Dublin, September 2022 – The world’s transition from fossil to low-carbon energy requires enormous investments. In 2021, global investments in the low carbon energy transition amounted to US$ 755 billion, an increase of almost 20% compared to 2020. Renewable energy, the largest sector, attracted US$ 366 billion, up 6.5% year-on-year, of which close to US$ 80 billion were invested in Europe.
Wind energy becomes a security need
But substantially higher investments are required to reach the overall goal of net zero carbon emissions, limiting the rise in global temperature to 1.50°C by 2050. According to Bloomberg’s ‘Energy Transition Investment Trends’ global energy transition investments must triple to roughly US$ 2‘000 billion annually until 2025 and then double to US$ 4’200 billion per annum until 2030. Investments in onshore wind energy have to increase by close to four times from the current annual US$ 80 billion to annually US$ 300 billion from 2022 to 2030, while investments in offshore wind energy must grow more than sixfold from the current US$ 18 billion to over US$ 100 billion annually. These assumptions do not yet reflect the need to balance energy security, price stability and national resilience with the efforts to reduce carbon emissions and combat climate change.[1]
The EU countries invested US$ 30.5 billion to generate 19 GW of new wind farm capacity in 2021. However, new installations just totalled 11 GW. Following last year’s low rate of installations, the EU will have to install 35 GW of new capacity per year, if it is to meet its target of 40% renewable energy by 2030. Due to improved efficiency and technological advancement, cost for new capacity installations came down further in 2021, declining to US$ 1.36 million per MW for onshore wind projects and to US$ 3.7 million for offshore capacity. Thus, despite slightly lower investments than in 2021, the EU’s wind industry financed 20% more capacity than in 2020.[2]
High capital needs
However, the tighter monetary policies in response to the surge in inflation as well as rising prices for fossil fuels are expected to influence investments in renewable energy. With higher cost of capital and attractive returns in the oil and gas industry, access to financial capacity tightens. Nevertheless, annual investments in energy supply are expected to double by 2035. Almost all growth is expected to come from decarbonisation technologies and renewables. EBIT in these technologies is earmarked to outpace the growth in the underlying investments, as McKinsey predicts in its report on Global Energy Perspectives.[3]
Globally 80% of total energy sector investments in energy assets was financed by private sources. The ratio is expected to expand further to meet the 1.50C scenario. In addition, the share of debt capital is anticipated to increase from 44% in 2019 to 66% for the period 2021 – 2030 as energy transition technologies are expected to secure more affordable long-term debt financing while the more risky “brown” assets will rely on equity financing from retained earnings and new equity issuance.[4]
Europe, 71% of the capital raised for onshore wind was financed on balance sheet, with the remainder coming from project finance with debt ratios of close to 90%, reflecting the low cost of capital of the past and the familiarity of banks with the mature onshore wind farm technology. Taken on- and offshore wind projects together, US$ 16.4 billion were financed through debt in 2021, provided predominately by banks to finance the construction period. According to WindEurope, the low interest environment had provided the wind energy industry with competitive financing cost. However, recent market turbulences will change that paradigm as risk premiums charged by lenders are bound to increase.[5]
Investment in new wind farms in the EU 2012 – 2021 (GW and €bn)
Source: WindEurope
Market can’t afford uncertainty if it is to meet its objectives
Given the amount of capital and debt financing required, investors need the confidence that their investment will achieve its returns. Uncertainties on future feed-in prices or unpredictable and lengthy construction processes due to opaque permitting procedures, erode investors’ trust and threaten the availability of capital.
With its recent REPowerEU initiative the EU wants to accelerate the permitting of wind energy. But although the European Commission aims to set renewables as a principle of “overriding public interest”, asking member states to designate so-called “go-to” areas, where the permitting is fast-tracked – based on best-practice principles, a simplified approval process and streamlined legal challenges – uncertainties remain because, firstly, member states need to convert the EU’s action plan into national law and secondly, people will retain the right to challenge public projects.[6]
Insurance as a mechanism to de-risk investments
Mechanisms of de-risking investments are sought to improve risk management. Insurance is likely to be the most obvious choice as it could assure the quality of projects, serve as financial security or a guarantee for lenders, maintain cash-flow in case of disruption and enable the transfer of executional risk off the balance sheet of a developer.
In terms of permit challenges, insurance basically serves three different dimensions. Firstly, in an environment, where the European governments aim to accelerate the permitting of wind farms and need to strike a balance between security needs, ambitious carbon reduction targets and exploding energy prices, insurance provides a form of quality assurance. Through its pricing and – even more fundamentally – through insurability, insurance helps to differentiate and regulate between “good” and “bad” risks. Risks which fail to comply with best or at least standard practices will find it difficult to be insured and access financing, unless they improve their risk profile through preemptive measures. In addition, the type of contingent insurance that is applied to permit risks, serves as far more than a mere security in case of a loss. Insurers also consult with their clients, providing them with recommendations on how to anticipate and reduce conflicts by initiating measures to mitigate that risk.
Secondly, as a risk transfer mechanism insurance necessitates the ability to quantify and structure an otherwise unpredictable risk. Through its underwriting process insurance determines the exposure of the risk – the magnitude and likelihood that a loss will arise. In permit challenge insurance this is foremost a question of time. A permit challenge may lead to a court decision requesting for instance changes to the design of a project and thus delaying the construction. As a result, unbudgeted costs may occur and possibly the project will suffer a loss in expected revenues, as its completion and thus its connection to the grid is deferred. The risk management benefit of such a process is apparent as the clients have the certainty of an indemnification against the loss caused by the additional time needed.
Insurance as a capital substitute
Thirdly, from a financial perspective insurance is a substitute for capital which enhances the bankability of a project, reduces the cost of capital and assures cash flow and liquidity. On the one hand, insurance improves the confidence in a project’s delivery. The insurance policy is accepted by a bank or lender as a guarantee that protects the investment or loan against a loss and assures that the interest or returns are paid in time. In case of a permit challenge, insurance will thus contribute to ascertain that a loan is released, and construction can continue. Insurance thus improves the likelihood of a timely completion of a project and that it will generate revenues as budgeted.
On the other hand, the policy serves as a collateral that lowers the risk of the investment or loan for the investor or lender. This improvement might be reflected in the credit rating of the asset. Due to its higher security and better risk profile, the yield to be paid for the capital and, consequently, the cost of capital will be lower too.
And finally, similarly to the way how credit insurance protects account receivables and thus serves as a means of cash-flow management, a permit challenge cover enables advance payments on expected revenues and assures liquidity in case of a challenge as banks will continue to reduce their loans. Therefore, insurance reduces the risk of a project’s default.
To sum up, wind energy is a key component to address climate change, ballooning energy prices and heightened security concerns. Although the current rate of wind energy installation falls short of the renewable energy targets set for 2030 and beyond, these goals have now been increased to an annual capacity of 35 GW of wind power to be erected until 2030, while in 2021 a mere 11 GW were completed. In 2021 the EU countries invested US$ 30.5 billion to finance 19 GW of new wind farm capacity. Thus far the energy transition has been financed by more than 80% through the private sector. Going forward its share of contribution is expected to grow even further.
In light of rising interest rates and attractive investment opportunities, which arise in the energy sector due to ongoing high pricing for fossil fuels, investors and lenders need the confidence that their investments and returns are sound. Insurance could provide a mechanism to de-risk investments. In a time when permitting is accelerated to increase installations, insurance could assure best practices and quality control. It could make it possible to quantify and manage the risk of a permit challenge and, finally, improve the bankability of projects, lower the cost of capital, assure liquidity and a timely delivery of projects according to plan.
Sources
[1] IRENA, World Energy Transitions Outlook 2022
[2] WindEurope, Financing and investment trends, April 2022
[3] McKinsey & Company, Global Energy Perspective 2022, April 2022
[4] IRENA, World Energy Transitions Outlook 2022
[5] WindEurope, Financing and investment trends, April 2022
[6] WindEurope, How to accelerate permitting for wind energy? May 2022
