premium that the company is willing to pay for coverage will be recalculated.”
The World Bank, the counterparty to UTE in the deal, worked with the global reinsurance market on this transaction. Two reinsurers were selected through a competitive bid process to offset the risk for the World Bank, Allianz through its partnership with Nephila Capital and Swiss Re.
The involvement of Nephila Capital likely signals that some of this risk has been backed by third-party reinsurance capital which is under management at the insurance-linked asset manager.
“Financial risk management is an important part of the overall picture for countries concerned about energy security.” said Hasan Tuluy, Vice-President for Latin America and the Caribbean at the World Bank. ” But the solutions that our clients need are not always standard or straightforward. This is especially true for middle income countries such as Uruguay with a more complex set of demands.”
“This transaction, the largest of-its-kind in the weather risk management market, demonstrates how public-private partnerships can help ease the budgetary impact of a volatile climate,” added Swiss Re Corporate Solutions CEO Agostino Galvagni.