Mitigating climate risk(Click here to get to the topic overview page)

Keeping wind farms going when the wind doesn’t blow

Summary

The biggest risks facing operational wind farms are sharp falls in electricity prices and sharp falls in wind speed.

Over the course of a year, wind levels can vary by 10%, with many days when the wind doesn’t blow at all.

By 2030 the level of European wind farms fully protected against price and volume risk will fall to 6% from 75% now, as advances in wind power technology are making it increasingly competitive against traditional energy production, with public subsidies being withdrawn as a result.

In place of these subsidies, wind farm operators need to embrace risk transfer solutions such as hedging instruments and insurance cover designed to protect their revenues when the wind doesn’t blow.

Renewable energy hedging should not only be part of insurers' strategies to combat climate change, but could also provide insurers with revenue streams to replace those from industries and technologies that have a negative effect on climate change.

In depth

Wind power is coming of age.

Many countries with mature wind energy infrastructure are now reducing or withdrawing public subsidies and support.

The state-backing of wind farms was necessary to support investment in this green technology when high costs and low efficiencies made it difficult to compete with traditional fossil-fuelled power plants.

However, lower manufacturing and construction costs together with bigger, more efficient turbines means it is now claimed wind farms can produce the cheapest electricity on the market.

As a result, wind farm investment is increasing even as subsidies are being withdrawn. The level of public subsidy fell by 80% over the three years between 2013 and 2016 in the US, but the number of new wind farms added each year increased eight-fold over the same period.

And in Europe, developers in both the Netherlands and Germany have secured agreements to build offshore wind farms with zero subsidy over the past year

Increasingly exposed

This decreasing reliance on public subsidy is good news for both taxpayers and those seeking to cut carbon emissions as part of the battle against climate change.

However, this trend also increases the exposure of wind farms to risk, both in terms of electricity prices and potential lost revenues when there is no wind.

A report by WindEurope, sponsored by Swiss Re, found that over the course of a year the variation in a European wind farm’s power production can be 10%. When looking at individual days, wind power generation varies wildly from 0% to 100%, meaning that some days will bring in no revenue whatsoever.

This poses a problem for wind farm operators trying to stay competitive in the open electricity market that they increasingly participate in.

The WindEurope report, The Value of Hedging, shows that the exposure of wind farms to both price and volume risk are set to rise dramatically in the coming years.

While 75% of wind farms in Europe today are fully protected against these risks thanks to public subsidy and support schemes, just 6% will be by 2030.

“We are moving from a world where governments are paying wind producers around EUR 100 per megawatt hour to one where producers must face the merchant risk of selling at EUR 35-40 per megawatt hour with less certainty on the open market,” says Stuart Brown, Swiss Re Head Origination Weather & Energy APEMEA.

 

Hedging the weather

To stay competitive in a world after subsidies, wind farm operators must find ways to transfer some or all of the price and volume risks they will be exposed to.

The WindEurope report estimates that the wind farms in need of hedging products in Europe alone could be the equivalent of the entire electricity generating capacity of Poland by 2030.

Stuart Brown says that at present wind farm operators’ attitude towards hedging instruments can be at best described as “conservative” and “in its infancy”.

“Since the WindEurope study last year, the most popular form of hedging we have seen has been operators hedging the impact of wind variability on spot price variability,” says Brown.

These short-term contracts, typically three to six months, allow operators to fix electricity prices. This protects them against the risk of short-term electricity prices – known as spot prices – collapsing during exceptionally windy periods. Several such price events occurred in Europe in 2017, most notably in Germany, where the market entered into negative electricity prices as low as minus EUR 52 per megawatt hour.

As more wind farms lose their subsidy support towards 2030, Brown says he anticipates longer term products that hedge volume risk becoming the key risk transfer solution in the industry.

“Such a product can last as long as 10 years, and is typically paid monthly, quarterly or annually to wind farm owners,” he says.

“For example, you may have a site that typically produces 150 megawatt hours, with protection cover set at 120 megawatt hours. If you have a quarter of bad wind and only produce 100 megawatt hours, the cover is designed to pay out funds to cover that 20 megawatt hours of lost production.”

Having such products in place will be essential for new wind farms to continue attracting investment. To date, wind farms have largely attracted long-term debt financing and equity investment based on the predictable, long-term revenues that the certainty of subsidies provided.

With those certainties disappearing, wind farm developers will need to show that they can still service their operating costs and debts, even when the wind doesn’t blow. Having hedging contracts and insurance that covers these shortfalls will help provide the certainty that investors crave.

The WindEurope study says that risk management services such as hedging may help new projects secure EUR 7.6 billion in financing that they otherwise would not have access to between 2017 and 2030.

There will also be additional demand for hedging products from existing wind farms as they come to the end of the support schemes they are currently enrolled in.

Committing to greener policies

For insurers, providing the products that help wind farms hedge their risk isn’t simply a case of identifying and servicing a growing market.

Encouraging the financing and construction of new wind farms also serves the wider interests of insurers.

The insurance industry is on the front line of dealing with the effects of climate change.

Total economic losses from natural and man-made disasters in 2017 were USD 337 billion, up from USD 180billion in 2016.

And the gap between protection from insurance policies and the total economic cost of natural catastrophes wasUSD193 billion globally in 2017.

Closing this gap relies partly on greater insurance coverage, but it also depends on tackling the causes of climate change for instance by backing clean energy technologies such as wind power.

It may also mean no longer supporting the most polluting energy sources, such as coal-fired power plants.

It is for this reason that Swiss Re introduced its thermal coal policy earlier this year. Under the policy, Swiss Re will not provide re/insurance to businesses with more than 30% exposure to thermal coal across all lines of business.

As insurers and reinsurers like Swiss Re move out of areas such as thermal coal, they will need to find new areas of growth to pick up the 'lost revenue'.

Where better to look than wind power, a clean energy source already beating coal on price in many energy markets around the world?

Talking points

“These cost declines across technologies are unprecedented and representative of the degree to which renewable energy is disrupting the global energy system.” Adnan Amin, director-general of International Renewable Energy Agency (IRENA)

“While we are reaching maturity in the wind sector overall, its approach to managing operational risk is still in its infancy.” Stuart Brown, Swiss Re Head Origination Weather & Energy APEMEA.

Further reading

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