MIKE VENABLES: Thank you for joining. And Steven Munday, the natural resource global renewable energy leader.
STEVEN Munday: Hi, Mike. Thanks very much for inviting to contribute to your podcast.
MIKE VENABLES: Thank you for joining. And joining Maria and Steven, we have Alan McShane, the natural resource global leader for risk engineering.
ALAN MCSHANE: Hi, Mike. I'm happy to be here today, and I'm looking forward to the discussion. MIKE VENABLES: Thank you, everybody. So as we continue our journey towards net zero, the energy industry is evolving at a faster rate than ever to get us there by producing and connecting more clean energy. This means more innovation, more technology, and a lot more creativity. From a technology perspective, Alan, is construction risks in the renewable energy sector becoming more challenging?
ALAN MCSHANE: Mike, that's a great question. I think it's extremely nuanced. We have lots of different technologies that we're looking at within the sector-- hydrogen, battery-powered storage, offshore wind, onshore wind, and a bunch of other technologies besides that there's probably too many to go into here in this particular segment. But they've all got a [INAUDIBLE] challenge around technology readiness, I think, is one of the pivotal areas.
And in that space, I would say there is a greater challenge for the construction sector. I think because of the nature of the renewable space and the fact that there's such a high demand and expectation for development and growth in this area, that development is happening at a rapid pace. And I think everybody needs to become more accustomed to that, which means there's a lot more nuanced technology, prototypical in nature to some degree.
Now, that in itself is not a problem because in the past, we have dealt with technology issues by engaging in a more collaborative and detailed way with the various stakeholders, be it licensors, project sponsors, and insurers alike. So we have got the framework to address these issues. But I do feel that there is more of that, and this will scale accordingly. And I think we need to be aware of the issue that the technology readiness level is not quite there in some areas. But with partnership between all different stakeholders, I think those risks can be managed to an acceptable level.
I think the other area that we need to consider very carefully here is the rate of development, which I hinted to a minute ago. I think that is one of the key areas that needs to be focused on as well, because with the rapid development, there is a tendency, and there is also a pressure on all stages of the value chain, be it through the licensor into the individual component manufacturer into the construction of these operations, that is time pressures and a compression of the timeline from start to finish. And as a result, there's a need to be very cognizant of that pressure and make sure that well-tested and understood controls within the construction sector are maintained through that process.
For example, there could be pressures on individual component manufacturers that affect the QEC and the quality of the components coming through. And we know there is also some key issues in the construction of various operations as well. We've seen that on the offshore wind area where it's manifested in some of the cable installations that we've seen over the years. There's some QAQC issues there.
Now, beyond that, one of the other areas which maybe sits slightly separate to all these different areas is hydrogen. And hydrogen has a slightly different risk profile compared to the others. And the reason for that is because hydrogen itself is not just going to be an industrial type of energy vector or material.
There's also a desire for hydrogen to be a more commercial energy vector as well, such as replacing natural gas. That means it's potentially going to become more in contact with the general public.
And what that means, basically, is if you look at hydrogen as it currently stands, it's manufactured and consumed in highly restricted facilities where you've got lots of people with very good experience, be it engineers, technicians, operators. And that environment will change over time to where you're going to have a lot more contact with the general public who may not be as aware. And also, you've got a distributed asset as well in that space. So there's some nuances there.
But it's not a situation, necessarily, that's a bad thing just now for the construction sector because if we look at the nature of where we see the development of hydrogen in the near term-- and I mean the next 5 to 10 years-- what you're seeing is the development is in the industrial setting. So it's replacing natural gas in power stations, in oil refineries and petrochemical plants as an energy source. So in that sense, you can manage the risks accordingly.
And therefore, actually, the risk to hydrogen in the short term, the short to near term, is actually no different to what we currently deal with today. And then that gives us more time to work out what the actual risk profile is in the longer term if we move to that longer term use case where it may replace such things like natural gas.
So from what I said, I think maybe you can appreciate that there's no one answer fits all. I think there's a general increase. But I think what I'm trying to say here is that we have the technology and we have the know-how within the construction sphere to manage those risks accordingly, but we need to be more vigilant.
MIKE VENABLES: So I'll ask you, Alan-- the buzz word, as you quite rightly highlighted there, is the hydrogen sector here. Is this new, or have we seen this before? Is this brand-new technology being used, or is it a scale-up or an adaptation of what's been used in the past?
ALAN MCSHANE: Well, it's a bit of both, isn't it, because the generation of hydrogen is new because it's renewable, so you're using electrolysers in that space. There's technology nuances there. However, once the hydrogen is produced, the actual storage, transportation, and consumption of hydrogen is well understood. So the balance of plan, if you want to call [INAUDIBLE], away from the generation of hydrogen is actually technology that's been used for many, many years. And it's well understood.
And as I said before, because it's we believe that the near-term development of hydrogen is going to be in the restricted, highly regulated, highly specialized sector, I think the risks are manageable and understood. And then all you've got to deal with is the technology issues around electrolysers in terms of their efficiency and effectiveness. But that's more of a business decision rather than a risk decision from a construction perspective.
MIKE VENABLES: Alan, I think you made some brilliant points there. And what I'm going to do is I'm going to throw the question over to both Maria and to Steven. As a client servicing a broker supportive question, how are we seeing the markets respond to this new energy discussions?
MARIA Sanchis: Well, I think that the specialized, especially on the construction side, renewable energy markets, have ample capacity and appetite on paper. Now, we are seeing, I think, across the globe, and in particular my area in Latin America and Caribbean, that many of these markets are really not deploying the capacity that they have to its fullest unless it's best in class. So they're being quite selective, really, in terms of reputation of the contractor. Obviously, technology, whether it's prototype or not.
And obviously, that has also an effect on the level of bridges, especially on the defects and design elements, on the maintenance element, and also, at a certain point, in sublimits. So obviously, just like Alan said, all of this technology might not be new, but the market is still a little bit perceptive on all these projects. And globally, we've been seeing such an influx of projects in this space that they are being more and more selective on how they are actually deploying their capacity.
So for us as brokers and recommendation for our clients and whether they're developers or whether they're contractors, we do have to approach the markets, really, with a good story to tell. So it's important to have a good and complete submission. It's very important-- not only the basis of, obviously, location, and especially when it's natural catastrophe-exposed in terms of site-- it's very important to really know the risk management plan and mitigation plan that is going to be used throughout the life of the project. So I think that markets now are really looking not only on the technology elements, but really, how the project is managed, from its very early stages in terms of development, engineering, and obviously even manufacturing. I think it's quite important where-- not only the technology itself, but where the panels or the turbines or the main equipment and the critical equipment is coming from. So all these elements really have to be laid out in a very comprehensive way to really get the best results from the market.
And then, obviously, with this ample capacity, I think it's quite important how you access that capacity. We're seeing that, at the moment, for certain size of projects, local markets are being quite competitive. But obviously, when we're talking about the larger, more complex projects in terms of values, we're seeing with inflation, the values really increase. The same project that maybe was built five years ago, same technology, we're looking at increases in values in workforce and materials and transportation, which has a domino effect and a knock-on effect on the overall CapEx of the project.
So it's quite important to not only access with the right information, but access the markets at the right access point. So I think it's important to know the local appetite and also to access markets, obviously, in London-- we have the center of excellence, in many ways, and very centralized capacity-- but also look at the players. If you're an owner and you're working with a European contractor, obviously, and they're from Spain, there's markets that are actually based in Spain that are going to know more about the reputation of the contractor as well. So I think that those elements are quite important when you're laying out a strategy. And I think that's also very important. You have to have a strategy, and you have to stick to it.
MIKE VENABLES: Yeah, OK. Thank you, Maria. Steven, with so many new projects coming to the market, what is happening with the timeline compressions and to the global workforce supply chains? Could we have your views and thoughts on these three subjects?
STEVEN Munday: Absolutely, Mike. And I totally agree with Alan and Maria. And I think certainly, in terms of, firstly, the technology, renewable energy is no longer a power sector. It's a technology sector. It's moving ahead incredibly quickly. That does impact throughout the lifecycle in terms of origination, the procurement, the construction, and the operations. And that has an impact on the timeline as well.
Now, we are seeing these new technologies coming through. There's upscaling of existing technologies. We've talked about hydrogen. We've mentioned very briefly battery storage. There's wind technologies, which has been upscaled. So all of this equipment has to come from somewhere.
And we are seeing that the original equipment manufacturers of all technologies are trying to produce sufficient amount of technology for what is required globally. That is very difficult, and it is challenging the supply chain, particularly after the pandemic. And we are seeing that there is a major impact on projects' timelines.
I think when you look at the actual timeline for building projects and where, historically, renewable energy companies were over the last few years, there was very much a race to deliver as quickly as possible.
Sometimes that impacted quality. Sometimes the experience and knowledge of the available workforce wasn't there. And sometimes we had challenges with the workforce being aligned to local content which didn't have the right experience.
But the workforce and timeline compression is interrelated. And what we are seeing now more is that post-pandemic, where you've got the workforce, where you've got the original equipment manufacturers-- and they have had challenges, and it's been quite well reported in the press, particularly by the big wind OEMs, that they've had defects. They've had to make reserves against their balance sheets. They've had challenges with defects, which is well known in the industry, which they're trying to rectify.
They're now realizing, I believe, certainly from what we've seen, that the performance of their equipment and the delivery of the projects needs to be not just in time. And we're certainly seeing this as a strategy to mitigate potential liquidated damages for delay, not delivering projects, not delivering projects on time, not delivering them with the performance obligations that they have.
So there is, in some regards, a movement to move away from a less experienced workforce, just-in-time delivery of the projects, and the lessons learned from the pandemic, recognizing the supply chain interruption and availability issues, to be more considered about the projects, to build them with, actually, longer timelines and be more considerate to the delivery of long-lead equipment, whether it's power transformers or other wind turbines or electrolyzers, to make sure that these are available or planned to be more available at the project sites at an earlier stage, in a way, to mitigate potential supply chain delivery and to avoid-- effectively avoid delay damages, which have been highly punitive.
MIKE VENABLES: That is a question close to my heart, and we're hearing it and seeing it and all classes of business. But you mentioning the supply chain concerns that you have, does this have an [? enhancement ?] to the DSU exposure that the client is incurring?
STEVEN Munday: It does. I think there's an additional exposure, but there's also risk mitigation. What we're seeing is there's a knock-on effect in the insurance industry by contractors and OEMs taking greater responsibility to avoid, maybe, liquidated damages, to have longer construction periods for their projects, bringing long-lead equipment on site at an earlier stage rather than a couple of weeks before installation and before testing commissioning. They are naturally building in additional margin to projects, which is making the projects more palatable to the risk and insurance community because there's built-in mitigants for delay and startup arising from physical delays or delays in commercial operations.
So there is that positive knock-on effect by having a natural built-in risk mitigation by the supply chain and the contractors. But separately, from an insurance perspective, we are seeing historically with operational projects, there are the indemnity periods that are currently put forward. Are they appropriate?
We are aware of many in project finance [INAUDIBLE] across lender-financed projects where maximum dem-- minimum debt periods are 12 months. Maybe they're 9 months. And we know that's geared towards the longest lead item, which is generally the step-up transformer or the general transformer. And at the moment, we are seeing, generally, the industry having 12-plus months as a lead-in time.
So there's two consequences of that. One is, should indemnity periods be extended to accommodate and recognize the longer lead times of the key equipment? And there's also response by the insurance market that if the indemnity periods are not extended and the insurers with their insurer engineers feel that they are being penalized on a first-loss basis for the cover that's provided in the shorter indemnity period being more likely to be exposed to loss of revenue risk, they're likely to increase the terms and conditions.
So from a broker perspective, we're trying to work with our clients to understand if they have any framework agreements in place. Are they talking to the OEMs about the current lead times for key equipment? Positioning that with insurers, making sure they're comfortable, making sure that the cover that they're buying is appropriate to the new considerations that we are seeing in the marketplace.
MIKE VENABLES: So Steven, some excellent points raised in your comments there. And I'm going to ask a difficult question here and play devil's advocate. Are the financing of projects pushing project sponsors to shorter project timelines instead of more manageable levels?
STEVEN Munday: I think there is still a high demand, obviously, for renewable energy projects. There's very available debt-financed project finance to move those projects forward. Many of the projects are still supported by [INAUDIBLE] subsidies regimes.
There is a very attractive and buoyant electricity power generation market in terms of the spot market and very attractive PPAs. So whether it's the financiers that are driving the projects to be delivered more quickly, broadly, I would think that the lenders and the debt financiers and the multilaterals are a little bit more risk-averse. They're in for the longer game. They want it to be built, and they want it to be operated satisfactorily with good workforce, delivered in a robust way.
I do think maybe the sponsors are taking advantage of the opportunity with the electricity market, the high spot market. The revenues are very strong. That does encourage projects to be completed more quickly. But again, to Maria's point, it really depends on the type of client-- if you're a developing client, if you've got a long-term interest in the project, and how you might manage that if you are looking to build and operate it for maybe 20 to 25 years.
So I'm not necessarily seeing the lenders driving timeline compression, but we are seeing the opportunity to move quickly is being very well supported by the industry and the desire to have an ESG clean net- zero power generation. So that is creating a positive impact to delivering projects. But we're obviously working with our clients and insurers to make sure that it's delivered in a most robust, risk-mitigated way as possible.
MIKE VENABLES: Thank you. Thank you very much, Steven.
ALAN MCSHANE: Is it possible I could ask Maria a question if that's OK? I was interested to hear Maria talk about that insurers have been highly selective in their selection of projects they want to underwrite. Do you believe, at this stage, that the selection process that we're going through is limiting development and adoption in the sector?
MARIA Sanchis: I can't really say the direct impact. But definitely, lenders are being a lot more flexible in terms of the guarantees and the coverages that are being put forward as minimum requirements. So I think that there's more flexibility in that respect where before with the softer market, we saw them pushing really hard, for example, for leg 3. Now they're being a little bit more flexible in the sense that they know that we want to insure this. We don't want markets to turn away or walk away from a deal because they can't get the level of coverage that is expected.
So I think that we're not in the face of it's not insurable yet. We are-- for example, in some spaces in hydro and maybe coal fire, I think that renewable projects are definitely insurable. And I don't think that lenders are walking away from deals or maybe deals not being materialized because of financing. But there is always a fine line between that pressure from the lenders and, really, what the market's willing to offer.
So like I said, that negotiation-- definitely, at the moment, I think that the markets have a little bit more of the upper hand in that respect. And if you want quality, security as well, you have to put everything in perspective. But we're not there yet. I think that renewable projects are definitely insurable, but obviously-
- and I think that that's a point that Mike wanted to also bring up-- is also where they're located. So when there's that natcat exposure-- and I'm quoting Steven on his latest report-- the increases in pricing are a little bit jaw-dropping.
So sometimes, you're working with the margins. When you're talking about low margins, especially for some contractors, they're thinking insurance might make them consider walking away or not. So I think that the natcat element, especially in areas where there's wind, high wind, like the Caribbean, Gulf of Mexico, coast of Florida, those, I think, they need higher consideration in terms of-- not insurability, but really look down at their bottom line and maybe the revenue stream impact in terms of insurance costs need to be reconsidered.
ALAN MCSHANE: OK. So do you think that-- you're thinking, how do we enhance the communication in the sector? Because obviously, if we can bring all the parties together in a lot more collaborative environment so we share more, we collaborate more, do you believe that is an opportunity for us to access more capacity in the market to allow projects to move forward quicker?
What do you think about that approach? I know we do quite a bit of that already, but I'm thinking of having to take it to different level, as I mentioned, because of the technology issues and stuff, to bring people into the discussion a lot earlier in the process so they feel more comfortable and have a keen understanding of the project as it develops.
MIKE VENABLES: Definitely. And like I said earlier, it's really about a good story to tell. There's many projects that are actually being managed in an excellent way. And somewhere along the process, it's not being maybe put forward to the market in the best possible way. And also, I think setting expectations in terms of putting the parties together at an early stage.
I think from an EPC perspective, setting those minimum requirements and flexibility within the EPC is important, but having that flexibility from lenders as well in their term sheets to be able to meet that. Because at the end of the day, we're all going towards the same goal. We want the project to be developed. We want that project to be financed, and we want that project to be insured in the best way possible. So it's just getting that balance right and setting expectations from early stages.
ALAN MCSHANE: Because I think it's interesting to note that in many projects, from my experience, that there's a lot of-- as we mentioned before, a lot of elements of these projects that we're involved in are aspects of current projects or past projects over the years. So I think it's important that we help everybody, all the stakeholders, to differentiate between what existing technology may be used in a slightly different way or existing technology or new technology. And then we can hone in on the areas that are more concerning for everybody and then work on them together to try and alleviate those concerns.
MARIA Sanchis: Definitely. Like you said, sometimes the technologies just scale up. Maybe we have haven't reached the market standard of 8,000 of operation, but we know that there's certain projects that are being developed in other parts of the world that once that particular project that is considered prototype goes into testing, we know that we're going to have results to get back to the market.
So again, that flexibility should be there. And I think that that's early-stage conversation. And also, I have an example-- knowing contractually, too, where the obligation lies. We had a manufacturer working in one of the islands in the Caribbean where there was going to be a long period of storage because of that supply chain disruption. And the markets were very concerned about material being stored in a very exposed manner during the hurricane season. And we saw that contractually, actually, the obligation were laid on the manufacturer and not so much on the project developer or the sponsors.
So we also need to know where the risk allocation is, and not only insurability, but also where the risk lies in terms of contractually. And I think that's more into Steven's space.
STEVEN Munday: I'll just comment, actually, on the net cap, because I think that that's incredibly timely and interesting after the 1/1 treaty renewals. We have seen the insurance market go through a hard market where there's been a constriction of capacity and supply and increase in terms of conditions, more limited terms and conditions for our clients. We were, with new capacity coming in, which was ESG- driven, starting to see leveling of the insurance market last year. But towards the end of the year, we had the treaty renewals. And we are seeing now, probably, the greatest impact from natcat to reach the markets, as well as the international markets.
And because the natcat withdrawal of some of the restrictions, some of the treaties, is pro-placing greater risk on the domestic insurers, the direct insurers where they don't always have the treaty protection, that, again, it's reducing capacity and appetite where the direct insurers don't have the treaties for the additional support to lay off risk. Now, that's reducing capacity. It's increasing connectivity with the international marketing hubs without needing to underwrite, technically, these risks. And we are also seeing lots more renewable energy projects that are being delivered in more challenging territories around the world than we've ever seen before.
And we now have, with the climate initiative, much more unpredictable weather patterns, as we've seen around the world, from wildfire and droughts and natcat events. So it's becoming increasingly difficult for what the insurance market wants to be a technical market. It does look very closely at all risk factors,
particularly in natcat, and is trying to run its models, trying to understand the technical design specifications of the equipment that's been deployed for that occupancy in that location. But it doesn't have the history to rely on anymore.
So we are seeing great challenges with the new projects. And as we mentioned earlier, some of these new projects, they're not small projects. We're looking at big utility-scale projects being deployed in Australia and wildfire zones in California, in Texas. And risk and insurance is moving very rapidly up the discussions in the boards about whether the projects are viable or not and what is the predictability of insurance costs for those projects over the financing terms, which is very difficult for all of us. We don't know how the market is going to perform.
And what we are seeing-- we've got historical projects that were maybe financed 5 or 10 years ago, and the market is starting to constrict. And that's now having an impact on the lender mandate requirements which were put in place at financing, which are now increasingly difficult to deliver at the same premium. And that is having a major impact on projects' profitability, almost viability in some areas. And we're then seeing the need, relative to maintaining costs or maintaining cost at the regional level, to reduce some of the cover.
Now, that then brings it into, for natcat, insurers are trying to impose sublimits. We spend a lot of time, as you know, Alan, with the engineers, trying to work out PML studies and what's appropriate, particularly for renewable energy projects where we've got a large footprint, maybe not the single footprint with a CCGT or coal-fired [INAUDIBLE] project.
How is it going to be exposed from a [INAUDIBLE] perspective? And that is something that's really been brought into that risk transfer cost and the appropriateness of the PML studies going forward. I mean, Alan, we're doing a lot of this at the moment, and it's highly impactful for our clients and the level of transfer that we put to the markets.
ALAN MCSHANE: Indeed. I mean, it's something that's very, very keen for me, from my point of view, being the lead on risk engineering, to ensure that we build out our loss estimate analysis at the construction and early operational phases to ensure that there's a keen understanding of what those risks are over the entire project cycle, from inception through to final handover into operations. And that's an important factor. And obviously, with the increased issues around natcat, that's definitely an area that we are working very hard to ensure is covered in those analyses.
MIKE VENABLES: So Steven, Alan, Maria, you've made some very valid points there. And the million- dollar question on my mind is the global inflation versus escalation up-flips. How are we ensuring that the right values are being insured?
Before we ask our guests to answer this question, we're going to take a break. There's so much to say on the topic, we're dividing the conversation into two parts. We hope you join us for the continuation of our discussions with Steven, Alan, and Maria. And thanks for listening to Construction Blueprint.
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