20 October 2016

Hedging, whatever the weather

As renewable energy becomes an increasing part of the grid, the volatility it creates is generating demand for weather hedging products. Q&A with Stuart Brown, Head Origination Weather & Energy EMEA APAC, at Swiss Re Corporate Solutions.

What is driving the growing demand for weather risk products?

Stuart BrownThere is more and more renewable energy coming into power markets, and power transmission systems. This – and particularly wind power – comes at a cost in terms of variability of supply, and that spills over into the financial side.

You have negative power prices in some markets where wind dominates, and you basically have to apply a congestion charge to thermal generators to let them operate.

Financial instruments are emerging that address negative power price risk. You can design a hedging product that says: when there is a sudden and unexpected amount of wind in the system, the weather risk provider can provide payment for that.

With those kinds of instruments, liquidity providers – who trade electricity and provide an important source of stability – are more able to cope with the impact that wind has on power prices.

Who are the potential buyers or users of the tools?

Largely energy traders. Let's take the risk of negative power prices arising because of congestion in the system brought on by wind. If you are a thermal generator who is exposed to that, then you have an interest in being paid when there is a lot of wind.

In some markets – Germany is one – as a wind producer, you also have exposure, because the market operators have changed the rules so that you no longer automatically can put your wind power into the system and get paid a feed-in tariff for it.

Those guys are both natural buyers of protection.

Is it just insurers providing these products?

In the last year or so, some power exchanges have developed reliable wind production information in the form of tradable indexes, and launched hedging products around those indices.

Aren't these products a direct competitor to what you are offering, is that right?

In some senses they are, but we are happy to see them because more hedging activity means a bigger market for those of us who do more customised products.

If you are a wind producer in a region of Germany where what you care about is the wind in your region or the wind specifically at your location, so you need that customisation of the underlying reference index that is different from the published wind system index that the exchanges are using.

Are there any other factors driving the market?

Capacity markets and balancing markets are more and more called on or are developing, basically finding a way to compensate non-wind producers for providing the backup power to deal with the intermittency of wind, the standby capacity.

But they also apply very severe penalties for failure to generate, so we are seeing a pick-up of interest in outage protection for generators, because they need to be compensated or they need to manage the remote risk that they cannot produce because of forced or unanticipated outage such as from a technical failure.
I would call it a knock-on impact of a lot more renewables coming into the system.

Another area of interest we are seeing is on the construction risk side, particularly for offshore wind construction, which is expensive and tricky but cannot work if there is too much wind or the waves are too high, so we have applied weather protection techniques for onshore construction.

What geographies are you seeing more demand in?

Europe is of course the home of a lot of the offshore construction activity, so that makes that a European business.
Penalties for capacity, penalties or market impact of the intermittency of wind, that is global; we are seeing that in Australia, we see that in some US markets, Texas in particular, where there is a lot of wind, a lot of wind power, and some volatile power markets.

Stuart Brown currently leads Swiss Re's origination activities in the Weather & Energy business for Swiss Re Corporate Solutions in the EMEA and Asia Pacific regions. He has been with Swiss Re since 2001, prior to which he spent nearly 20 years at JP Morgan, based in New York, Tokyo, Paris and London in energy investment banking. At Swiss Re, he was with the capital markets team in structured corporate insurance before joining the weather and energy team in 2009. He serves on the board of the Weather Risk Management Association and Swiss Re Capital Markets Limited and is based in London.