Can we turn green to gold? How the insurance industry can best support the energy market transition in Australia: Part Two

In this second article in our series ‘Can we turn green to gold’, we investigate the biggest challenges facing renewable energy projects in Australia and explore what Insurers can do in response.

Supply chain

While Australia has enormous potential to become a renewable energy superpower, there are various issues that are inhibiting the mass growth of renewable energy projects in the country.

Australia has not been exempted from the supply chain issues that are plaguing the international market, with the COVID-19 pandemic exacerbating already-present issues. Lockdowns, social distancing practices and reduced flight activity around the world have hindered or temporarily ceased the flow of raw materials and completed goods, which has consequently interrupted manufacturing processes and caused subsequent delays. Business interruption and delay in start-up claims are now starting to filter through to insurers.

The Australian Bureau of Statistics recently found that over 33 per cent of businesses experienced supply chain disruptions in the first quarter of 2022, which was a reduction on the same figures for January 2022 (when 47 per cent of businesses reported supply chain issues), but still elevated compared to April 2021.[1]

The solar industry has been particularly affected by supply chain disruptions as China, dominant supplier of solar materials, continues to experience lengthy lockdown periods. A reduction in the availability of vessels shipping replacement parts has also contributed to delays in the solar market and renewables markets more broadly.

The recent flooding in New South Wales and Queensland has further contributed to pre-existing labour shortages, and the extensive damage to transport networks is placing additional pressure on producers and developers.

Inflation

The international market is grappling with a surge in inflation. Supply demands and disruptions from the COVID-19 pandemic (as above), wage increases and the decrease in unemployment levels have all contributed to the rise.

The construction market is particularly vulnerable to inflation and the rising cost of debt; construction and operational insurers will need to pay close attention to the accuracy of reinstatement values on a policy. The insured may not have updated its scheduled asset values for some time, such that the cost of reinstating those assets in the event of property damage is inaccurate and underestimated. Local insurers in Australia have reported anecdotally that average repair costs are up 20 per cent on previous years. Underinsurance provisions in policies can to some extent address this issue but such provisions may not be broad enough to account for all potential increases.

The term ‘greenflation’ was coined by the Financial Times recently to describe increasing costs associated with the construction of renewable energy projects caused by (i) the disruptions stemming from COVID-19 and its effect on supply chains, and (ii) the inflationary effect of governments pledging further investment into green projects, which increases the demand and therefore cost of materials and skilled labour in the industry, at both the initial construction phase and maintenance and repair stages.[2]

Copper in particular has suffered the effects of greenflation, with analysts predicting that global demand for copper will exceed supply by more than six million tonnes by 2030.  Shortages caused by the war in Ukraine (Russia and Ukraine are both global suppliers of copper) have further exacerbated cost increases. These inflationary pressures are being felt acutely in the renewables market, where copper is commonly used in wind, solar, hydro and thermal projects given its efficiency as a conduit and its high recyclability.

Russia / Ukraine

Russia’s invasion of Ukraine in February 2022 led to many countries imposing sanctions and embargoes on Russian goods and services. Russia is one of the biggest energy producers in the world and exports 5.5 million barrels of crude oil per day - more than 3.5 million barrels are exported to Europe and the remainder is largely imported by China.[3]

In early March 2022, the US declared a complete ban on Russian oil, gas and coal imports, with the UK intending to phase out Russian coal by the end of 2022. In late May 2022, the European Commission agreed on an embargo of 90 per cent of Russian crude oil imports by the end of 2022. Russia has been able to redirect the oil elsewhere in the global market, with China and India importing more crude oil in April 2022 compared to March 2022. [4]

Australia’s wholesale energy prices have been slightly protected by the fact that it is one of the world’s largest natural gas exporters, exporting around 80 per cent of its natural gas as LNG through long-term contracts.[5] Australia is now ideally positioned to fill the trade gap left by sanctioned Russia, with a similar trade profile to Russia and parallel export markets. Australia’s biggest exporter of LNG has reported a huge increase in demand from Asian countries in recent months, particularly from Japan and South Korea. Australia’s coal resources are also high in demand, with thermal coal prices expected to remain elevated as new buyers in Europe look to replace Russian supply.

However, despite currently seeing high demand for its coal and gas, the longer-term benefits for traditional fossil fuel industries may be more muted, as Asia Pacific follows the global trend towards achieving increased energy self-sufficiency by investing in renewables, with the need to end reliance on unstable superpowers becoming increasingly apparent.

Australia is the windiest and sunniest inhabited continent on earth and possesses significant reserves of critical minerals needed for clean energy technology. These resources, together with its location in the Indo-Pacific and its geopolitical alliances should enable it to become a huge exporter of renewables. Australia’s neighbouring countries in the Indo-Pacific region have a particularly strong interest in successful climate change mitigation and have all set timeframes for phasing out fossil fuels.

Australia is already taking advantage of its positioning with the largest solar farm in the world, the Sun Cable, being built in northern Australia and set to help power Singapore and Indonesia through an underwater cable.  Fortescue Future Industries is also building in Queensland what is reported to be the biggest electrolyser factory in the world, in a push towards green hydrogen[6].

China

China has a stronghold in the Indo-Pacific as the most important trading partner for most of the region’s economies and as a major investor in infrastructure.[7]

China is also the manufacturing hub of the world and is dependent on international energy security to sustain economic growth as the largest oil and gas importer globally.[8] China recognises this as a strategic vulnerability and in recent years has committed itself to renewable energy production. At the start of 2017, China announced that it would invest US $360 billion in renewable energy by 2020 and scrap plans to build 85 coal-fired power plants. As of 2019, China was able to follow through on this promise and became the world’s largest producer of wind and solar energy.[9] Australia is thus in direct competition with China to become the leading renewable energy producer in the Indo-Pacific region, which poses a risk to the trade relationship between the two countries.

In response, Australia is attempting to de-risk by reducing its reliance on China as a trade partner. In 2017, Australia re-established a ‘Quad’ partnership with India, Japan and the United States, which supports a strategic security dialogue for a “free and open Indo-Pacific”.[10]

What can Insurers do in response to these market challenges?

The supply chain issues and inflationary pressures are not unique to Australia but its location and reliance on international trade may make it particularly exposed to project delays and claims inflation. In recognition of these market conditions, it may be prudent for insurers to consider the following measures. [11]

• Require an insured to update their project valuations more regularly.
• Ask that this schedule of values is granular in respect of physical assets i.e., not only itemising on a per wind turbine basis but per blade, gearbox etc.
• Require an insured to provide evidence of its critical spare stock on a project.
• Request details from an insured on where they intend to source spare stock from.
• Ask an insured for its comprehensive business continuity and contingency plans in the event of property damage.
• These contingency plans should be drafted and communicated clearly by the insured with its stakeholders, developers and suppliers. Risk mitigation measures should also be kept up to date.
• Insurers should consider which raw materials are required and whether the risk surrounding price changes or shortages has been sufficiently factored into timetabling and budgeting by the insured – this is particularly the case in Australia given its reliance on international deliveries.
• Consider whether average clauses in the Policy are appropriately drafted.
• Anticipate issues arising on adjustment, where e.g. a Policy may have been underwritten on the basis of a loss of revenue according to an agreed price under a Price Purchase Agreement and the insured then moves its contracts over to a spot market price to better accommodate market conditions. Engage forensic accountants or delay specialists at the appropriate juncture to assist.
• Business Interruption cover should also address longer lead times for critical items.

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With over sixty offices and associated offices worldwide, Clyde & Co’s global network is represented in all key markets for renewables and is therefore well-placed to assist insurers in relation to renewables losses wherever they arise. Please contact the authors below if you require any assistance in this space.