Governments and companies around the world are investing in renewable energy sources. The role of financial services in supplying capital to make sure wind turbines, dams and solar installations get built is well known. But there is also a role for the sector when the wind, sun or water needed to generate electricity does not appear.
By removing the volatile effect of the natural environment on energy supplies, we can also remove volatility from the balance sheets of corporations and government bodies.
Let’s take the situation of hydroelectricity as an example. This energy source is very attractive because, after the initial outlays to plan and engineer the dams and turbines, large regions can generate a steady stream of power at an economical rate. Assuming, of course, you have water. Unfortunately, the amount of raw materials needed to generate energy are not always guaranteed, especially if you need to rely on Mother Nature.
Uruguay, for example, suffered from an extreme drought in 2012, which resulted in the Uruguayan government having to supplement its energy generation with very expensive imports of crude oil, which at the time cost more than $140 per barrel. All in all, the event left a $500 million hole in the Uruguayan government treasury.
The development of renewable energy production plants was a smart investment for the Uruguayan government; however, it is not a consistently reliable source. In order to keep the economy running, energy is key. If they do not receive enough rainfall, oil imports can cause a taxpayer-funded deficit. Proactively securing the funds to implement a fallback plan was an even smarter investment, and one that provides stability.
The solution to the Uruguay dilemma came in the form of an insurance-based hedge which allowed the government to offload the fiscal volatility of its energy risk. When rainfall levels are not sufficient to generate power from its hydro-electric sources, this solution compensates the state-owned power company for the cost of the necessary oil it needs to buy to make up shortfalls. This transaction is a template for how other governments can balance the responsibility of delivering reliable clean energy to their citizens, with maintaining a stable balance sheet.
Such solutions require strong vision, and partners who share that vision. In this example, the World Bank played an invaluable role in arranging and providing funds for the technical work. They also allowed for the programme to be integrated into their bilateral lending programmes with Uruguay. From the government side, data is being provided from the national services, while the reinsurer and insurer involved have put together the weather indices and models to make the risk insurable.
The idea of pre-funding weather risks instead of waiting until the disaster has happened is not new. However, usually the types of financial solutions that make the news are related to huge catastrophic events, for example the billions of dollars that go towards covering earthquake or hurricane losses. The Japanese Earthquake Reinsurance scheme, the California Earthquake Authority and the Mexican MultiCat bonds are all very different in nature, but they show how governments can put systems in place to better prepare for the inevitable.
According to Henry Ford. without insurance the Manhattan skyline would never have existed. After all, who would invest in a skyscraper that one carelessly tossed cigarette could burn to the ground?
In the 21st century, renewable energy investment faces the exact same problem – after all, who would invest in wind or solar energy when we just don’t know how often the wind will blow or the sun will shine? Today, we are more than capable of meeting that challenge. We have a much broader pallet of financial solutions available, plus the technical expertise and the track record. I think we are in a good position to repeat our success and work together to secure the resources for consistent energy supply.
Author: Carlos Represas is a member of the board of directors of Swiss Re, as well as several other prominent company and institutional boards, and a member of the Latin America Business Council.
Image: General view of hydroelectric dam Cachi in Ujarras de Cartago, 60 miles of San Jose, Costa Rica, May 25, 2007.