Bioenergy, Energy Efficiency, Geothermal, Hydropower, Project Development, Solar, Wind Power

The Last Word: Financing Renewables

Issue 3 and Volume 14.

A swathe of natural disasters topped off by Japan’s earthquake and tsunami will undoubtedly see insurance companies hike premiums in a bid to claw back cash after some big payouts, so Fraser McLachlan argues that developers will have to work harder still to cut costs in both Europe and further afield.

With the publication of the latest budget from the UK’s coalition government, the country’s renewable energy industry found itself questioning state commitment to the wider green agenda.

Whilst undoubtedly measurers to assist small business are manifest, the wider policy lacked the specifics that many in the industry were hoping for.

Following the ‘green budget’ first published by the previous administration; perhaps many industry expectations had been raised beyond the realistic confines of the wider economy. Perhaps.

Alternatively, the renewable sector lacks some of the political punch and influence of its wider industry brethren, such as oil and gas, and its voice is quieter in the corridors of power. Either way, as the numbers were crunched and the analysis completed, the final result didn’t look so promising.

One could argue that the government has a wider commitment to a low-carbon economy rather than one driven by the renewable energy industry — and it’s important not to conflate the two.

The green investment bank has been promised an extra £2 billion (US$3 billion) in capitalisation in addition to £1 billion already committed. This should, in theory, allow for sponsorship of new projects and investment in research and design. The limiting factor is, unfortunately, the fact that the bank will not have the power to borrow until 2015, limiting its capacity to support industry across the board.

The floor price put in place in the carbon market of £16/tonne in 2013, rising to £20/tonne in 2020 has also polarised the renewables industry. Some fear it will give more impetus to the nuclear energy lobby, whilst others believe it should support the renewables sector as the future of feed-in tariffs remains uncertain.

Nonetheless, it’s very easy to be overly negative, and although this government, and many others, may not live up to its promises of being the greenest government ever, the prospect for private industry with the right incentives to support the renewable energy sector is still evident, and it is in this realm that the insurance sector could really make the difference.

Without insurance, no bank, fund, or third party investor will be able to raise the cash to support a given project, and with the insurance sector for renewable energy becoming ever more competitive, insurers must ensure that they support the industry by pushing for quality standards in construction and operation, appropriate due diligence and a willingness to engage with a host of different industry players. But like renewables, insurers face their own challenges.

In the green energy sector, with many larger firms piling into the industry to make short-term gains, competition on price is steadily increasing. What many insurers fail to remember, however, are the early 1980s, when brokers rushed to support the fledgling wind industry in North America.

Back then, technology, particularly with wind turbines, suffered from numerous faults, and a general lack of awareness by the insurance market into the complexities of turbines and the host of potential pitfalls, resulted in a number of insurance companies ‘losing their shirts’ and sparking a flight from the renewables sector back into the relative safety of conventional power generation.

And whilst, yes, renewable technology has improved, substantially in many cases, the green energy industry is still not without its issues, and it is the insurance companies which ultimately bear the costs.

With insurance rates at an all time low and many more wanting to ‘play’ in the renewable energy space, it will only be a short matter of time before the insurance market wakes up to the fact that it is getting harder to make any reasonable profit from renewable energy.

On a macro level, Deepwater Horizon, the natural disasters in the past 12 months in Australia, New Zealand and most recently, Japan, will cause the insurance market billions of dollars in losses. Undoubtedly, the insurance industry is going to need to find additional revenue streams to make up for these losses and, eventually, put up insurance premiums.

But if developers feel uncomfortable about a squeeze on their implementation costs, it’s worth a word of warning, with the old adage of ‘buy cheap, buy twice’, often ringing true. Whilst some insurers will offer very competitive products, developers should be aware of the small print, which may exculpate any pay-out.

With a high degree of volatility in renewable energy operations, developers should also ensure that they are covered from the construction phase, where equipment is very easily damaged in transit, right the way through to the operational phase, where equipment failures can result in losses of power, and ultimately revenue for energy providers. It will be those insurers that have a heritage and track record in the space that will be able to support the industry most effectively via an understanding of the market complexities honed over a number of years.

What insurers, commensurately, need to bring to the table is an added impetus by way of clearer thinking into how the insurance behind projects can work most efficiently.

Without an acceptance of higher future costs from developers, and without continual innovation from insurers on how best to serve the growing renewable market, the green energy industry could lose one of its greatest facilitators, and further risk the delicate balance of financing, construction and risk management being unbalanced for years to come.

Taking the effect of the Japanese earthquake and resulting tsunami on an individual basis, the concerns caused by the problems with the Fukushima nuclear plant will, however, raise concerns as to the safety issues associated with nuclear facilities. Indeed, already in Germany, Chancellor Angela Merkel, has stated her intention to expedite Germany away from a future reliance on nuclear power. The question is, though, will this mean a return to coal or other forms of conventional power generation, or can the European renewable industry be strong enough to argue the case for further expansion for Germany — a country already a long way ahead in renewable energy technology? It will be interesting to speculate as to whether we will ever see a day in which renewables usurp nuclear energy as the de facto choice for energy security.

So where does this leave us? In the final analysis, it is a shame that the UK’s green bank will not be able to come into effect any earlier, as with insurance premiums set to increase, the costs for bringing renewable energy projects online will need to be mitigated through external sources of funding.

Some would argue this is not fair or does not support the renewable industry. Others would say the price of insurance has been way too cheap for too long, driven by over capacity and a desire to compete in a fashionable space.

Either way, lenders (be they government sponsored or not), insurers, equity, developers, owners and operators need to continue to push hard for quicker, more effective renewable energy growth.

Whilst it would be easier to write the latest UK budget off as having failed the green energy sector, one could argue that it may well act as a catalyst for renewables by proxy. With adequate support for a resurgent skills base in marine engineering, there are opportunities to kick-start a domestic UK supply chain entirely focused on renewable energy, rather than investments in specific offshore projects.

With wider industry momentum, from manufacturing as well as professional services, the sector should have the confidence to ensure that it continues to be a key part of the energy debate.

Problems at the Fukushima plant aside, a message has been sent world’s large power generating companies and perhaps more importantly to the public – renewables will have to play a key part in the mix of power generation. No one has ever pretended that renewables are the sole answer to the world’s energy crisis but more than ever they are looking like a very logical part of the mix.

Fraser McLachlan is chief executive office of underwriting agency GCube Insurance.