As more countries renew their pledge to cut emissions to net zero by 2050, there is growing momentum to speed up the world’s energy transition. Mirroring this development is a strong appetite for green or sustainable financing, where the sustainable bond market boomed in 2021 with the emergence of sustainability-linked bonds complementing the continued growth of use-of-proceeds green, social and sustainability bonds. According to rating agency Moody’s, the aggregate sustainable bond volumes stood at US$600 billion in the first nine months of 2021, already eclipsing the US$613 billion issued during all of 2020.
All over the world, the number of renewable energy projects has been increasing at an unprecedented rate in recent years. However, renewable energy output remains volatile and vulnerable to weather variability: wind speed for wind energy, rainfall for hydroelectric and irradiation for solar energy.
UK energy giant SSE, for example, says that its renewable assets produced 32% less power than expected between April to September thanks to historically dry and low-wind conditions. The low wind output for much of the European summer season last year was one of the factors that contributed to the region’s power crunch, which continues to play out till today.
Traditional insurance does not provide adequate cover to protect renewable energy businesses against such weather risks, primarily due to the need for proof of physical loss or damage as a pre-condition to a payout. Hence, businesses would have to retain such weather risks due to a lack of insurance options.
The good news is that parametric insurance is now able to fill this gap by providing coverage for the financial loss of renewable energy arising from a lack of weather resource - without the occurrence of physical damage.
From a green financing perspective, banks recognise that their credit risk is ultimately linked to weather risk when extending credit for renewable energy projects. Hence, we are seeing banks making parametric insurance a condition under their loan terms, as is the case in Vietnam which is the leading renewable energy player in Southeast Asia.
Insurance payments are triggered by the value of an index such as the modelled renewable energy output. The value is based on data provided by an independent third-party source, while the pay-out amount is calculated according to a pre-agreed threshold. Coverage options are straightforward and objective, which allow the claim to be settled immediately when the contract is triggered.
For instance, insurance coverage can be triggered for an energy provider if its renewable production is lower than 90% of the expected output arising from unfavourable weather conditions.
The parametric Non-damaged Business Interruption Insurance largely provides two main areas of coverage.
01
The loss of production due to weather risks doesn’t necessarily occur with physical damage. Parametric insurance responds to the event rather than damage to the insured company’s physical asset and covers loss of revenue caused by unfavourable weather conditions that disrupts renewable energy output. For example, a hydro plant cannot generate as much power when there is insufficient rainfall in the region, and likewise wind speed affects how much electricity wind turbines can generate.
02
Carbon credit is considered a high value asset for the renewable energy industry that allows operators to emit a certain amount of carbon dioxide or other greenhouse gases over a period of time. For many of them that are publicly listed companies, they have pledged to achieve net-zero emissions by 2050 and are taking measures to reduce emission, and also purchasing carbon credit to offset the remaining.
With the rapid development of carbon credit trading in Asia, Europe and the US, there is a rising demand for the protection of Certificated Carbon Emission Reduction (CCER) tradable asset value. In the process of renewable energy production, corporations can obtain CCER through carbon-dioxide emission reduction and trade in the secondary market.
However, the delivery of carbon credit trading from renewable energy is susceptible to weather risks and subject to validation and verification. Parametric insurance has the ability to cover the risk facing both sellers and buyers of carbon credit. For the seller of carbon credits, which is the renewable energy project company, they may not be able to deliver the credit as promised, and this means suffering a loss in trading value. And for the buyer who pays to receive the carbon credit for the right of emission, there is a significant trading risk to bear if the seller cannot deliver.
Conventional insurance is not there to protect the intangible asset of renewable energy projects, but parametric insurance can fill the protection gap by covering the loss of revenue from production without physical damage, as well as protect the carbon credit trading value.
The world needs an expansion of renewable energy to meet climate targets while ensuring energy security for the future. To do that requires much needed investment, and the ability for investors and creditors to manage their risk would go a long way to ensuring the growth of renewable energy.
Weather resources are the fuel of renewable energy. With parametric insurance safeguarding a minimum amount of revenue for the renewable energy investment regardless of weather variability, lenders can assume a more confident estimate of their expected revenues and thus offer more favourable debt service coverage ratios.
We cannot control the weather, but we can control how we handle the ways it affects the renewable energy market. In protecting renewable energy investment returns against weather risks, parametric insurance will play an increasingly important role for renewable energy development all over the world.
The article was first published in The Asset on 15 February 2022.
