Insurance Post

The power of wind

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The growing awareness of a worldwide energy crisis has prompted the UK to focus on developing sustainable alternatives to generate power - particularly wind farms. Marcus Alcock charts the progress of their insurability

The UK's energy needs are a pressing concern for the government, especially when looking at the facts at hand. The stark reality is that if the current situation is left unchecked, the UK will not have enough power to supply its future needs in the future. As such, unless the Exchequer decides to spend significantly more money on importing energy from abroad, a new strategy needs to be found.

One of the problems is the finite reserves of oil from the North Sea, which has provided a welcome boost to the UK's energy needs since it first developed in the 1970s. While primary oil demand in European Union countries is projected to increase by 0.4% per year until 2030, North Sea output peaked in 1999 and has been declining since.

It is not just oil that is the problem. The proportion of electricity generated from the UK's nuclear power stations is set to drop to 7% by 2020 - from the current 20% level - if older plants are closed as scheduled. Seven of the eight newer, advanced gas-cooled reactors are earmarked for closure by 2023 unless the decision is made to extend their lives.

Although the government feels there should be more thought invested in using nuclear power in the future, there is little doubt that renewable forms of energy will nonetheless play a significant role in the years to come. According to the British Wind Energy Association, wind power from onshore and offshore farms will generate 8.8% and 9.4%, respectively, of projected UK electricity supply by 2020.

Due to this, the association is calling on the government to extend the Renewable Obligation so that these forms of energy produce 20% of UK electricity by that year. This option forms the core of current government policy and was introduced in April 2002. It is a scheme designed to encourage greater electricity production from renewable sources by increasing the income renewable generators receive above and beyond the market price of electricity.

Wind farms

The statistics so far are perhaps less than encouraging. According to the BWEA, there are 127 wind farms across the UK, encompassing some 1618 turbines, producing 1694.55 megawatts, and providing enough electricity to meet the needs of 947 506 homes.

Although this may look good on paper, the UK lags behind Germany, Spain, Denmark and Italy in terms of the amount of energy it produces from renewable sources. Nonetheless, the long-term signs are positive.

According to Tom Sexton, senior vice-president at Marsh and an expert in the renewable energy sector, there is no doubt that renewable energy is here to stay: "The European industry is growing at a rate of 18% a year, and the US is growing rapidly because of the tax levy."

Furthermore, the US - one of the world's thirstiest oil guzzlers - has in recent years become a serious player in developing alternative energy resources, with wind energy currently producing 6300 megawatts of wind generating capacity, according to the US Department of Energy.

With such growth, it is hardly surprising that the insurance industry is there to provide a degree of risk mitigation. Although this is an interesting area in terms of technological development, the insurance products that support the renewable energy sector are nonetheless quite traditional.

As a result, policies for this sector generally follow the format of mainstream property damage, business interruption and construction risks. Mr Sexton comments: "They are pretty good risks to write because although there might be 25 to 30 wind turbines in each farm, you might lose only one or two. This means that the main risks insurers take are with technology because a lot of turbines could be deemed prototypical."

Naturally, underwriters have been cautious so far when it comes to the extent of the cover they are prepared to provide, especially given the unproven longevity of many of the wind turbines in operation. Thus, the standard policy has been to provide consequential loss cover but for faults arising as a result of, for example, damage to the gearing of a wind turbine - the line has been that the manufacturer's warranty must be relied upon.

Broaden horizons

According to one broker, breakdown cover is slowly being provided but the problem is that for onshore risks the premiums are too low for insurers to fully commit themselves. As far as the volatile offshore market is concerned - especially in the wake of Hurricane Katrina - insurers and reinsurers are in no mood to broaden their exposures, no matter what sorts of extraordinary rate hikes are being seen.

Capacity is, however, not a problem. Mr Sexton explains: "We've seen a lot more capacity in the onshore market in the past 12 months and prices have been driven down. A lot of this has come into London and the European market, with Lloyd's having stepped in during the past couple of years and picked up a lot of this market."

One such player that has recently done just this - having entered the market in the wake of 11 September 2001 when others decided to pull out - is Lloyd's underwriter Kiln. So is the wind farm industry buying traditional insurance coverage or is it keen to explore alternative risk transfer mechanisms?

David Horwood, from Kiln's marine and special risks division, is a renewable energy specialist. He, alongside Charles Franks who underwrites for the same division, believes the products themselves are not substantially different from others in the market, although this is not to suggest that alternative forms of risk are not around.

"Our involvement started with onshore wind farms, and over the years we've gradually grown the book," Mr Horwood explains. "Quite a lot of it is based in the UK but we also write in Europe, where our main areas have been Spain, the Netherlands and Scandinavia. The other big area is North America.

"Charles and I come from a background in offshore energy and that's probably true for some of the brokers in this field too," he adds. "The coverage we're offering is a relatively conventional physical damage coverage, and the only area where alternative risk transfer operates is with the bigger utilities, some of which already have their own captives."

He adds that when Kiln first started writing the renewable energy sector, a big area of concern was systemic risk. As such, despite the fact that renewable energy - and wind farms in particular - have become an embedded part of the physical and financial energy landscape, there was no way of telling when the insurer began covering this area five years ago that major systemic failures were not in the offing. For example, a design fault in a wind turbine would not be a one-off problem but would instead be something that could potentially affect vast swathes of the renewable energy market.

Systemic risk

Although systemic risk has not proved to be a problem so far, Mr Horwood is far from complacent. "It hasn't happened yet but turbines are getting bigger all the time and that's something we're wary of," he comments. "The biggest problem we've had is transmission cables as they tend to unbury themselves or they can be upset. That's made the offshore side quite difficult but it's the nature of the offshore construction industry where you've got a whole host of contractors on one project."

One London market broker also identifies the increase in turbine size as a potential problem for insurers. "There are technology issues when wind turbine size increases from 2.5 megawatts to five megawatts," he says. "If a gearbox fails on a wind turbine, the chances are another 50 turbines with identical gearboxes have been made, which then becomes a major issue for insurers. It also becomes a major logistical problem if that wind turbine is located offshore."

Risk management considerations are also important at the planning stage of a wind farm, and the industry can sometimes prove crucial in terms of providing innovative financing solutions to otherwise intractable problems.

Julian Boswell, a partner at law firm Eversheds, which specialises in this sector, says that it can sometimes be frustrating to put the insurance arrangements in place when a contract is being negotiated for the construction of a wind farm. "Insurance is always going to be part of the planning process," he says, "but one of the problems we have as lawyers is that when you talk to insurance brokers they always tell you they have a bigger share of the market than anyone else."

Nonetheless, he feels that the industry can play a vital role in many projects: "Risk management is fundamental, particularly when it comes to financing. People may be prepared to take a view on things in a project finance deal that banks are not prepared to take a view on."

Other alternatives

As important as they are to the UK's renewable energy sector, wind farms are far from the only provider of alternative energy.

David Way, executive director of the international energy division at broker Alexander Forbes, points out that there is more to the energy landscape: "We handle onshore wind farms, though there are a lot of other renewables. For instance, there is biomass, which in essence is burning natural material and waste to energy.

"In my opinion, waste-to-energy is going to overtake wind as a source of renewable energy in the UK. We produce a growing amount of waste placed in landfill sites but there are various regulations that say such waste should be disposed of in a more efficient manner. The technical term for doing this is pyrolosis, and it will become increasingly important. Some countries are more advanced than us, such as Germany, but the UK is advancing rapidly as the technology becomes more proven."

Mr Way points out: "Wind only blows an onshore turbine 40% of the time, and every time you build another wind turbine you need to have spare capacity elsewhere." His theory is that the waste to energy market will pick up this capacity.

Mr Way adds that whereas a wind turbine generates on average 2.5 megawatts of power and a wind farm can constitute up to 25 turbines, a waste to energy plant can provide 40 megawatts and is a small, localised entity "looking more like a big shed than a power station - there will be 50 of them in the UK in 10 years' time".

So even if insurers continue to be wary about broadening their exposures to onshore and offshore wind farms, there may be signs of an alternative renewable market offering considerable potential.

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