Published on: 03-Dec- 2012 | Comments: 0
One of the larger concerns in the renewable energy industry is the impact of weather on power production and, by extension, revenue. Rainfall varies from location to location and from one day to the next, with some regions and locations experiencing higher and more consistent rainfall than others. Hydro power plant developers often target sites based on other factors, such as access to existing grid infrastructure and distance to major power consumption hubs influence plant site selection.
At the project planning stage, developers typically install site-specific monitoring equipment to assess local precipitation trends, usually supported by long-term regional data. But natural variations in weather patterns, which may occur in cycles lasting far longer than any site-specific monitoring program, are often overlooked or misunderstood based on limited data from assessment studies.
Shorter-term weather phenomena, such as El Niño and La Niña, may also result in extremely dry or wet seasons. Unfortunately, there is very limited capacity to store both precipitation and electricity in those years with good hydrology. In addition, the revenue in wet years is also capped: an abundant supply of power typically suppresses the sale price of electricity.
In dry years, these problems can compound. Water, a nearly cost-free resource, must be replaced by more expensive fossil fuel-based generation. In addition, the fossil fuel-based generation often must be supplemented, as it is frequently insufficient to generate all needed replacement power. Contractual obligations force hydro generators to purchase replacement power in the spot market—which can be costly in times of limited supply.
Several solutions are available to assist hydro generators to manage these exposures.
Payment under this coverage is triggered by the level of precipitation. If annual precipitation is below a pre-defined threshold, the client receives a fixed amount per inch or millimeter of shortfall. The payout for this solution is independent of fuel prices.
Precipitation Linked to Commodity Price(s)
Low precipitation is also the trigger for this coverage, but the payment amount is tied to the prevailing market price of fuel (oil, natural gas, etc). For example, if fuel is expensive, the payments are larger.
This coverage provides protection against both low precipitation and high fuel prices. Payment is triggered when both conditions are met – precipitation below a fixed level and fuel prices above a pre-defined level. The payment may be fixed or set to increase as the fuel price increases. This is an economical solution tailored toward extreme exposures
The cost of all three solutions may be further reduced if the hydro producer is willing to share some of the upside in wet years. Capital for these solutions is provided by traditional insurers and specialist risk takers.
Hedging against the impact of low precipitation is designed to protect insureds from unwanted outcomes and create more stable cash flows.
In the chart below, the red bell curve shows the projected unhedged revenue distribution for a portfolio of hydro plants and the blue curve shows the projected revenue after hedging. Stabilizing cash flows underpins project financing and provides more predictable returns for plant owners, operators, and investors.
This same approach to managing low precipitation can be applied to all renewable energy projects (wind, solar, stream-flow, and geothermal). The availability of suitable weather data is essential to the development and pricing of all solutions; wide ranges of historical data are available in many countries to assist the process.
Marsh’s Weather and Energy Specialty Products Practice helps clients build insurance solutions to protect against adverse weather conditions.
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