The decision to buy Weather Risk Transfer can be based on a number of different drivers, many of which will be tied to project or portfolio-specific concerns. In this interview, taken from GCube’s February report, Gone with the Wind, David Krsevan, Energy Markets Manager at Infigen, explores the factors behind the firm’s choice to purchase cover for its Australian portfolio.
Gone with the Wind: An Asset Manager’s Guide to Mitigating Wind Power Resource is available to all insureds and brokers in a digital format. To request a copy, please click here.
Who are Infigen and what do you do?
Infigen is a developer, owner and operator of renewable energy assets in Australia. We currently own six wind farms and a solar farm with a combined capacity of 557 MW, located across New South Wales, South Australia and Western Australia. In addition, we have interests in an extensive pipeline of renewable energy projects – 1200 MW in total – covering large-scale wind and solar across five states in Australia.
We were formed in June 2003, but listed on the stock exchange in October 2005. In terms of size, we are still a modest company, and employ about 60 people at the Sydney head office.
Who and what were the key drivers that led to the decision to buy weather risk cover in 2015?
One of our core mantras is to constantly look for opportunities to make our revenue more predictable and stable across our portfolio, but at the same time also retaining the upside of good production or market conditions. So we had been looking at a number of different products for a few years.
At the end of the day, the contract that we actually executed was one that we co-developed with a large reinsurer – and that was the result of a lengthy process of developing an appropriate mechanism that delivered the desired outcome for us. In the end, it was a portfolio product, across all of our wind assets.
You might expect this kind of product to be of more interest to asset owners who don’t have a portfolio, but actually we’ve been seeing demand from companies with significant portfolios like yourself – why might this be?
I would say there are probably a few reasons why demand is not exclusive to young companies that generally don’t have a portfolio. Australia is already a pretty big market and our portfolio extends across multiple regions, so we do already benefit to some extent from geographical diversification.
However, having access to in-house skill sets and resources enables larger companies to assess and identify opportunities to participate in weather risk transfer products more readily. A company with just one wind farm for example, may not be able to commit the intellectual capital, time or resources to assess products and make an informed decision to participate. For larger companies with a portfolio of assets, they are more likely to be able to do this.
That said, if smaller companies did acquire this sort cover, it may mean that they don’t have the same motivation to expand for the purposes of portfolio diversity; they can operate a portfolio of just one or two assets, secure in the knowledge that their revenue flows will stay predictable within the limits of the product entered into.
Was your motivation for buying this cover purely risk aversion, or were you hoping to achieve better terms on (re)financing?
While we understand that there could be some benefit to people that want to refinance – or perhaps even want to finance a new asset – in this case our need to underpin a minimum level of cash flows from the portfolio was the primary reason. The decision was based on a desire to manage risks within the wind portfolio. It was a short-term (12-month) deal. Obviously if you’re looking at refinancing you would probably seek a longer-term product. On both sides it involved ‘road-testing’ the product to see if the structure in question worked and was viable to look at again for a longer period in future.
What advice would you give to one of your peers considering their exposures to sustained low wind speeds and resource risk?
The important part is really investing the time to drill down into and assess the risk profile. That’s the first point. The second point, once you’ve reached that stage, is actually working with your insurer to find a structure that works for both sides.
You must also know how resource variations are actually affecting your revenue streams. This will involve looking at both interactions with market prices, with other contracts you have in place, and also other operational risks you have in your portfolio. Another important point that we spoke a lot about when formulating the product was basis risk; making sure that the product didn’t expose us to underinsured basis risk in terms of the contract pay out versus our revenue structures.
We spoke to a number of insurers and underwriters, enabling us to work through the high- level concept with a number of players. Once we had filtered the shortlist, there was a lot of work still to be done after the initial structure had been agreed to actually document and agree the delivery mechanisms.
We understand you based the structure on actual energy production rather than synthetic wind speeds or other potential settlement methods. Why?
The contract was settled off a measure closely related to actual energy production. Obviously the structure itself includes some specific contract mechanisms, so it is not as simple as just looking at the naked energy production. There were several layers of structure within the product itself. But, as you say, it was not based on a wind index like a satellite measurement or a separately measured wind index from somewhere off-site.
How could the market make procuring lack of wind cover easier?
We found that you have to build up a fair amount of understanding in terms of what your risk profile is and what types of low wind risk might manifest as issues for a particular company. You could probably identify 4 or 5 different ways that low wind might be an issue for your assets, and a number of different ways you might want to look at protecting them.
For smaller companies with limited resources it may be difficult to achieve a thorough initial understanding of what those risks are and what sorts of cover might be available. So, for the insurance market, making procuring risk transfer easier will, to a large extent, come down to helping clients reach that thorough understanding.
This could involve standardising some of the terminology, or the ways these risks are talked about. In addition, this would help to build that knowledge of what the risk types are, what type of product structures are available, and what sort of indices can be used to settle them.
From our perspective, having gone through the process of talking to a number of underwriters and looking in depth into what sorts of areas we would like to cover for our business, it’s evident that the product will always need to be bespoke in nature. If you go back a couple of years, the Chicago exchange weather derivatives had a very high amount of basis risk because they were highly standardised. As such, it is likely to be a balancing act of standardising concepts where possible, while retaining the ability to tailor products for each client.
Would you say weather risk transfer products are more complex than traditional insurance products covering property damage?
It can be argued, especially from the clients’ side, that the complexity is probably a bit higher for weather risk products. The way they interact with revenue streams is different from outage protection, for example. Outage protection is pretty standard and fairly simple to understand, including how it might affect your revenue, whereas, with these kinds of resource-based products, it can be a bit more complicated for the client to get an accurate picture of how they will impact revenue flows and therefore the precise value they offer.
Looking at the traditional insurance industry, there is standardised language, and standardised types of risks that are put into various baskets. With weather risk, there is always going to be a bit more complexity, but the sector could move further towards having common descriptions of similar types of risks.
Would you agree that one advantage of weather risk products is that the settlement process itself is much more simple?
I agree. The documentation is quite detailed, so the process of settlement becomes relatively straightforward because a lot of time has already gone into documenting mechanisms and actually building the spreadsheets. It’s probably fair to say that we spent roughly as much time analysing how to create a settlement structure that functions correctly as we did analysing the underlying risk itself. But you don’t have concerns like bringing in independent engineers, and, once you have the structure set up, the settlement process is pretty simple.
What benefits have there been to transferring weather risk, and, more broadly, what benefits could there be to yourselves or others in the future?
Once you have a product in place, you will have greater revenue certainty, so that you can focus more on actually running the business and making best use of the available resources within it. That means having to allocate fewer contingencies or buffers in forecasts, particularly related to concerns about low production periods. It also leads to greater efficiencies with capital, which allows companies to focus on other areas that create more value. So you can deploy capital to value creation or growth areas with the knowledge that wind risk has been kept in check.
What impact does this, and could this have on (re)financing?
We do think there is potential down the track for weather risk transfer to positively impact financing, because it reduces the effect of resource variations. This is still fairly new ground in Australia – we haven’t seen this play out in discussions with financiers or live projects yet, but it’s certainly something we’ll look at for future projects.
We have, however, heard of smaller, single-asset companies that have secured better financing terms and higher gearing as a result of having similar products. Also if these players are looking at contracting off the offtake for a new asset, this allows them to provide a bit more certainty to the off-taker on the levels of energy they’ll be able to contract to. Our understanding is that this has happened for a few operational assets internationally – but it’s very new ground globally and to our knowledge, hasn’t been done on a portfolio level, only for single assets.
Do you see weather risk transfer becoming an increasingly popular risk mitigation strategy among renewable asset owners?
Absolutely, yes. Looking at the Australian market, the country is geographically diverse, so assets do have diverse resource risk profiles. However, we also have a market that is fairly well integrated across the entire country – the NEM (National Electricity Market) connects a good portion of the country into a single electricity market. Furthermore, national green certificates ensure similar value can be extracted from wind resource across the country. There is already an advantage in being able to spread the resource risk across a nation where the market as a whole is well put together and connected. Initially, when you’ve got targets of higher renewable penetration and a large number of the players are looking to build one or two assets at a time, it can be helpful to get those first projects underway with a degree of resource protection in place, rather than deploying capital to achieve geographic diversification by building multiple wind farms. You can gain some of these advantages through the use of WRT products.
Why do you think that the product is starting to take off now and hasn’t done so before?
I think the origination process is improving. Several products have been successfully implemented, and we’re getting a lot of insurers approaching us with different ideas now. This is part of the evolution of the weather risk management market. On top of that, as you get more build of renewables, you have a more liquid market – you are not trading exactly the same thing, but, if insurers are pricing and selling products to a large number of potential customers, there are efficiencies to be gained in terms of how insurers can price the product with regards to margining on their side – which in turn leads to more effective products for customers. It has a snowball effect.
In addition, with more capital going into the market, you need more risk management products to protect that capital. And, with the regulatory space improving, particularly in Australia, the uncertainty surrounding renewable energy targets has settled in the last year or so – translating into more demand for renewable energy assets and as a consequence more demand for these kinds of products.