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Running on empty?
Written by Trevor Morton
Dwindling energy reserves, energy security fears and ambitious renewable energy targets call for radical steps in the energy arena. Insurers, too, have a vital part to play. Trevor Morton writes
November 2008 saw the Climate Change Act receive royal assent, its purpose being to avoid the potentially apocalyptic effects of climate change. So it became the duty of the Secretary of State to ensure that the UK’s Carbon Account for the six Kyoto greenhouse gases for the year 2050 is 80 per cent lower than its 1990 equivalent. Since then, much legislation has followed, including the Energy Bill now working its way through Parliament.
In its wake, renewables as an industry has taken off in the UK in an effort to reduce CO2 emissions and it should help plug a widening gap in carbon-based fuels. Prominently featured is energy security, which defines the vulnerability of nations to volatility and risks in what has become a globalised energy supply market. The drive for energy efficiency has not been overlooked. With the EU spending in excess of €400 billion per year to import energy, 2012 saw legislation aimed at reducing the EU’s foreign energy bill, increasing EU’s geopolitical independence and with it, energy security. It sets a bold 20 per cent energy savings target aimed at cutting €50 billion per year of the wealth transfer from EU economies to new energy producing countries such as Russia.
As dwindling reserves signal the end to the halcyon years of North Sea oil, the UK and others EU nations must adapt to a low-carbon future based in increasing contributions from renewable energy sources. Achieving the binding targets for renewables established in 2008 European Renewables Directive (ERD) as well as energy security is beyond the reach of nation states alone. To achieve the ambitious renewable energy targets (RET) of the ERD, governments in Europe and elsewhere are dependent on the private sector in the form of existing power generators, and most critically, new, innovative entrepreneurial ventures, if they are to achieve a low carbon and energy-secure future. These firms, be they established nuclear generators or new ventures at the leading edge of wind, solar or geothermal power innovation, face many challenges. Globally, 66 countries have committed to RETs, 27 members states in Europe, 39 states and provinces in North America and the behemoth of all, China.
There now exists a new and potentially massive market for second and third-generation renewable power generation plant and technology. The identification of risk, its transfer and management are set to be key enablers of what is a burgeoning industry for power generation plant, equipment, technology transfer and services.
With renewable energy the fastest growing in its sector, fuelled by in excess of US$250 billion of investment in 2011, a chronic skills shortage is seen as a primary risk to securing UK’s place in the burgeoning global market. Current estimates are of around 1.5 million people employed in renewable energy across Europe with Germany leading the way. A similar sized economy to the UK, it employed over 382,000 people in its renewable energy sector in 2012. Its already ambitious plans to account for 35 per cent of its energy consumption from renewables by 2020 was trumped when, in a surprise announcement a year to the day after the March 2011 Fukushima Daiichi nuclear disaster, chancellor Angela Merkel moved the county’s goalposts to 80 per cent from renewables by 2050. Many doubt the wisdom of Merkel as she also announced the total end of nuclear as a part of her country’s power generation mix.
German industry, which prides itself on adapting to new global trends, has shifted some of its traditional heavy engineering to green technology in the last decade. This has helped to shield its economy and job market from the worst of the 2007 financial crises and created a skills-base to service the emerging renewables sector. As Gaynor Hartnell, chief executive of the UK’s Renewable Energy Association (REA) noted, “Germany is renowned for its quality car-making, yet in its government’s own words its renewables industry is now ‘on the verge of challenging the German automotive industry’s status as the flagship of German manufacturing.
Despite the well-meaning words of the UK government, the UK renewable energy market is growing at a slower rate than most of the developed and major developing nations.” Innovas, a key contributor to the Renewable Energy Association‘s 2012 report Renewable Energy: Made in Britain, estimates global growth across the sector and its supply chains is forecast to increase market value from £360 billion in 2010–11 to £770 billion by 2020. With an economy barely out of the doldrums, the UK is at risk of missing out on its share of a global renewables bonanza that some estimate to be far in excess of the £410 billion already forecasted. According to John Sharp, managing director of Innovas Solutions, “If the UK were to take a rather modest share of three per cent of the increase in the global market value this would provide an additional £12 billion in international trade revenues and potentially a further 90,000 jobs in higher value manufacturing and services. The UK could do even better. Other areas of the world are taking the lead in areas where the UK has the capability to develop its own world leading companies. Whether or not they are interested in climate change abatement, what drives these countries are the compelling economic benefits, including jobs. There is no doubt that the majority of renewable energy technologies provide long-term jobs across all skill levels at a regional and local level. This is in sharp contrast to other energy generation technologies such as gas and nuclear, where much of the economic benefit will be seen overseas rather than in the UK. When the UK gets it right, such as in offshore wind, long term support and planning is known and highly visible.” The REA report advocated the benefits to the economy are relatively poorly articulated in Westminster and Whitehall and called for action to address the matter. For entrepreneurs and corporates alike, the shortages of skilled labour in the UK have the potential to stymie investment and the realisation of ambitious renewable projects.
A complex challenge
Renewable projects are becoming increasingly complex, employing new innovative technologies, scaling in size and output, and, in the case of wind and wave power, locating power-generating plants further and further offshore. Insurance is pivotal to the future of the industry for all parties; infrastructure providers and power generators at the sharp end, to governments subsidising renewables, and the public and third-parties when things go wrong
Rigour in the identification and quantification of risk is fundamental from the outset. As in the game of Monopoly, risk determines financial viability and whether projects pass go and collect £200. The sheer diversity of the sector and the need to determine the viability early on is seeing the emergence of specialists in the field. “Robust and thorough risk management from the outset can substantially increase the chances of a successful project outcome being delivered to owners, operators and associated parties” says Ian Harris, senior underwriter, Renewable and Alternative Energy with ACE European Group. “Risk identification, management and transfer are a crucial component of enabling this new target-driven renewable energy landscape. However, too often this is not considered sufficiently early in the stage of a project. In most cases, project finance will not become available unless insurance provision is in place.”
Renewable energy risks require insurance and risk management parties with experience of a range of relevant sectors. In the case of underwriting parties, balance sheet strength is a basic requirement.
A clean future?
The perception of renewable energy is, for some, that of a technology at the ‘bleeding-edge’. This is despite the fact that windmills have benefited mankind since the 12th century and were generating electricity by end of the 19th. What has changed are the extremes of location as wind and wave farms move offshore into hostile environments. Turbines such as those currently being proposed for location off the coast of Dorset dwarf even London’s Gherkin, testing still further the appetite of underwriters. Risks including public liability, the environment (most especially during the construction phase) and finally during the decommissioning phase are relatively untested. Where past experience to call on is limited, traditional insurance markets struggle to rate renewables and will price accordingly. Subject to market forces, premiums normally reflect the loss of similar competing projects. The potential is for captive insurance to reduce the insurance spend and bring greater certainty to the budgeting process.
According to Fiona Le Poidevin, chief executive of Guernsey Finance, which also founded Guernsey’s financial services clean technologies group in 2011, “The use of a captive allows a project to demonstrate to the reinsurance market the confidence it has in its own risk management by retaining some of the risk itself. There are certain risks or costs that are known to exist at the outset of a project, but are difficult to quantify. One such risk is that of decommissioning. A captive vehicle could be used to write a policy that responds upon the requirement to decommission a project. A captive can provide a cost effective method to fund risks, the occurrence of which is known, but the quantum/cost of which is unknown.”
Those renewable projects that have been operational for some years with insured losses are beginning to provide actuarial data and insights into risks and future scenarios. Where global competition for energy is driving the need for greater capacity, scaling of developments – such as the proposal for between 136 and 218 Gherkin-sized wind turbines off the coast of Hampshire and Dorset, is a necessary step. The technology has moved on too. The quantum leap in sophistication of what are now multi-megawatt turbines is comparable to early windfarms as the Airbus A380 is to Bleriot’s 1909 biplane. Elsewhere in the ‘cleantech’ sector, process and technological innovation in renewable power are being combined with the scaling outputs. These include hydro (power from waves), biomass (energy from burning plant matter), biofuels (ethanol or methanol derived from crops), solar, geothermal and, waste-to-energy (W2E), collectively creating the feeling of a warm, clean and green CO2-free future.
However cornucopian, the reality is that the renewables sector carries risks that require rigorous attention to the environmental and operational elements. According to Ian Harris of ACE Group, “The nature of the risks in renewables has not changed, with the exception of planning permission and the public acceptance of windfarms in the next field or off their favourite beach becoming more of an obstacle and risk to projects. For example, wind power is now moving into its third generation of technology. Windfarms and their turbines are increasing to achieve the economies of scale, deliver payback on the investment, and contribute to RETs. The key difference is in the turbines that are like modern day cars in many ways – very little can be done at the roadside. Remote diagnostics enable distant control centres to monitor and manage the turbine machine, 24/7. This includes remotely shutting down a turbine to prevent mechanical failure or damage in the event of extreme weather. Online videos of wind turbines bursting into flames may be spectacular but not representative of the real risk.”
Solar power is a relatively mature and for the most part, a benign technology. However, the high combustibility of its heat transfer fluids, or misalignment of solar reflectors can cause losses to plant and equipment.
“Where risks have scaled in line with technology are in the Biomass and Waste-to-Energy processes,” Ian Harris added citing a February 2012 fire at Tilbury Power Station in two bunkers of wood fuel. The incident took six hours to bring under control and continued to smoulder for a number of days. The plant was out of service during that time. Elsewhere, in the W2E sector, losses stemming from failings in operational procedures and health and safety saw the number of fatalities doubling for 2012. “Waste to energy has evolved significantly from simply burning municipal waste and steam as a bi-product. Incinerators have been scaled up and technology has become more complex in line with other renewable processes. Now, a variety of wastes are processed individually to achieve greater efficiencies of output. Once commissioned, the pressure is on the operate site at least cost. As W2E plants become more common, the presence of skilled engineers onsite to oversee plant operations is seen as key to managing risks from physical damage to plant and injuries to staff attributable to failures in operational process.
Increasing global competition for oil-based fuels is driving research into the third generation of biofuels that have the potential to significantly reduce CO2 emissions of cars, lorries and aircraft. In contrast to the almost cottage-industry approach to first generation biofuels, such as biodiesel, the complexity of the evolving sciences now demands deep R&D pockets, scalable production, and access to global markets. Taking shape on Humberside is the £350 million plant of Vivergo fuels, a joint venture between AB Sugar, BP and DuPont, which, when fully operational, is set to be the largest bioethanol plant in Europe. Its only by-product is set to provide enough animal feed to nourish 20 per cent of the national dairy herd. At the time of writing, information on the plant’s risk profile was not available. Algal biomass, the raw ingredient of third generation biofuel is just emerging from the R&D phase. It negates the contentious issue of ‘food versus fuel’ associated with corn or wheat based biofuels. The Vivergo plant can be taken as the blueprint for biomass production facilities of the future and comparable to petrochemical production processes in terms of risk and insurance liabilities.
Nuclear, which is after all the paradigm of renewable power, is regulated by national as well as international legislation. Contrary to popular opinion, nuclear power plants are insured and have been so in the UK since 1956. London-based Nuclear Risk Insurers Limited represents a pool of 20 leading UK market property and casualty insurers from both Lloyd’s and the general market. Unlike the emerging renewables sector, nuclear it is the most comprehensively regulated industry in the world. It’s now overseen by the UK Office for Nuclear Regulation, established in the UK in 2011.
Notwithstanding exceptional circumstances of Chernobyl and Fukushima, nuclear remains a low risk source. The virtuous march of the power generation industry to a carbon-free and renewable future is fraught with complexity. However, this stems less from the pioneering technology and new frontiers of wind and wave power and more to the risks and penalties from failing to meet the goals of a 20 per cent reduction in CO2 emissions by 2020.
Unlike Germany, few can doubt the ambivalence and in some cases, the outright hostility to alternative and renewable power from the much of UK’s political classes. UKIP is unequivocal in its stance on the matter. With ‘dirty’ oil and coal-fired power stations scheduled for closure by 2015, and 10 per cent of their capacity having been ‘switched off’ ahead of time in April, fears of the lights going out on UK Plc are real. Ofgem, under its obligations to the Department of Energy and Climate Change, went public on its concerns over the looming reduction in electricity generation margins over the next four years. Margins, the amount of spare capacity across the national grid, could fall from the current 14 per cent to only five per cent within two years.
Chief executive of Scottish & Southern Energy, Ian Marchant, went public in March stating in no uncertain terms, “The capacity crunch facing the country is one that needs to be taken very seriously if the government, industry and regulators are to avoid a catastrophe.” For the UK’s energy intensive industries such as steel, cement, petroleum, paper and construction, the combination of risks to continuity of energy supply and tightening of prices are unwelcome. They bring the potential to make UK and European output uncompetitive. In 2012, typical gas and electricity prices in the USA were 50 per cent lower than the Europe, attributed to the ready supply of shale gas. Such disparities could pose unwelcome risks to economic recovery. Germany’s flagship carmaker, BMW has opted to expand its energy-hungry carbon-fibre production in the USA.
For UK PLC, the progress of the Energy Bill that underwent its report stage and third reading at the start of June, is critical. In her letter of 22 May, Angela Knight, chief executive of UK Energy is calling on Ed Davey, secretary of state for Energy and Climate Change to take radical steps to avert a potential capacity shortfall. In her letter, Knight cites policy uncertainty as contributing to delaying of investment in new generation, low carbon gas and the longer-term challenge of being able to meet peak demand when the UK is more dependent on intermittent renewable energy. UK Energy is endorsing the creation of a capacity market incorporated into the Energy Bill to ensure secure energy supplies and promote the long-term investments required and bring on the new capacity required.
The potential to de-risk the UK’s transition to a greener, low-carbon future is clear. New technologies so far appear more benign that conventional carbon-based extraction and processing. However, the risk of the lights going out in 2015 is in the hands of politicians in London and Brussels.
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