Risk treatment for renewable energy developers

Developed by Erlend Thabiso Rømyhr Sehube

Risk treatment is the process of selecting and implementing measures to modify risk. This article will describe risk treatment in the energy sector and analyze the benefits and challenges that it may present. The risk treatment measure includes retaining risk, avoiding risk as well as optimizing risk. Risk management is an important and crucial part of project, program and portfolio management. There are currently a lot of changes and innovation in the energy sector, and several companies push for sustainable energy. This will include a lot of risks, and how they manage these risks could be of a great importance for the feasibility of the green transition. This article will focus on the treatment of risks for renewable energy projects. Firstly, risk treatment and its role in a risk management process is explained, thereafter the article focuses on aspects and characteristics that may be unique for projects in the renewable energy sector.

Risk Treatment in Risk Management Process

Risk is defined as an uncertain event or condition that, if it occurs has a positive or negative effect on a project's objectives. In every project the Risk management process (RMP) is essential to keep control, reduce cost, and using resources as efficient as possible. An important task for the project management is to try to mitigate the negative effects and benefit from the positive outcomes. RMP consists of 5 steps that are used throughout the project life cycle. The 5 steps are as follows:

1. Step 1 - Establish context
2. Step 2 - Identify risks
3. Step 3 - Analyse risks
4. Step 4 - Evaluate risks
5. Step 5 - Treat risks

Risks and risk management will vary a lot in projects due to every project being unique. Both risks and projects varies a lot in importance and threat throughout the project life cycle. Therefore, standardization of risk treatment is almost impossible. This article will mainly focus on the treatment of risks, and highlight some of the characteristics that renewable energy developers might face in renewable energy projects. Even though risks vary from project to project, the process of identifying, assessing, and controlling risks is standard for almost every project. Risk treatment is the final step in risk management, and therefore a vital step for the project manager in order to efficiently handle risks that are identified.

Risk Treatment and Control

Risk treatment can be defined as the process of selecting and implementing measures to modify risk. When analyzing the risks and measures to modify them, every risk should be measured and considered based on a cost-benefit analysis. The cost-benefit analysis is done during the first steps of the RMP. If this analysis is done thoroughly and every direct or indirect costs whether substantial or theoretical, and estimated either monetary or other terms, the risk treatment will be done better and more efficiently. Risks can have both negative and positive outcomes, by identifying the potential outcome of each risks, the treatment of these risks are handled similarly, although interpreted differently. Risks that have potential positive outcomes are likely to get the management to start or continuing an activity that is likely to create or maintain this positive outcome. Management would like to avoid risks with possible negative outcomes by stopping or reducing activities that can cause this risk.

There are in general four different strategies to controlling negative risk. These four are also most used strategies in energy projects. The strategies are as follows:

1. Avoid
2. Mitigate
3. Transfer/share
4. Acceptance

These strategies and what they imply is described further on in this section.

Avoid

The strategy of eliminating activities that can harm or influence the project in a negative matter, is called risk avoidance. Although complete elimination is almost impossible, the strategy aims to deflect or reduce as many threats as possible. When performing a risk avoidance, the strategy is an intentional tactic, therefore not the same as ignoring the risk or failing to identify the risk. Even though this strategy may be the most desirable risk treatment strategy, it is important to analyze the strategy with the cost-benefit analysis, and how it may affect the entire project. An example in energy projects is to use well known materials in the construction, instead of new materials that only has performed at specific conditions. The cost risk of the untested material will usually outweigh the benefits it may present. This strategy has several advantages, such as the strategy could eliminate the risk completely. The strategy could also generate higher confidence from the organization that the project will continue to operate due to the risk being avoided, and therefore do not have to plan for the negative consequences the risk might present. The disadvantage with this strategy is that it could slow the project down, as employees and other stakeholders must follow the rules of what the risk avoidance strategy may present. It could also limit opportunities for positive outcomes of risks, and stop innovation for future projects.

Mitigate

The strategy of mitigating risks, is to lessen the negative effects. It is similar to risk avoidance, but rather than aiming for avoiding the risk completely, the goal in mitigating is to reduce the negative impacts. Risk avoidance is therefore often used when the consequences are too high to justify the cost of mitigating the risk. The strategy is also used as a strategy for increasing the probability for benefiting of a positive outcome of an identified positive risk. Mitigating risks is the process of preparing project management for all potential risks, and therefore it is common to establish a mitigation plan. This is to plan ahead of the possible negative outcomes the risks may present. A good mitigation plan should ensure that the strategy is feasible and that the resources, both financial and manpower, are less than the potential outcome of the risk.

Transfer/share

Risk transfer and sharing is a strategy to shift the risk to another party, and sharing the risk with another party, respectively. When transferring the risk, it is usually done by purchasing insurance on certain items. Thereby transferring the risk from the project to the insurance company. This is often used in certain aspects of a project that is outside of the projects control, such as weather and political unrest. Another way of shifting some of the risk is by sharing the risk with another group or company. This is common in international projects where another company may have more experience in managing risks in the country where the project is being constructed. In that way, the project management reduces the possibility of unknown risks that they do not have the experience or knowledge of handling, affecting the project. Sharing risks is also a strategy that project managers could use to attract more investors. It can be attractive for investors knowing that the project management has partnered up with a company with better knowledge in the technical department, or a better capitalized company.

Acceptance

Risk acceptance is a passive risk strategy. The strategy is to intentionally retain an identified risk where the management considers that the project could handle the potential outcomes effectively. The risk is not to be forgotten and the choice to accept the risk might alter throughout the project life-cycle. These types of risks usually are small risks that the management considers not to be worth spending time and resources resolving. It could also be risks where the consequences are so huge that insuring against it would not be feasible due to the costs it may present.

Risk Treatment in Energy Projects

There are many uncertainties and risks in renewable energy projects. Political, organizational and technical uncertainties can affect the profitability and viability of renewable energy projects. There is also a difference in interest of the stakeholders and participants of these projects. Whilst engineering, procurement and construction contractors mainly focus on uncertainties that are tied to completing the contract within the allocated time and budget, the operator may focus on uncertainties tied to the operating cost and electricity price variations. In order to illustrate what makes risk treatment of renewable energy projects special, this article first describes the uncertainties in conventional energy projects and how they may differ from renewable energy projects. This section will also provide insight to some efforts that can be used to manage the risks.

Technical

Several technical risks can affect conventional energy projects. Risk related to technical part of projects have possible consequences that could influence the project most in terms of money and time. The two most common technical risks is listed:

• Having complex investment estimates that do not have substantial benchmarking possibilities, implementation of new technology and a stable cost.
• Having difficult project management due compound coordination, many stakeholders and contractors, as well as interface issues.

Project management tend to mitigate these risks through financial contracts and agreements. These are typically insurances and guarantees, which can provide security from possible damages or delays, and also sign up contracts between contractors and bidders. It is also common to use risk sharing with technical contractors in energy projects.

Economic

There are several different economical risks in conventional energy projects. There are some risks that are specific for individual energy projects and are unique due to their specific supply chain. The general economic risks is:

• Market risk which usually is evaluated continuously through statistics from the demand side. The supply side assesses market risks through long term contracts that can provide cash flow and mitigate risk of the possible price variations.
• Commodity risk is normally managed through derivatives like swaps, contracts and options.
• Interest rate derivative transactions is the usual way to manage risk and balance between floating and fixed rate debt.
• Exchange rate risk is due to many energy projects being international and operations conducted in different currencies. Often companies will have strategies where large cash balances or borrowing in the currency where the project is operating.

Political

Political risks often occur to conventional energy projects due to a vast part of oil, gas and coal being in countries that are politically less stable compared to other OECD countries. This could alter the feasibility to operate in such countries and therefore preventing any financial profitability. Within OECD countries there are also financial risks. There could be a big variation of how much backing the project gets from he respected countries, and this could lead to complications of the financing and licensing process. Many of political risks are hard to predict. Many big companies have created a risk profile for each country to assess the possible profitability of investments. The most common strategies to manage political risk are:

• Political risk insurances (PRI), which is instruments that cover a wide range of political risks. These insurances are often used in infrastructure.
• Partnership/joint ventures are also used. These are used to share risk. This can be through partnering with local government to receive more support and mitigate risk that could elsewhere exist.
• Country Credit default swap (CDS). This is a contract where the buyer makes several payments to the seller. The buyer will then receive a payoff if a loan defaults.

Social

There are now high expectations of environmental performance and sustainability to measure the success of an energy project. There are several instruments and measures used in the energy sector, to mange these social risks:

• Environmental and social standards. There are a lot of standards and issues that energy projects strive to be compliant with. These standards often include guidelines and requirements on environmental and social standards.
• Environmental and social impact assessment. In order to improve the project planning, the environmental and social risks are evaluated and analyzed. Life cycle assessments (LCA) are a common method to analyze the environmental impacts.
• Public consultation and participation. Engaging both local and international society could strengthen the sustainability of project. This is by getting as much information from as many stakeholders as possible, and eventually ending up with the best possible practice.
• Compensation. There are often local areas and towns that could be affected by energy projects and in order to receive an acceptance of the project, areas and towns would be compensated.

Applicability to renewable energy projects

Based on these parameters in section 3, table 1 shows the applicability of risk management to renewable energy projects.

Table 1: Applicability of risk management in renewable energy projects

	Conventional Energy projects	Applicability to renewable energy projects
Technical	Insurance	Applicable
Technical	Guarantee	Applicable
Technical	Risk sharing	Applicable
Economic	Futures	Not applicable
Economic	Long term contract	Applicable
Economic	Exchange risk contract	Not applicable
Economic	Derivatives	Could be applicable
Economic	Guarantees	Applicable
Political	Risk insurance	Could be applicable
Political	Partnership	Applicable
Political	Credit default swaps	Could be applicable
Social	Environmental and social standards	Could be applicable
Social	Environmental and social impact assessment	Applicable
Social	Public participation	Applicable
Social	Compensation	Could be applicable

Most of the strategies that are used to control the risks in conventional energy projects are also applicable for renewable energy projects. Renewable energy projects are often categorized and utilized where they are dependent on local supplies and consumption. Hence, there is limited need for exchange rate or supply contracting. Although as the increase in renewable energy projects continue, this may change.

The biggest difference of conventional and renewable energy projects are the maturity in the markets and track record. Due to several years of doing conventional energy projects, the risks are well established and understood from experience. This make decision making and planning to run more efficient and smooth. As a result there might be several risks that could occur in renewable energy projects that has not happened frequently enough to be assessed as a risk yet. Conventional energy projects have experienced cost reduction through development of technology and a project learning curve over several decades. Therefore it is a higher operating margin for conventional energy projects. There is huge developments in the renewable energy sector international that would improve financial viability in the sector and its projects. This could in turn make technologies to be quickly outdated compared to the project start. This is one of the reasons renewable energy projects often depend on subsidies from governments.

Renewable energy projects should use the same methodologies as conventional energy projects to assess their risk. It is still important to alter the specifications to fit its project and the complexity it may present. There are a lot more uncertainties in renewable energy projects that could present many risks that are unknown due to not having much experience. This could also present positive risks and opportunities for innovation in the renewable energy sector. This may be detrimental for the feasibility of the green transition and present several new green industries. While treating risks it is therefore important to seek to discover possible risks and outcomes of the identified uncertainties.

Limitations

There are several limitations that could alter how project managers will and do perceive risks. Two of the limitations are listed as follows:

• Little confidence in emerging technologies that could prevent decision making to take the best solution. If the risk or project manager has identified a new technology to provide less risk, but due to lack of confidence could prevent the feasibility of the project, that could affect the project in e negative manner.

• Risks that is connected with the toleration of the public sector. As renewable energy is still dependent on subsidies and if the public influence the government based on other factors than the project, it could still affect the project.

Annotated Bibliography

• IEA - Renewable Energy Technology Deployment (2011), Risk Quantification and Risk Management in Renewable Energy Projects.
  • This book aims to provide insight and methodologies for renewable energy developers and the sector as a whole for risk/return profiles in renewable energy investments. It is developed by renewable energy specific guidelines for classification, assessment and management of different risk elements with renewable energy projects.

• Project Management Institute, Inc.(PMI) (2019), Standard for Risk Management in Portfolios, Programs, and Projects.
  • This is a standard created by the Project Management Institute to address that risks may occur to portfolio, program and project objectives. The standard identifies core principles for risk management, describes the fundamentals, define risk management life cycle, and applications of these.