Wind farmers turn to hedges

Increasing investment in wind power projects is encouraging more wind farm operators and financiers to consider wind hedging. Emily Saunderson reports

Weather derivatives dealers have had the growing wind power market in their sights for several years now, with products designed to overcome one of the technology’s biggest drawbacks – that there’s no guarantee the wind will blow. But in recent months, they have closed several wind farm hedges – and are hopeful that more will follow as the market continues to accelerate.

“The increasing number of wind power projects, and growing awareness that wind risk can be hedged, have been the main drivers behind demand for wind derivatives,” says Jens Boening, London-based manager of weather origination for Entergy-Koch Trading (EKT) Europe, an energy and weather trading firm.

Wind power is the most viable renewable energy source, and investors around the world are ploughing an increasing amount of money into the sector. But the financial viability of wind farms can be precarious. One of their vulnerabilities is that they might fail to generate as much power as expected. Wind hedging has been discussed for some years (see Environmental Finance, March 2002, page 15), but the first reported deals have only been closed within the past 12 months.

One of the reasons is that in countries such as Germany, where substantial wind development has already taken place, most of the prime locations have already been exploited, forcing developers to look increasingly at ‘second tier’ spots. “Wind hedges make it easier for developers to find financing for these second tier locations because the predicted consistency of wind speeds will necessarily not be as good as for the prime sites, so financiers are taking more of a risk,” says Boening.

Germany, where the wind industry is supported by a generous ‘feed-in tariff’ system that guarantees high prices for its power, has generated the first wind hedge deals.There, the market has been led by Munich-based bank HVB, and EKT, which began to produce Wind Power Indexes (WPIs) on which to base wind deals at the end of 2001.

Wind farm developers Reinecke und Pohl Neue Energien (RPNE) and König & Cie are among the firms that have taken advantage of wind derivatives to hedge wind risk at several of their project sites.

Wind farms in Germany have struggled with adverse wind conditions over the last three years, so RPNE decided to look into wind hedging, says Martin Schulz-Colmant, chief executive of Centurion Energy, a Hamburg-based subsidiary of RPNE that has been set up to manage wind farms and sell power into the German electricity grid.

Centurion begins operations this month. It is planning to set up between 25 and 30 wind farms in Germany – each between 7.5MW and 22.5MW in capacity – and it will cover the wind risk on each of its projects with derivatives from HVB. It plans to hedge both against light and strong wind speeds, as turbines cannot operate once wind speeds exceed certain levels.

Centurion is to buy three-year ‘collars’ from HVB, which involve buying a put option linked to a wind power index created specifically for the wind farm site, and financing the put by selling a call option on the index. The index takes account of regional wind speed measurements and also the turbines used at the site. In a bad year for power production, the contract will pay Centurion, whereas it will pay HVB if it has a profitable year, explains Armin Wagner, weather trader at HVB in Munich.

The pay-out is capped symmetrically so neither party will have to pay more than 25% of the expected wind farm turnover. Neither side would comment on the size of the deal.

Dealers have also been selling the concept of wind hedges to help attract financing, and reduce financing costs, by showing investors that the hedge would smooth revenues. While Centurion’s first wind trade was completed after the project financing was in place, the firm is planning to use wind hedges for future wind farm projects and hopes that the hedges will make it easier to attract investment, Schulz-Colmant says.

Meanwhile, König & Cie, a Hamburg-based fund management company specialising in maritime, renewable energy and real estate investments, also entered into a three-year wind hedge with HVB to protect its 18.2MW Herzogtum Lauenburg wind farm in Schleswig-Holstein in northern Germany last year.

The Herzogtum Lauenburg project began to produce electricity in April 2003 and the hedging deal was finalised at the end of 2003 and became effective at the start of this year. The wind farm was connected to the electricity grid earlier than planned, providing König with some unexpected earnings.

“We took this opportunity to reduce the volatility of the income stream by using a wind hedge. The overall idea was to make the park more attractive to the investor,” explains Bastian Dittrich, in König’s renewable energy division. The firm opted for a three-year deal because it wanted to test the product before asking investors if they would like to continue the hedging programme.

König used a similar deal structure to Centurion, and it was linked to an index provided by EKT. Again, the company declined to provide details on the size of the hedge.

EKT’s trademarked WPIs are proving popular among wind hedgers – including those not dealing direct with EKT – partly because they address the perennial problem of a lack of weather data. “We have managed to find reliable independent sources of wind data, and individual WPIs can be created for nearly all sites,” Boening says.

The indexes are based on the relationship between wind speed and direction at a specific location and the turbines used at that wind farm. While the indexes are fundamentally based on wind speed, the fact that they also take account of the turbines used means that they give an indication of the power generation that is theoretically possible, given historical wind speed data, at a specific site.

While the wind derivatives market is still relatively small compared with the market for temperature-based products, traders are confident that projected dramatic increases in wind power capacity in other parts of Europe, and beyond, will encourage more developers and financiers into the wind hedging market. EF