Why are investors looking at proxy revenue swaps?

Weather risk, price risk, shape risk.

These are among the largest operating risks that wind farm owners face in a merchant market. Their main challenge here is to hedge against those risks in order to secure a stable revenue flow.

A new financial structure, called proxy revenue swaps, promises to help them do just that.

The structure was launched in 2016 by a group led by Allianz Risk Transfer, which is part of German insurance giant Allianz, and including evaluation and analytics risk management firm REsurety and investment manager Nephila Climate. But in the last few months we have heard more about it.

For example, Enel Green Power secured a proxy revenue swap on a 295MW portion of its 450MW High Lonesome wind farm in Texas; Ares Management agreed this month to sign three PRSs to repower wind farms totalling 430MW in Texas; and Engie has also entered in a proxy revenue swap for its 196MW East Fork wind project in Kansas. So why's everyone going crazy for PRS?

In simple terms, a proxy revenue swap is the exchange of a fixed payment for the variable value of the project’s revenues.

We spoke to Allianz Risk Transfer managing director Karsten Berlage to find out how this works. He said that proxy revenue swaps “replace the wind farm’s volatile cash flow stream with a fixed cash flow stream over multiple years". This enables wind farm owners to protect themselves against weather risk, shape risk and, in merchant markets, price risk. In this sense, PRSs can be used as an alternative to long-term power purchase agreements to hedge against price risk.

“Let’s say that a wind farm has an annual revenue projection of $10m, which the project is supposed to generate on average wind and on average forward price”, he says. “If the wind farm only generates $8m because the wind isn’t blowing or the market price is lower than expected, then Allianz would pay the remaining $2m to the wind farm. If the wind farm generates more than $10m, the wind farm pays to Allianz the excess.”

In order for Nephila Climate and Allianz Risk Transfer to execute a proxy revenue swap, they first work to understand the risks involved.  This is where REsurety comes in. “We provide the hedge seller with a suite of data and analytics that enable a determination of risk in the context of their broader portfolio,” REsurety’s senior vice president Adam Reeve has explained to us. After the PRS contract comes into force, REsurety would “crunch the numbers” on a quarterly basis to calculate the settlement of the contract.

This analysis is particularly important for ‘greenfield projects.’ These are projects which haven’t been built yet and need to get financed.

“The amount of risk that we perceive is partly related to the amount of data that we have available,” Reeve has explained. “For a greenfield project, for example, if the project developer has been collecting wind speed data for only a few years, there’s quite a bit of uncertainty in going from that data set - which is very scarce - to a projected revenue profile for the future wind farm.”    

However, Reeve has said that level of uncertainty in their analysis is typically lower for operational wind farms.  “We have much more data available and this allows for an increase in confidence - as we can use the data generated by the operational turbines to fine-tune our models. And we can then further calibrate those models against other data sets in our database, such as the performance of other operational wind farms throughout the country.”

Berlage says the main advantage for wind farm owners to enter into a PRS contract is that it would enable them to secure better financing terms.

"Wind farms are securing debt financing from a bank, and to repay that loan they need to generate revenues through energy generation. However, weather and price risks affect the project cash flow and hence its capacity of paying back the loan.” As PRSs guarantee the stability of the wind farm’s revenue flow, they can be used to secure a better long-term value at a lower interest rate.

Proxy revenue swaps are still a niche product. However, they look set to gain more traction as a hedge solution as wind companies seek to attract better financing conditions in merchant markets.