30 September 2024
Supporting Renewable Decommissioning with Surety Bonds
As with all large energy infrastructure, at some point the project lifespan will end and then bring with it the challenges of decommissioning assets.
As mentioned in our recent decommissioning article, it is estimated that by 2035, over 3.5 GW of offshore wind farms will reach the end of their operational life. In 2015, Sweden's Yttre Stengrund wind farm became the first to be decommissioned after 27 years of operation.
BNP Paribas has estimated renewable energy will be the second most expensive sector to decommission going forward, with 19% of all decommissioning costs globally.
Contractual obligations
Companies that have installed wind and solar energy farms in the United Kingdom (UK) have an obligation to ensure that such installations are removed or maintained safely and to a satisfactory standard. It is usually the obligation of the original installer to do this unless such obligations have been transferred to a new owner with agreement by the Landowner.
The risk to the landowner, and therefore the taxpayer, is that by the time the installation needs to be decommissioned, the owner/installer is no longer operating or does not have the necessary funds to carry out the work. Therefore, financial security is required to ensure the funds are available to decommission the installation. This security may take the form of cash collateral, a bank letter of credit, or a surety bond which is a guarantee issued by a regulated insurance company.
A surety bond does not transfer risk away from the principal – the owner/installer still has to meet their decommissioning obligations – the bond is there to protect the landowner in the event such obligations are not fulfilled. The risk to the surety in providing a bond is that the principal has gone bust, and they then have little ability to recoup their losses. The underwriting is therefore very much credit driven, with underwriters reviewing the latest group financials, including profitability, balance sheet strength and liquidity to ascertain the likelihood of the principal being financially robust enough to honour their decommissioning obligations when the time comes.
Decommissioning - bonds versus traditional finance
Decommissioning bonds offer an alternative to traditional bank finance. While the traditional bank financing market will provide the capital needed to develop and decommission renewable energy projects it requires significant capital to be set aside to cover the associated costs. It is important for renewable energy companies to look after their cash and have access to working capital, so that they can utilise these funds for further development and growth. Unlike using a bank for bonds which ties up working capital, a Surety Bond is usually unsecured.
UK surety insurance market - insurer appetite
The UK Surety insurance market comprises approximately a dozen or so insurance companies.
Many sureties have provided bonds for energy companies over the years, but these have been mostly in the traditional oil and gas ‘upstream’ sector, where decommissioning bonds are prevalent. Due to the on-demand wordings and extend or pay obligations these bonds are really only available for high-quality ‘blue chip’ companies. The trend is also to move away from ‘dirty’ fuels to cleaner energy sources which has impacted surety’s appetite in this space.
Bonding appetite is linked to credit strength and, due to the relative infancy of renewable energy and the companies involved, appetite has been constrained. But as companies are becoming more established and balance sheets are growing, we are seeing an increase in appetite amongst insurers and more companies being able to source suitable bonds.
UK renewable energy market
The UK’s renewable energy sector size is expected to grow from 134.85Gw in 2023 to 217.57Gwby 2028, registering a CAGR of 10.04% during the forecast period (2023-2028). Supportive government policies and efforts to decrease dependency on fossil fuels are contributing to significant growth of the market in the UK. With the country’s wind resources, and the high growth of wind energy has made the UK one of the leaders in the renewable energy space. Wind energy is expected to be the main driver in the UK’s growth in renewable energy, with the UK aiming to expand its offshore wind sector to around 50 Gw capacity by 2030 (up from 13.45 Gw in 2022).
Bonds offer an alternative
With demand for renewable energy continuing to rise, surety bonds could be the ideal form of security:
- They can be used to ensure project completion and connection to the grid
- They provide cash flow advantages because using a bank has the potential to impinge on a company’s working capital facility whereas a bond from a surety is ‘off balance sheet’ and frees up the bank facility to be used for other matters. A bank tends to require full security via fixed and floating charges over assets whereas a surety will not normally require this, taking their security via a group counter indemnity
- Sureties’ premium rates also tend to be competitive compared to a bank.
How we can help
It is important for renewable energy companies to look after their cash and have access to working capital, so that they can utilise these funds for further development and growth. A surety bond is an advantageous tool as bonds being provided by insurance companies will have no effect on the balance sheet of a business, unlike using a bank for bonds which ties up working capital.
Sourcing bonds through the Surety insurance market will also allow more flexible options on bond wordings, whilst also spreading out the liability, a broker will set up facilities tailored to bonding requirements. It is therefore critical to utilise the services of a specialist broker to access the entire surety market to ensure the necessary capacity is available.
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