Assessing risk in renewable energy investments

A good risk assessment framework for renewable energy projects should show how to quantify, mitigate, and communicate risk effectively to investors and lenders. It should also clearly and concisely identify and explain all major categories of renewable energy project risk, with practical examples of how risk is quantified and mitigated.

As projects are rolled out across the globe, different areas present different risks, and risk appetite can vary by region and technology, which should be factored into any risk assessment. We take a look at the tools used to assess and communicate project risk, a key skill for securing finance and stakeholder confidence.

The main categories of project risk

Renewable projects entail unique risks, with alternative approaches to managing and mitigating them.

Technical: Resource assessments can help to address the fact that renewable energy sources are inherently unpredictable, so the technology doesn't always perform as expected. Elements to consider in a plan might include technology reliability, performance variability, and Operational and Maintenance (O&M) performance.

Market: Price volatility can occur due to unpredictability of the market, which can lead to a volatile trading environment, which might result in wholesale price exposure risks and even affect the demand for energy 

Regulatory: Policy changes usually benefit renewable projects over, for example, fossil fuels. But permitting delays and grid access rules can result in renewable energy projects that are market-ready facing delays, while other projects that aren’t yet ready to be connected don't.

Financial: Interest rate changes and currency exposure can shift the economic landscape over the lifecycle of your project, and construction overruns can increase risk.

ESG and reputational risk: Environmental, Social, and Governance (ESG) goals can reduce a project's risk. As many businesses look to improve their environmental credentials, reputational risk would be lower than with a fossil fuel-based alternative.

How investors evaluate and price risk

Due diligence is crucial to risk assessment in renewable energy. A good level of due diligence would incorporate sensitivity analysis and scenario planning to simulate hypothetical situations that test the operational limits of a renewable project and its financial consequences. This can also be done using probabilistic modelling and Monte Carlo simulations, which model a range of possible outcomes. The weighted average cost of capital (WACC) allows investors to calculate the effects of debt and equity on a project. To determine the price of debt, investors use credit spread metrics, while risk premia are used to calculate it.

Tools and techniques for risk assessment

There are several different tools and techniques available to investors and lenders to help determine the level of risk to their capital. Risk matrices and scoring systems are used to identify specific risks and rank them by impact severity.

Lenders’ technical and environmental due diligence is the enlistment of an impartial third party, either a Lenders' Technical Advisor (LTA) or Lenders' Independent Engineer (LIE/IE), to assess environmental, social and technical risks to a project. This can include factors such as construction, ecological liabilities or non-compliance. Project participants can also take advantage of insurance tools, such as performance guarantees to ensure the output of a plant or political risk insurance to protect plants against political developments that might affect production.

Mitigation strategies and best practices

Spreading risk across a broader range of factors can help reduce risk for a specific party, for example, an investor. Contractual risk allocation allocates risk to different participants in a renewable energy development. For example, EPC Contracts allocate risk among the engineering, procurement, and construction participants in a project, with each party agreeing to take responsibility for any fault that impacts the project. O&M terms concern issues arising during the plant's operational lifetime and may include factors such as maintenance or equipment failures. PPAs place the risk on the power producer, with penalties if production falls below agreed levels.

Portfolio diversification and geographic spread, on the other hand, focus less on participants' performance and more on balancing risk across multiple sources. This could be different types of renewable energy, for example, wind and solar, or it could be investing in the same kind of technology, for example, solar, in different areas with varying sunlight or weather conditions.

How risk perception is changing with market maturity

As the renewable market matures, we expect technology risk to decline, partially due to the abundance of readily available data. Digital data is a key element of risk assessment: the more data that has been collected as the renewable market has matured, the more data there is to inform plant behavioural and predictive models, both in real time and for future risk forecasting. AI can take this risk assessment one step further by integrating it into predictive risk analytics. AI can identify patterns and develop algorithms to predict how a renewable plant might perform based on historical data, and how this might affect the risk level for the investor financing it. One thing is sure: risk is never eliminated but can be measured, managed, and priced, turning uncertainty into opportunity.