Institutional Investors – Financing wind projects in changing subsidy environment - total return insurance as solution ?

Introduction

Wind generation industry is still highly debt financed with significant exposure towards volatile cash flows particularly in the first years of operations. Cash flows and therefore power generated depends on prevailing wind conditions as well as technical availability. In times of fixed feed-in tariffs lenders have cushioned volatility of both with quite conservative assumptions about assumed production. With auction systems replacing subsidy schemes competition for projects will be introduced and more sophisticated approaches are required.

Approach

Since wind energy generation has gained such importance in the energy mix the issue of lack of wind and its impact on financing has been addressed by the financial services industry, mainly insurers and reinsurers. The offerings were limited to weather index hedges without considering turbine availabilities and thus potential large gaps between theoretical calculated and actual generation. These gaps left all involved into wind project financing with demand for a total return insurance.

Main body of abstract

A wind park's return depends on the amount of energy generated. Lack of or excess wind is one extremely influential factor for the generated volume and a wind production index mimics the wind turbine's generation by laying reanalysed satellite data over the turbine's power curve and calculating theoretical production. However even for very carefully designed indices there will always be a gap between index and actual generation, caused by turbine unavailability. Letting aside planned availabilities, unplanned ones, being a result of predictive or emergency maintenance, are the root cause for the potential difference between the calculated production index and actual generation. This difference is called basis risk. As in the worst case unplanned unavailability might occur at times of good wind conditions the basis risk is potentially substantial.

Risk takers so far offered wind index hedges as pure weather risk coverage with investors being left with the basis risk.

The reference to the usual turbine warranty which guarantees a minimum availability for 5 years is weak. It does not apply for older turbines and also doesn't consider wind conditions at time of unavailability.

In order to add substantial value for a financial participant the volatility of the cash flow needs to be reduced as far as possible, ideally towards 0. For being able to do so one needs not only the capability to develop fair estimations about future wind availability but also a good idea of the technical reliability of the underlying infrastructure. Insurance companies have this technical view anyhow as assets are already insured against many other perils. Moreover particularly reinsurance companies often have renewable assets in their portfolios for asset diversification reasons with the operational know how available at their third party operators.

The combination of know how about weather and outage risk together with access to operations experience puts reinsurers in a unique position to evaluate all prevailing risk of a wind farm. The remaining challenge is that this information is often widespread in the organisation.

Conclusion

Financing wind projects leaves still room for optimization, ideally with a total return insurance. The key is in the hand of risk takers whom are able and prepared to take the whole spectrum of risk and offer 'easy to understand' solutions to the lender and investor community. In a market environment with competition between projects the demand for such a product will increase significantly.


Learning objectives
For being able to offer a total return insurance for wind parks one needs to collect and manage the information. A total return insurance for wind parks would open a ground-breaking chapter in the area of renewable financing. Lender could offer less conservative financing conditions and auction bids could be made more competitive. Energy Risk Solutions has picked up this challenge together with the global reinsurance industry, for more details please ask us.