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Renewable energy defects – mind the gap

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COVID 19 Coronavirus

By John Rae | February 15, 2021

Renewable Energy Developers need to safeguard the future of planned projects by rethinking their approach on defects

Renewable Energy now accounts for 24% of Australia’s total electricity generation. Capacity grew at a record rate in 2019, according to a study by the Clean Energy Council, 4.4 gigawatts of new clean generation capacity was added to the grid in this year alone.

Investment in a wide range of green, low carbon technologies is responsible for this generation boom; the same CEC study showed that 2019 was Australia’s best year for wind generation, overtaking hydro as the nation’s major source of clean energy. New projects are regularly being announced, reflecting a strong business imperative to explore opportunities.

But behind the headlines lies a sobering tale for developers seeking to become part of the clean energy revolution. The technology which is delivering this new landscape is evolving so quickly, insurers who are trying to understand the technology, it’s global experience and underwrite accordingly are struggling to keep up with the pace of development.

Such rapid evolution of new technology, together with relatively limited operating experience, especially when considered against conventional power, has created a growing delta between the level of insurance renewable energy companies need and what can be achieved as they plan for new projects.

This issue is often compounded by insurance being negotiated on new technology at a time when the technology itself has not yet achieved certification by a reputable independent testing body, or achieved the level of global deployment and trouble free operating hours to be considered proven. This is like buying a new house off plan and arranging insurance on it before construction has started.

The challenge over who covers what when things go wrong?

Life should be relatively straightforward – if you identify a defective product, it’s replaced under warranty, or if there is physical damage it should be replaced as an insurance claim and the project may proceed. However, as many developers are discovering, this scenario is proving to not be so straightforward.

To understand the situation, we need to look at a commonly used set of wordings in insurance policies, known as the London Engineering Group (LEG) clauses. The widest defects cover in construction policies is known as LEG3, however Insurers are only very selectively offering the widest cover if at all. In the Australian Renewable Energy sector, LEG2 is more prevalent, this is not so wide as LEG3 as it does not cover costs to remedy the defective part, portion or item if this has sustained physical damage, it only responds for the downstream consequential physical damage to surrounding property resulting from the original defect. Leaving the replacement of the defective part to be replaced as an original equipment manufacturer warranty claim, whether the defective part is damaged, or just defective.

Let’s illustrate this by using the construction of a wind farm as an example. There have been instances where a defective transformer part has caught fire, causing resulting physical damage to the transformer property surrounding the defective part. Whilst the current insurance market will often limit cover offering to a LEG 2 coverage basis, in this scenario only the resultant damage to the non-defective surrounding parts would be indemnified by the insurer, however the defective component part in the transformer would not be indemnified .That is held to be an issue for the developer to take up with the manufacturer via warrantees, who may challenge the existence of a defect in the first place, the extent of the defect i.e. the component part or the whole transformer. After a substantial fire, it is particularly difficult to determine the root cause, leading to disputes between manufacturers, developers and insurers. Given that the replacement cost of a transformer can be anywhere between $3-6 million, the size of the problem quickly becomes apparent.

The market has seen a notable spike in claims resulting from damage due to defective technology

The market has seen a notable spike in claims resulting from damage due to defective technology. This has made Insurers very reluctant to offer the widest defects in design coverage available i.e. LEG3. Many developers are very nervous that any dispute in determining the responsible party for a defects could result in reinstatement and delays in operating facilities. This is further complicated by Insurers insisting that in the event of a loss which appears to result from a defect which would be covered by an original equipment manufacturers warranty. Thus developers must take every possible and reasonable action to seek to recover from the manufacturers, with insurance policies only responding once this has been proven.

Insurance market dynamics

Insurers are expressing growing concern that some technology manufacturers in the renewable energy sector view insurance as a ‘cost service’ underpinning their research and development costs. That has led to increased cynicism from Insurers leading to developers being forced to accept inflated premiums and/or deductibles together with lower coverage levels when there is a concern.

The result is that the level of commercially available cover from the market is starting to impact the bankability of some technologies and projects. Where there are known defect issues with certain technologies, insurers are excluding known operating platform or fleet issues, adding rating buffers and/or reductions in coverage. This is designed to alert developers to the risks of proceeding with these elements and a strong signal to consider more well regarded technologies.

The COVID-19 pandemic is also directly and indirectly affecting this sector, impacting on replacement times for defective items, which also increases anxiety for underwriters and developers. A further complication is the attitude of the manufacturer, insurers are taking an increasingly dim view of manufacturers who remove damaged equipment from site, do not share root cause analysis and claims failure statistics and dispute warranty losses.

Keeping pace

This is a tricky problem to fix but it comes back to ensuring developers complete appropriate diligence in selecting technology providers and have a clear risk mitigation plan to deal with losses and or defects.

Risks can be mitigated by working closely with insurance advisors and insurers to understand their opinion on the type of technology being considered, also to ensure that warranty, particularly long term performance warranties are financially secure. In the event of uncertainty, this can be achieved through the purchase of an insurance security warranty product.

As brokers with considerable experience in this market, we know that the level of coverage is much more expansive than the traditional manufacturer warranty. Manufacturers will offer warranties for their technology or equipment for a given period of time but for any form of product there is a diminishing return at an agreed level – not a 100% guarantee for the lifecycle of the project.

Consideration must also be given to the standing and financial strength of the manufacturer. A 10 or 15 year warranty is of no value if the company is no longer in business. Due diligence on suppliers is crucial. We are working with clients to help minimise the pitfalls – there is not an insurance solution to every problem developers may encounter in the renewable energy sector, so the knowledge we provide on market conditions and known issues can help in negotiating a strong manufacturer contractual and/or insurance position when it comes to defects, ensuring you mind the gap.

What to do?

Renewable Energy projects can be complex, the substantial initial development costs together with sizeable costs to adequately insure some projects to a level required by financiers may, if approached in the wrong way may make it commercially unviable. The approach to insurance needs to be bespoke, but it is vital for any developer to go down this path and get an understanding of their full exposure at the start of the project. It also provides significant comfort to investment funds financing these projects who will need assurance that there are safe and solid returns into the long-term.

Any developer considering a project in this sector needs to engage with risk mitigation specialists and insurers as early as possible. Given the worldwide interest and activity in renewable energy, we have much to offer by connecting local projects with our global network.

Author

Australasian Renewable Energy Leader

Contact

Tony Seto
National Manager, Construction

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