Profit generator

By Jeremy Golden.

Alternative or renewable energy (RE) - defined as wind, solar, biomass, geothermal and wave/tidal power - so far accounts for a small proportion of total electricity generated. In Europe, easily the fastest growing region worldwide for the installation of new facilities, RE only generates approximately 6% of electricity consumed.

However, the European Commission (EC) has made the reduction of carbon dioxide (CO2) emissions, which contribute to climate change and global warming, core to its energy policy. Since electricity is mainly generated by burning fossil fuels like coal, oil and gas which release emissions into the atmosphere and harm the environment, the EC has set targets to double the level of RE produced by 2010. Each member state has its own target for 2010, with the UK's being 10%, for example.

According to Dr Thomas Streiff, the head of group sustainability management at Swiss Re: "The renewable market is certainly growing but not as fast as was predicted say five years ago; the voluntary aspects of the program have certainly diluted demand," he asserts.

Yet despite the apparent lack of effective policies at government level to ensure that ambitious targets are met, a number of leading international brokers and (re)insurers express cautious optimism that large-scale renewable energy projects will rise substantially in the coming years, as will the the level of demand for (re)insurance and risk management services which are considered an essential component to get such projects off the ground.

The industry consensus is alone among the competing natural sources; only geothermal and utility-scale wind has the generation capability on the scale required to service the mass market. Among these two, wind energy is considered to be much more competitive price-wise, as well as being superior in terms of reliability and technological innovation. As Dr Streiff says: "Among the renewables, wind power has emerged as the bulk electricity generator of choice worldwide."

Mike Parry, executive director, energy, Aon, says the annual growth for wind energy has been particularly dynamic although small from a low base and that much of the growth has been, and will continue to be, concentrated on offshore facilities in the Irish Channel, the North Sea and the Baltic Sea. Germany is the fastest growing market for offshore wind boosted by highly supportive government policies including generous tax incentives.

Translating this into value terms, based on the conclusions of The World Offshore Renewable Energy Report, a study undertaken by consultants Douglas-Westwood, the global market for offshore renewables will be worth EUR12bn by 2007, consisting mainly of offshore wind energy in Europe.

Wind energy benefits

Mr Parry asks: "What are the main competitive advantages to relocating wind turbines offshore? It is aesthetically acceptable; the wind resource is more consistent and larger turbines can be installed compared to onshore facilities."

Many leading offshore wind facilities are managed by mainstream, multinational oil and gas companies such as BP because they have the enormous capital resources and expertise required and have high experience of loss events in commissioning and installing offshore. The kit suppliers also tend to be the main contractors on the project.

"From our experience, around half the losses such as they are can be attributed to a design fault or material damage. Single, large catastrophic losses such as the collapse of an offshore oil platform rig are not applicable because each wind turbine works independently and the breakdown of one does not affect the rest," Perry explains.

For Tom Sexton, head of the offshore wind team, Marine & Energy Practice, Marsh, the main growth for Marsh within the renewable energy portfolio is also concentrated in wind power projects both offshore and onshore in the UK and Europe. Sexton believes it to be a potentially significant source of revenue for Marsh over the long term.

According to Mike Perry, Aon's global expertise in conventional offshore oil and gas projects "allows us working with our (re)insurance partners, to design bespoke, comprehensive coverage specifically to match the risk from construction through to business interruption and we are involved in risk assessment for many of the largest European projects ongoing and in the future".

In a similar vein, for Marsh's Marine & Energy Practice it took considerable effort and ingenuity in order to assess the highly specialised risks relating to an offshore wind project and then to design the appropriate coverage for it.

Mr Sexton says: "Generally, we have focused our attention on collaboration with marine and energy underwriters because these insurers have the expertise in offshore underwriting. They also have the capacity and the treaties in place. It is a reasonable horizontal risk; there are no pollution liabilities or individual risks that have to be accounted for and it is set up for reinsurance excess of loss within certain levels. However, until relatively recently it has been an uphill struggle to educate and reassure the (re)insurance market about taking on the risks."

The caution lies partly in the early history of the industry, back in the 1970s and early 80s; a case of 'once bitten, twice shy'. Some (re)insurers were hit hard in those early days when underwriters, with little or no understanding of the wind energy business, were insuring some inferior technology. They would provide insurance for risks such as the performance of wind turbines and their efficacy. In effect, they were underwriting the wind industry's research and development risk. In hindsight, it is not surprising that this resulted in some bad losses. Consequently the insurance market backed off, and wind energy became a no-go area.

"One could say the market has changed its response over the last year or so. It is no longer a case of trying to encourage direct insurers or the major reinsurers to participate, they are keen to get involved," Mr Sexton concludes.

Growth areas

Alfred Fackler, alternative energy specialist at Munich Re, confirms that wind turbines is the main alternative energy sector for which there has been growth in reinsurance business mainly in Germany, Denmark and Spain, albeit representing only a small proportion of Munich Re's total energy portfolio to date.

"We have ongoing project development with respect of offshore projects in Denmark, where we already had gained considered experience, including claims experience. Our key products are providing the terms and conditions for the property cover for such plants.

"Further value-added services are mainly in the area of risk assessment. Especially in respect of offshore plants, Munich Re leverages our widespread experience concentrated in our energy team with specialists in alternative energies and in offshore business, whose expertise and knowledge allows us to make a proper risk assessment at an early stage. Consequently, we can apply adequate terms and conditions, which up to now are confirmed by a still acceptable loss ratio for our own account," Mr Fackler says.

When asked if he envisages alternative energy underwriting becoming more significant to the company, Mr Fackler says: "The importance of renewable energy in our portfolio correlates with its share in the total power production worldwide, which is still fairly small. If all the scheduled projects, above all in the field of offshore wind farms, will be realised, we see a chance for generation of a certain portfolio, which justifies our efforts to develop (re)insurance solutions parallel to the development of the offshore wind turbine technology."

Other reinsurers, such as a senior representative at Partner Re, remain sceptical based on heavy losses in the past. According to the representative: "We have two or three projects in our portfolio but we are not particularly keen to take on any more at this stage."

In contrast to its ambivalent support for RE projects, the European Union (EU) has been far stricter in regulating CO2 emissions responsible for global warming. The EU emissions trading scheme (ETS) effectively translates Kyoto targets into a regional cap and trade system with the aim of reducing carbon emissions.

Each EU member state will make the allocation of CO2 allowances to affected industries annually at national level. This will allow the impact of CO2 caps to be included in business plans after renewing the options available to manage these impacts, such as by an investment in emissions reduction, or by reducing or divesting their operations.

The EU directive imposes penalties if emissions surpass the allowances allocated to facilities. Affected industries can avoid such penalties by trading in the new EU system to buy extra allowances from industries that have a surplus in the same year. The new EU emissions trading scheme therefore serves to reward those industries who become more efficient and reduce their emissions, while reducing the cost to others who can not make reductions or who experience a significant rise in commercial activity requiring more CO2 allowances.

For Europe alone, the projected trading market in emissions is estimated to be EUR15bn per year as of January 2005, when it starts.

According to Charles Crosthwaite Eyre, climate change practice leader, Aon Risk Consulting: "The corporate awareness of the emissions reduction challenge is already developing rapidly in Europe. However, companies may not have necessarily all worked out exactly what the financial and competitive implications are, even among those that sell products that have a high CO2 process or energy carbon content such as the utilities companies."

Aon Risk Consulting is involved in helping companies in the UK and Europe to assess how the European emissions trading scheme will affect their overall competitive position or could change their fundamental risk exposure.

Mr Eyre highlights the impact of business interruption on emissions trading as just one example that his clients should be aware of. If a high carbon emissions plant breaks down for six months what are the implications in terms of the company's emissions credit and future trading allowance?

Warren Diogo, climate change specialist for the marine & energy practice at Marsh, believes the enormous volume of trading represents an untapped source for new products and services designed to alleviate the substantial risks involved. He is working with leading (re)insurers to bring suitable products to market.

"Most of our clients have already started to meet targets. For instance, two of the largest oil and gas companies are taking steps to quantify emissions trading. But generally speaking, there is a further need to raise awareness.

"We also need a 'new breed' of underwriter to look again at new levels of exposure. Underwriters are not necessarily accounting for climate change risk and the impact of carbon trading into their underwriting. We can advise them on services that mitigate risk of climate change and encourage renewable energy," Mr Diogo says.

Meanwhile, Swiss Re launched a greenhouse gas risk solutions unit in 2001 charged with mitigating and managing risk, developing solutions and facilitating opportunities around global climate change issues. Subsequently Swiss Re has introduced a product - a contingent cap forward for emissions reduction trades - which helps ensure that companies buying and selling emissions credits on the open market complete the transactions economically.

According to a company representative, the product "facilitates the trades", by guaranteeing that the cost of the emissions credits stays within a certain range and helping ensure that the credits are delivered, should the transaction apply to some future time period.

In addition to offering its emissions trading product, Swiss Re is also asking directors and officers of companies what they are doing about reducing greenhouse gas emissions as part of the directors' and officers' liability insurance renewal process.

Munich Re is developing coverage that would respond to increased regulatory costs should a company's 'clean' power plant break down, forcing it to use an alternate plant that doesn't meet Kyoto, or any other, emissions limits.

US block

Yet so long as the US - the world's largest producer of CO2 - continues to opt out of meeting greenhouse gas reductions targets, risk management for emissions trading will never be as dynamic or as effective as it could be.

The industry has mixed views on the impact of US non-participation in the scheme. Representatives for a number of leading brokers have stated that it is inevitable that even the US eventually will impose emission constraints, and therefore companies need to proactively start managing these emissions now because early action will be more cost efficient.

Others assert that the US' voluntary efforts to cut emissions won't deliver what is generally accepted to be required and that a certain level of compulsion has to be imposed on a national basis as in Europe.

However, the prospects of the current Bush administration imposing a European style solution on big business seems unlikely to say the least.