Renewable Energy: Risk Management Maturity Contributes to Lower Project Costs
Economic, technological, social, regulatory, and investment-driven forces are accelerating the global energy transition and expanding demand for renewable energy. In 2019, global investments in renewable energy generation reached $282.2 billion, a slight increase over the previous year, while levelized cost of energy (LCOE) for wind and solar hit all-time lows.
But optimizing operations and maintenance (O&M) costs over the life of renewable assets, while simultaneously maintaining efficient access to capital, has never been more challenging. And this is considerably harder for companies that do not evolve to take advantage of proven risk management tools and resources.
The current state of the insurance market further complicates a challenging situation. Specialty underwriters, already struggling to profitably insure renewable energy projects, are now recalibrating their models and adopting strong measures to mitigate exposures, including enhanced underwriting discipline. In addition, reduced insurance capacity and increased cost are jeopardizing existing and future projects, which may struggle to meet the types of commitments historically required to satisfy investors.
Companies that demonstrate greater renewable energy risk management maturity have historically had more access to risk capital, and flexibility in negotiating terms and conditions. Project developers, suppliers, owners, and operators of renewable energy assets should endeavor to improve their risk management strategy.
First, they need to consider where they fit within the four stages of risk management maturity:
1. Project-level risk management contemplates the marketing and placement of insurance policies designed to insure each individual project and promotes efficient access to third-party capital. The transparent simplicity of the approach is the primary benefit: It readily supports non-recourse financing, and asset transfer, without requiring specialization. Even proven developers, however, may find themselves at the mercy of a limited number of insurers; projects presented individually face greater underwriting scrutiny, particularly if they have catastrophic or emerging risk exposures, and securing coverage on a per-project basis can be time-consuming. This approach can also lead to higher premiums and a greater likelihood that insurers may decline to offer coverage since a single project brings limited premium and actuarial benefits to an underwriter’s overall portfolio.
2. Portfolio-level risk management is increasingly used by renewable energy asset developers with multiple projects, as well as those looking to own or operate multiple assets and achieve economies of scale. This approach leverages insurance policies designed to capture the risks of a collection of projects with similar characteristics. With fewer policies issued and more than one asset insured, the cost of risk and administration is generally reduced - additional markets can be expected to express interest and new program structures, designed to support projects individually and collectively, are introduced. Portfolio-level risk management requires the development of project cost allocation, lender and key stakeholder engagement strategies, and specialized brokerage and advisory services.
3. Program-level risk management has long been used by asset owners, such as investor-owned utilities and leading independent power producers comfortable with integrating a diverse set of complex energy risks across business units, operating companies, and partnerships. In some cases, companies can integrate construction and operating assets. Leveraging a broader, more diversified exposure base materially reduces individual project costs, improves expected volatility, and can dramatically increase the effectiveness of risk management services from the perspective of key stakeholders. While this is typically a complex approach, the benefits can be substantial, generating sizable competitive advantages for successful practitioners. This approach requires engineering services to maximize/realize the potential benefits.
4. Program-level risk management with optimization is practiced by the most sophisticated asset owners who consistently assess the value of risk retention and risk transfer. They typically leverage their own risk capital unless third-party risk capital creates an advantage. Integrating industry mutual insurers as well as protected cell, group, and wholly owned captives capable of directly accessing reinsurance markets is proving to generate major savings and competitive advantages for renewable industry leaders during the current challenging market. This approach requires the most complex project and program cost allocation, lender and key stakeholder engagement strategies.
As the energy transition continues to accelerate, demand for renewable energy projects will continue to grow. But only the most mature practitioners can achieve the lowest per-project costs while accessing increased coverage and financing opportunities. The current challenging insurance market underlines the need for renewable energy stakeholders to take the necessary steps to improve their risk management maturity.