Ebook Financial Risk Management Instruments for Renewable Energy Projects
This study was funded by UNEP’s Sustainable Energy Finance Initiative (SEFI) and conducted by a consortium of consultants and advisors led by Marsh Ltd with the objective of providing an overview of the barriers and/or risks affecting investment in Renewable Energy (RE) projects, ‘financial risk management’ instruments currently supporting RE projects and those that could be developed to reduce uncertainty and facilitate more efficient and effective financing of such projects.
The study was undertaken under the premise that current approaches to financing renewable energy are inadequate to realize the potential of these technologies to meet expanding energy needs while helping to mitigate climate change and other adverse environmental impacts. Public interventions are therefore needed to help accelerate RE development, commercialization, and financing.
Key messages of the report include: Traditional insurance products are gradually becoming more widely available to the RE sector. However, ‘institutional inertia’ is preventing any significant progress with regard to product development. The tendency in the insurance industry is to readapt existing products rather than create new ones. Substantially more engineering tests must be carried out on RE technologies for the purposes of actuarial studies: there is an important role for the public sector in the sponsorship of this work.
Capital allocation within insurance companies is dependent on senior management being convinced that the business case for underwriting a certain class of risk meets their minimum criteria. Most small projects have a high opportunity cost and rarely exceed the internal hurdle rates required by management. There is currently an impasse in RE market development in part due to restrictive thinking. Fresh approaches and financial innovation are required. Based on the responses to this study, the hypothetical provider of such innovation in the insurance markets is likely to be a small- to medium-sized specialist risk transfer/finance operation with dedicated capital and low overheads. Such an enterprise could facilitate and attract additional capital by providing industry leadership. However, few such operations currently exist.
This study proposes that there is a gap between the developers, their advisors and institutional investors. On one side are the boutiques and consulting firms that really interact with the majority of renewable energy (RE) project developers. On the other side are the major financial institutions who interact at a high level with policy makers but, despite good intentions, are usually too large/inflexible to operate usefully in the RE space at this time. There is a useful role for the public sector to act as a ‘mezzanine player’ or bridge between the expertise, creativity and nimbleness of boutiques and the distribution networks, balance sheet and market influence of major financial institutions.
New financial risk management approaches and instruments are evolving and can be adapted to meet the needs of the RE sector. These include; risk finance approaches, alternative risk transfer products, specialist underwriting vehicles, credit enhancement instruments and indexed derivatives. Insurance collaterallized debt obligations may be one method of directing capacity at particular insurers and lines of business. There is an ongoing role for risk mitigation and especially credit enhancement products provided by Multilateral Financial Institutions (MFIs), Official Bilateral Insurers (OBIs) and Export Credit Agencies (ECAs).
A key objective of this study is to accelerate plans to develop product blueprints for actual application in the market. A learning-by-doing approach to developing new and commercially acceptable RE financing and risk management products could be usefully adopted through focused interactions between the public sector, specialist financial boutiques/insurers and global financial intermediaries. This can be accomplished through joint ventures that combine the perceived support and credit rating of public sector entities with the creative vision of specialist private boutiques and the distribution networks of large financial services companies.
A number of programmes are suggested in section 6. The main suggestion is to develop Special Purpose Underwriting Vehicles (SPUVs) with dedicated capacity for the RE sector. An example of a risk management start-up operation from the forestry sector demonstrates the possibility for specialist Lloyd’s syndicates to provide cover to commercially viable RE projects. There are a variety of SPUV structures which could be developed. The nature of the cover to be provided determines the level of public support required. An insurance company providing standard fire and wind storm protection for forestry requires nominal public support unless/until it takes on broader environmental agendas. However, the technology and operational risks inherent in RE projects mean that providing standard insurance cover is actually quite complex because of the data requirements. Public sector support is required for engineering as well as project risk rating studies for most Renewable Energy Technologies (RETs) that have limited operational experience.
Contents
Acronyms and abbreviations
Glossary of terms
Executive summary
1. Renewable Energy Technology assessment
2. The role of financial risk management instruments
3. Overview of risks and barriers
4. Existing insurance products for renewable energy projects
- The role of insurance
Insurance capital allocation
Existing availability of insurance for RE projects
Wind energy projects
Geothermal energy
Biomass/biogas
Wave/tidal/ocean current
Solar PV
Small hydro
5. Evolving financial risk management instruments that can support renewable energy projects
- The role of emerging risk management instruments
Weather derivatives for RE projects
Adaptable credit products
Risk finance vs. risk transfer
Evolving/adaptable risk management and ‘new capacity’ structures
Public sector instruments
6. Scope for developing new financial risk management instruments for the renewable energy sector
- Scope for new product development
Least Developed Countries
Carbon Finance
Demand issues
New approaches in Europe
Expertise and markets
A learning-by-doing approach to new product development
Special purpose underwriting vehicles
Other programmes
Barrier removal priorities
Concluding summary
7. Bibliography
About the UNEP Division of Technology, Industry and Economics
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