Reducing Finance Risks in a Fast-Moving Wind Energy Market

Reducing Finance Risks in a Fast-Moving Wind Energy Market
March 6, 2023 29 mins

Reducing Finance Risks in a Fast-Moving Wind Energy Market

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The renewable energy industry is facing unique headwinds, but there are opportunities to accelerate the role of European onshore and offshore wind power.

Key Takeaways
  1. Investment in wind energy fell in 2022, but there are plenty of opportunities for those willing to adapt their risk and financial management strategies.
  2. Anyone looking to reap the rewards of the European wind energy market will need to invest early — which means taking on more risk.
  3. New credit and surety solutions have made it easier for financiers to secure the necessary funding to match high upfront costs.

Can Wind Energy Developers Keep up with the Market?

Although the demand for renewable energy sources has been building for decades, 2022 will be remembered as the year that the geopolitical landscape pushed that demand ever higher. The impact of the conflict in Ukraine has heightened debates around energy security and magnified the increasingly important role that renewables play in stabilizing the energy market. At the same time, the energy sector is under increasing pressure to find solutions to the world’s climate emergency — and fast.

Renewable electricity capacity additions broke new records in 2021, increasing 6 per cent to almost 295GW, while in 2022, solar and wind power generated more than a fifth (22 per cent) of the EU’s electricity, overtaking fossil gas (20 per cent) for the first time. Despite these steps forward, renewable energy demand continues to outpace delivery. As the impact of climate change begins to be felt more and more, pressure from governments, stakeholders, and citizens has increased. This has driven the International Energy Agency (IEA) to issue a stark warning about the financing needed to transition away from fossil fuel dependence and achieve decarbonization goals. To reach net zero emissions by 2050, the IEA warns that annual clean energy investment worldwide will need to more than triple by 2030 to around $4 trillion (3.7 trillion euros).

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To reach net zero emissions by 2050, annual clean energy investment worldwide will need to triple by 2030 to around 3.7 trillion euros.

In Europe, the electrification of industry and the broader economy remains the most cost-effective way to decarbonize. While currently meeting 15 per cent of Europe’s demand, onshore and offshore wind energy is anticipated to make up half of the region's electricity supplies by 2050. Floating offshore wind offers an exciting opportunity to increase energy production and is attracting significant governmental and private industry funding. It is also a critical link to the growth of green hydrogen. The potential loosening of European Union (EU) subsidy regulations in response to favorable government policies in the United States (US) and China could also present new opportunities for growth within the industry.

Investment in both onshore and offshore wind power is not only fundamental to Europe’s energy security strategy but is also delivering wider social and economic benefits to the continent through the creation of jobs and investments in local communities — with each new turbine generating an average of 10 million euros of economic activity. In 2021 there was a steady stream of investment activity within the sector, bringing 41.4 billion euros of investments into the market, financing a record 24.6 GW of new wind farm capacity.

However, 2022 saw a significant drop in investment, despite the demand for industry growth. Orders for new wind turbines were down 47 percent compared to 2021, with capacity falling well short of the 30 GW of development needed each year to meet EU energy and climate security targets. Challenging headwinds in the form of economic and political volatility have tightened profit margins, increasing financial risks across this growth market. But, as we kickstart a new year, there are still plenty of opportunities for those players willing to evolve their agenda and adopt a revised approach to risk management.

To develop a path to commercialization while delivering on global climate targets, wind investors and developers can look to credit engagement and capital insurance vehicles to help address key financing risks. With credit enhancement policies and capital insurance vehicles, Special Purpose Vehicles (SPVs) can secure finance across the whole lifecycle of a project and ensure they have adequate protections in place to help them transfer risk and finance their future ambitions at pace.

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With Greater Business Viability, Investors are Moving Earlier

  • The total energy bill paid by the world’s consumers is expected to top $10 trillion for the first time in 2022.
  • In 2022 global clean energy investment is anticipated to top $1.4 trillion.
  • Record-breaking wind and solar production helped the EU avert €11 billion in extra gas costs in the eight months after Russia invaded Ukraine.

Source: WEF, 2022 and EuroNews, 2022

With wind energy viewed as the cornerstone of the transition towards clean energy, investors have been drawn to the market by the growing demand for renewable energy, government incentives, and their own environmental, social, and governance (ESG) concerns. The sector’s appeal is also strengthened by an excellent track record of performance, with stable, long-dated returns and very low default rates.

The shifting entry point of investors reflects this asset class’ appeal. Historically, many investors were looking to enter the market once wind projects were operational. However, the strong track record of wind energy has seen that risk appetite mature, with an increasing number of players partnering with well-established development teams and deploying capital earlier in a project’s life cycle.

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We're definitely seeing a move in investment from asset to platform, and I think that trend will only continue.

Charlie Garrood
Head of M&A and transaction Solutions UK and Head of Infrastructure EMEA, Aon

Although the current economic and geopolitical volatility has created less stability for investors, large pools of liquidity are still available, and, when underpinned by insurance, the appeal of wind energy can be further strengthened. Credit insurance facilitates the provision of debt into the sector, helping to classify assets as investment grade in the eyes of banks and investors. By maximizing value, removing execution risk and increasing the pace of deals, insurance is opening up the possibility of investment where it might not have existed before.

Credit insurance encourages banks and non-bank financial institutions to lend more because it helps stabilize their risk-weighted assets, gaining capital relief. Increasing regulatory pressure on banks and insurers to improve the quality of their capital is also enhancing the appeal of the insurance market, which is less leveraged and, therefore, less exposed to liquidity risk than banks.

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Because of the new Basel III rules that will be operative in many countries in the years ahead, we will see the bank price for guarantees almost double — making the insurance market even more competitive.

Ruggero Nicodemo
Surety Leader EMEA, Aon

As the sector continues to transition away from projects underpinned by government-backed subsidies and become more cost-competitiveOpens in a new tab, the importance of commercial Power Purchase Agreements (PPAs) is increasing. However, uncertainty for PPA counterparties is rising due to energy price volatility and global inflationary pressures. By taking advantage of credit wrapping, corporate off-takers can limit their exposures, reduce credit risk, and improve the quality of cash flows to support more favorable debt terms.

To ensure financing is effectively mobilized by insurance from the private market, lenders need to be confident that their credit insurers have a solid track record of covering renewables projects and paying claims on project finance risks.

"As the use of credit insurance increases, underwriters are assessing PPA agreements to ensure an SPV project company has an adequate debt service ratio and evaluating the risks by asking, for example:

  • What do the termination provisions say in the event of a default by an off-taker of power?
  • Is there a termination amount mentioned in the contract that is equal to the value of the outstanding project finance loans and sponsors’ equity?
  • What are the arbitration provisions of the agreement?
  • In which jurisdiction is the court of arbitration?
  • What are the force majeure provisions in the offtake agreement?

Today, financiers must present themselves in the best light possible regarding their track record and ability to fulfill the fairly heavy obligations imposed upon them under the terms and conditions of credit insurance policies.”

Miles Johnstone
Executive Director, Structured and Capital Solutions, EMEA, Aon

Risks are Increasing Throughout the Project Life Cycle

"There is enough finance in the system, but success is linked to a series of challenging interdependencies. SPVs need planning processes to work effectively and the supply chain to be sufficient to meet the demand. You need to also have the labor and the resourcing for these projects to go ahead. So every touchpoint of the industry needs to grow to support the actual ambitions of the sector — at a time when inflationary pressures risk putting the handbrake on progress.”

Guido Benz
CEO Global Renewable Energy, Aon

While the increasing interest of European developers and investors has driven growth in the European wind power industry, the risks associated with the expansion of renewable energy infrastructure are becoming increasingly complex and, as a result, impacting the pace at which ambitions become a reality. As investors enter the market earlier, their exposures to risks are expanding:

  • Regulatory hurdles are growing
    Price caps implemented by European governments to protect consumers from high energy prices threaten to unnerve investors and stifle energy policy progression. At the same time, protracted planning processes threaten to derail the development of new energy infrastructure, with delayed approval processes creating cost and resource availability risks.
  • Supply chain weaknesses are disrupting development
    Increasing global demand for the raw materials used in wind technology, such as nickel, steel and, aluminum, is threatening the stability of the supply chain. Since the start of the conflict in Ukraine, imports of finished steel into the EU have dropped by a fifthOpens in a new tab, reflecting Russia and Ukraine’s contribution as major steel producers.
  • Tightening economic conditions are increasing costs
    As well as inflation pushing up commodity, shipping, labor and transaction costs, a hardening insurance market and increased borrowing costs are making price predictions even more uncertain. After steady decreases in capital expenditure per MW over the last decadeOpens in a new tab, current inflationary pressures will curtail these cost reductions.
  • Resource availability threatens to constrain progress
    A global shortage of ships used in the transportation and installation of wind turbines is constraining the success of future European wind projects. As competition intensifies and technology evolves, the demand for ships is set to outstrip supply by 2024 — a pressure that is only set to increase as the next generation of turbines will require larger vessels. If any combination of planning, funding or supply chain challenges hold up construction, SPV projects risk significant and costly delays as a result of industry bottlenecks.
  • New technology and cyber threats present new challenges
    Rapidly evolving technology is transforming the sector but also exposes developers and investors to new risks when scaling up relies on new technology with limited testing. Likewise, as countries rely more on offshore wind for their power needs, the risks of cyber attacks are also likely to increase. From ransomware attacks on the software used to manage, monitor, and control wind power systems to the theft of intellectual property, unprotected vulnerabilities threaten the resilience of SPVs.
  • Increasing exposure to severe convective storms
    Climate change and more extreme weather events are intensifying risks for the sector — particularly as offshore wind moves from near-shore shallow waters to far-shore deep waters. As a result, securing affordable insurance capacity has become more challenging as insurers and reinsurers try to control risk accumulation. With demand outstripping the supply of resources, developers must also consider the potential business interruption risks as projects attempt to get back up and running.

Today, project risk advisory must be much broader and deeper — from pre-construction through to decommissioning. In the current climate, it’s more important that both investors and developers understand, manage, and mitigate their exposures as early as possible.

Insurance has an expanding role to play within project budgets, and, as current headwinds create new risks for business, those protections must be evaluated — especially by those developers whose budgets have already been set.

Transferring Risk to Accelerate Growth

Comprehensive credit solutions help clients secure receivables, unlock capital and grow trade. These linked credit and insurance tools play an essential role at every stage of a wind project life cycle, helping to reduce credit exposure throughout the lifetime of a transaction.

With regulatory changes and macroeconomics impacting working capital facilities and liquidity, surety bonds are an innovative tool to mobilize capital for the sector. Their deployment is helping wind energy stakeholders to mitigate risk and protect their interests by increasing development capacity and minimizing financial exposure for investors.

Transferring Risk to Accelerate Growth Diagram

By partnering with a broker at the earliest stage of a project, SPVs can protect themselves from taking on too much risk, ensuring a fair and equitable sharing of risk right from the start. This project oversight helps developers to:

  • Gain a clear understanding of the project-specific risks
  • Identify which party is best equipped to carry each risk
  • Quantify the risks kept by the project, allowing for right-sizing insurance limits
  • Identify alternative risk transfer solutions

From a risk assessment perspective, insurance can also be a more cost-efficient way to cover everything from start-up delays and business interruption to third-party liabilities and cyber exposures. By right-sizing the risk transfer and negotiating with the lender's insurance advisors, experienced advisors will counteract lower deductibles and higher sub-limits, drive more preferential contract conditions and limit liability exposure to create value at every stage.

Parametric insurance can help stakeholders in a wind energy project manage and mitigate evolving risks. With ever-improving data sources available to run these analytical models, clients can access non-traditional financing and risk management products that are underpinned by greater intelligence.

In this rapidly evolving industry, knowledge is power. So, whether it’s the development of technology, the smoothing out of planning processes, or the evolution of the insurance industry, stakeholders need the best advice and analysis to help them make the right decisions to grow and succeed across Europe’s wind power industry.

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Collaboration and knowledge-sharing between developers, manufacturers and the insurance sector are going to be critical to the industry’s growth to ensure that risks and the associated costs are fully understood and insurable.

Mark Potter
EMEA and UK Power & Renewables Industry Vertical Leader

General Disclaimer

The information contained herein and the statements expressed are of a general nature and are not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information and use sources we consider reliable, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

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