Lesson 7 Overview

Overview

As Energy Market Professionals, we run across many different types of risk that we will need to manage going forward. Certain of these risks are very obvious - like the cost of the natural gas commodity increasing as the weather gets colder leading into October. Other risks may be less obvious - like the long term cost of the natural gas commodity remaining at long term historically low levels and thereby placing the value proposition of your utility scale solar power plant at risk. Other risks are seemingly less direct - such as the potential for the US Legislature to reduce or eliminate the Investment Tax Credit for a solar project or the imposition of tariffs on certain components. In this lesson, we will talk about identifying risks and ways to mitigate (or exacerbate) them through market-based and non-market-based instruments. We will further our understanding of risk management and how certain instruments can be used to de-risk our projects.

Learning Outcomes

By the end of this lesson, you should be able to:

• Explain the simple risk management financial derivatives;
• Develop risk management solutions for each identified risk in your project;
• Develop Pxx values for a typical solar project;
• Explain how contracts work to mitigate certain risks but introduce other risks;
• Develop a holistic risk mitigation strategy for your project.

Reading Materials

• Risk.net (2022) Editorial: How Energy Risk Managers are Responding to Extreme Volatility
• kWh Analytics (2023): Solar Risk Assessment 2023

• Video interview (32:44) with Jayson Kaminsky, CEO of kWh Analytics. If this video is slow to load here on this page, you can always access it and all course videos in the Media Gallery in Canvas.

  Video interview with Jayson Kaminsky (35:41).

  Click here for transcript of Jayson Kaminsky interview

  Hi Jayson. It's great to chat with you about energy markets and specifically energy risk management. We appreciate you taking the time to help our students understand this very important topic. May I ask you to tell us a little bit about your background, Mark? Thank you for having me and thank you everyone for listening. Yeah, my background. Let's see. I studied a technical undergrad. I guess I'll start there. I studied mathematics and climate change degree before climate change degrees existed. I'd like to say it's called atmospheric science, but the physical environment approach to the environment. Then I got a graduate degree in business and in energy systems, and this was now 15 years ago or so, solar. 15 years ago. Even at the time felt a little bit mature. I was like, I don't know, this industry seems like it's got all figured out. I was very wrong. It's got a lot to still be solved, it turns out. And a lot of growth ahead of us. We can talk a little bit more about that in a second. But I entered really as a solar developer, or working for a solar developer, A company that built, developed, and built projects really up and down California would talk to off takers, sell them a power purchase agreement. And then we also did the construction. They call it the solar coaster. I was laid off of that company a year and a half out of grad school. So there you go. Actually, the best thing that happened to me, I ended up at Wells Fargo doing a very specialty form of finance called tax equity. It was project finance. Making investments against hard assets but monetizing the tax credit predominantly in solar. And then about nine years ago left that job to come co found KH Analytics. Then I've been here now nine years. When we started, the thesis was better data to help identify and manage risk in a solar industry. About five years ago we pivoted into insurance, so I can also talk about that later on. All right, but that's been my path is not really thing I could have planned. It was taking the opportunities that seem the most interesting and frankly pushed me the most out of my comfort zone were the ones that seem like the best options. Great, great stuff. Was there a methodology? Choosing the energy business, or you just end up there at the beginning, did you say, hey, I wanted to do this or how did that fit together for you? Now, it's a good question. I know I wanted to work on something environmental. An undergrad math was too esoteric as doing pure math. It's like you lose grounded in reality. Law felt not really what I wanted to do. Policy felt too slow. I wanted to do something environmental. I didn't really know what business school became. An opportunity that emerged from me my first year in business school. I really took it as an opportunity to explore what is the right role for me. And I was looking at everything from corporate social responsibility to energy, to carbon, to you name it. And energy felt like the right intersection of topics. That was interesting to me. It was like global in nature. It affects geopolitics very much has a core economic benefit. It just felt like the most natural, maybe the most obvious opportunity, but also it's an important lever on almost everything else we do. Like if we're electrifying the grid, getting V's all that requires a long energy. It seemed like a macro theme that after my first year of business school, like okay, this is what I want to do then. Solar was an accident. I didn't think I was going to end up in solar, but it just happened to be the job that I found stuck here for 15 years. So I guess I like it right, exactly. What are your current duties at KWH Analytics? Are my current duties. Well, I'm the CEO, I got to keep on the lights. I guess that's my main duty. Okay. I was COO for about eight years and I became CEO a year ago. Maybe a little bit of a lens into the team, I guess is maybe the best way to frame that. I have a COO and a CTO. Most of my engineering rest, the CTO, I'm definitely not qualified to do anything there. My COO runs, I'll call it operations at some strategic initiatives, but HR, finance, legal, that stuff. Then I have a head of each of my product units. I have a new product development person, You know, I work very closely with our marketing and sort of, I guess I work closely with everyone. But a lot of my day is on raising awareness of the company, with the market, Working with the team obviously on sales, at operations, goal setting, priority setting. I often think I could do my job in any industry and it would feel the same day to day. I'm making calls, I'm sending e mails, I'm doing financial modeling, right. That's not really fulfilling to me. Doing what I'm doing to sell potatoes is often analog would not get me excited to wake up in the morning. Really like what I do. I really like the industry we're in. I think it's important. I have a young child now, Even more important than it was a year ago. What I've dedicated my career to, I think it's got a huge talent need. The more people we can get into it, there's tons of opportunity here and you feel good doing what you're doing. Well, congratulations on your new addition. Thankful. What exactly is KVH analytics to? Good question. I'm going to answer that nontraditional way. The lubrication, the enabling factor of pretty much anything in energy is the capital that is flowing into the industry. Whether or not you're a capitalist or not, like the end of the day is you can't build an asset if you don't have the capital court. So I'll say that's thesis number one. These number two is there's very, very large pools of capital, right? You have bank capital, you have private capital, giant pool of capitals and insurance capital. And you can't build a project if you can't insure that asset either. We really started as I touched on, as a data and risk management company. We were collecting data, evaluating risk, understanding predominantly how assets are performing and why they're not. Then five years ago or so, we said, hey, we think we have the best view on this risk, this was happened to be production risk at the time. Wouldn't it be cool if we could take this and package it up and allocate some of that to the insurance markets. These are insurance turns out is like nd finance for five years. Very similar, but they change all of the terms. It's opaque to many people, but essentially what you're doing is you're renting a balance sheet, right? You're transferring some risk. You're paying them a premium. If there's an event, they pay you back claim that's at the end of the day, then that gets packaged up, they reinsure it, they send it into other capital markets. It's a pretty elegant, a pretty efficient way to take really well defined risks and allocate into another market. A common thing we said at the bank was this is a pretty good risk, but it's not a commercial banking risk. The banks binary either have a default or you don't have a default. And if you have a, a loan, it's a really bad thing. Like people come out of the woodwork they didn't know existed to shine a light on your bad loan at an insurance company, a claim. And not that they don't care, but that's a common event, right? There's reasons to think that you could either take higher levels of risk and allocate it into the insurance market or more efficiently diversify risk and push into the insurance market. We do that with solar production, with the thesis being that if we take volatility in those cash flows. Project finance, you're lending against an asset, and I know you teach courses on this, but the asset needs to generate enough cash flow to pay off the loan. And it's not the owner. The ultimate parent, whoever that is, does not need to inject cash. They can just leave the asset and say, good luck to you, right? If you put a floor on the production, typically there's a revenue contract, you're putting a floor on the revenues. And the lenders can lend more capital against that because it's a more firm cash flow stream, that's a solar revenue put. Then a couple years ago, I got a call from some folks in banking that I used to do deals with. They said, Jason, we have a problem. Half of our loans are in what they call technical default. That means you're in violation of some term of your loan agreement. It's not bad enough. You're going to call the loan and foreclose on the asset, but it's bad enough that have a problem basically. Right. And they said we're in tech equal default because there's all these property insurance requirements and our loans, So object against things like fire, flood, hail, and our clients are saying they can't get the coverage anymore, right? So this used to be a check the box, I could tell you four years of banking. I spent an hour thinking about insurance, right? Went from really far down the chain of things that we cared about to like a top three issue for us, right? And that sounded like a pain point that should have a business opportunity, right? So we put together a team, put together a thesis, all of our, all of our business about using data to sort of get a differentiated view on risk. We collected a bunch of data on physical risk to solar assets. We entered the property insurance market earlier this year, now July 2023, depending on earlier this year we entered the market. It's proven to be a very important lever as well because if you can't get property insurance on your asset, you also can't finance it, right? These are hundreds of millions of dollars of assets sometimes. And the insurance companies are saying it's really expensive to insure and B are going to hold and retain a lot of that risk as an owner anyway. Long way of saying is we use data to underwrite risk. And allocate some of that risk into the insurance markets as an enabling the capital for other capital. Right? Right. All right. So that's, that's really interesting stuff and for students, you know, you know, hedging, hedging, that production risk is obviously very important because you've got an intermittent resource with the sun and that kind of thing. Just curious. Has there been folks who are interested in doing the same type of thing on the wind side and is it something you guys would consider? That's a complicated question. I'm trying to think the most efficient way to answer. In solar, we take really two risks. Predominantly, we take resource risk, which the sun is honestly mostly stable. Maybe getting a not the sun but like the resource risk exam, a little bit less stable as you have wildfire smoke, as you have pretty crazy environmental conditions that are happening all over the world. But the resource itself is mostly stable then operating risk and that's where you have a lot of volatility equipment outages predominantly, so that's what we underwrite. There was a product that was price risk and resource risk. This is the surety had a product with Hurricane EN in Texas, the Texas Freeze. A lot of those transactions I think had issues because grid prices were very volatile in Texas. That is not as active anymore in when what you have is a lot of resource volatility. But most of the availability or equipment warranties sit with basically the giant global manufacturers we've looked at. Could we provide more resource insurance? Reason why this is a complicated answer is that much of the Nancy for Solar is built around an investment tax credit, at least today. The structures that they use for that basically pushes a lot of that production risk onto the lenders. And when a lot of the investment structures are built around the production tax credit, actually the investor structure, the loan or the tax equity investment, that they can actually, there's more volatility allowed within the structure. The market demand for it hasn't been as strong. And honestly, if you look what's being built, most of the time the solar revenue put is being sold into a new build. Solar is actually being built more predominantly than wind, at least today, right? So we've looked at it, mark. But what I'd say is the structures I'd say are a little bit more insulated, the financing structures are a little bit more insulated from the volatility. Just from like a market demand perspective. I think we've seen solar is a little bit more attractive, right? Currently a lot of the wind that's getting built is offshore. And that would be to find a market in that case. Yeah. They are giant assets that the development timelines on those, they're still years away, right? Exactly. Excellent. What current trends in the energy markets are affecting your business right now? Let me answer a few ways. One is the Inflation Reduction Act, I think generally is helpful. Solar on a standalone basis, on an unsubsidized basis. You could look at the Lazard LC studies. It's cheaper to build the solar project today than even buy the coal to operate a coal plant on a fundamental economics unsubsidized basis Makes the most sense on a subsidized basis, even more so. But the inflation reduction at anytime, you can make those economics even more attractive. Certainly a tailwind, I'd say. Sitting here in bid 2023, what we're seeing is actually people are still waiting for guidance from Treasury and from the IRS. People are saying, well if I just wait a few months, maybe I'll get a bigger tax credit. This actually slowed down some of the development sitting here present day. But ultimately a big tailwind that's important for anyone who's looking at, at this market. Part of the Inflation Reduction Act allows for transfer of tax credits. Tax equity, the business I used to do, candle, is pretty inefficient and pretty scarce and pretty expensive. The idea is that if you can take the tax credit and transfer it outside of a tax equity structure, basically you can sell the tax credit to a corporate, or a bank, or anyone that wants it. It should, in many ways, democratize the ability to build and finance these assets. That's a very big theme. I think it's going to fundamentally change a lot of the way these assets get built. What kind of projects can get built? What kind of capital will be in the market? And is yet to be seen really how that changes the market. But I think it will have very dramatic effects on the market. Okay. The other theme, which isn't necessarily energy related but affects my business, is the insurance markets have also, I'd say, challenged. It seems like there's more billion dollar disasters every year than the year prior. Insurance companies buy insurance, they call that reinsurance. And one of the metrics that you look at is how expensive is the reinsurance in the property market, which is the market that I operate in. Reinsurance rates have gone up dramatically this year. The renewals were the most expensive renewals in the last 20 years. What does that mean? It just means that insurance costs generally are going up as appetite, I'd say, for very large limits for any asset, but renewables included. The consequence of that is that owners of these assets have to retain more of the risk. They have to have large deductibles, they're going to have lower limits that are available to them, especially for some of these natural disasters. It, if you're an owner of assets, it affects your own risk profile because it used to be able to insure all of that risk away and now you can't. I guess that's the energy connection. You know, like Texas now, there's as much solar in Texas as in California. Right? Texas is a lot of hail, California, unfortunately there's fires. So like pretty material risks and the forecast is we're going to build as much in the next five years as the last 20 years combined globally, Right? Right. So like, you know, I entered this industry thinking we had it all figured out, We're going to enter another *****, dramatic dramatic growth, right? So, a lot of these problems are only going to be more acute as we continue to grow and build in places that maybe aren't best suited from a physical perspective. For the other reasons to build there cots, a pretty liberal market permitting is pretty easy, the grid is pretty flexible from a contracting perspective. It just happens that you get four inch hail on a semi regular basis, which put glass panels out in the field. Those are the rest that we think about on a regular basis. All right. Right. Interesting. I'm sure you have a view on this. Are you seeing more folks decide to take the production tax credit on the solar side than the ITC? Is that a thing? I heard that people were thinking it might be something that would happen and I just wonder if you have a view on it for our students as they're thinking about their projects. Yeah, it's a good question. The investment tax credit, I assume people know what it is, but I'll just say it upfront. Is a tax credit based on the amount of capital you invest in the asset production? Tax credit is tax credit linked per Megawatt hour that you produce. When you look at what I call it, market analysis shows, you expect that you take the production tax credit or more likely to take it in regions with a high solar resource. If your production relative to your capital cost is high, the PTC tends to be more favorable than the ITC. That's one of those things that are still very new in the market. Folks structuring deals with PTC's but just beginning to do that cycle for these is a while the restructuring deals to allow for it, you have to bring in a different form of, if you're restructuring your tax equity deal could take some time. More people think. I think there's a thesis that the transfer market is also right for PTCs, but that transfer market is also brand new. It's coming, Mark, I'd say sitting here today, I know folks are looking at it, predominantly the Southwest, right? California, Arizona, sort like, where you have a super high solar resource, makes the most sense for it. I think it will be a bigger theme, but probably TBD, exactly what that looks like and how that ends up flowing through the capital markets, right? All right, But certainly maybe a greater opportunity for the kind of insurance that you guys do, right? I mean, anytime your production becomes a bigger proportion of your revenue stream. Absolutely. Right. Right. So there conditions, any markets or conditions that are affecting solar business in a manner that we might not have anticipated three to five years ago. I know that's a very broad question, but I mean, anything that you've seen that if you were sitting here and say 2019, well, I don't expect that to happen now. It has. And you're sitting here saying, oh, things look a lot different for our business and what we do. Yeah. You know the thing about how do I answer this? There's a couple, yeah, there's a couple of say political things. Affect our market that were maybe unanticipated. The inflation reduction at, I'd say I thought any extension of tax credits was dead until that was passed. So certainly that's a tailwind that was unexpected. There's regularly legislation or dispute about where the equipment comes from. A lot of the solar modules come from China, I think in the US. The average cost of a solar module is like 30% higher than anywhere else in the world. Because we have a lot of anti dumping duties, countervailing, countervailing dumping duties, and we have some restrictions on silicon and where it comes from. And if it's from the Injong region, I say from a supply chain perspective, like last year, much of 2022, it was hard to import modules like they were getting held at the border. Maybe in 2019 I would say is probably to continue because it was happening in 2019 and just like never end. But certainly the political environment matters. I've been surprised by how quickly growth has happened in Texas. Texas was very small market in 2019. As I said earlier, it's now the same size as California as far as installed capacity. Hopefully, this is not a self interested comment. But in 2019, insurance was not viewed as actually a very big risk, like you could easily buy an infinite level of insurance. Now you can't the proof point, I'll say that it's maybe a more macro theme is solar conferences. You go to them, you look at the agendas. Insurance was never talked about and the biggest asset management conferences here, there are four sessions on it. It's become a more acute form of capital, which is maybe a good macro theme for my business is at. But from a solar perspective, I'd say it's just become, become a much more serious issue. Led to new technology innovations, led to new operating innovations, led to different risk allocations in the market, trying to think what else as it relates to the AD CVD like. It also has led to some of the technology changes. Bifacial equipment, for example, where you have glass on the front and glass on the back and yourself get production from sides, was carved out of that legislation or somehow excluded from it. You saw a big wave of bifacial equipment being installed. The market is pretty efficient. The extent there's gaps in legislation, we're able to find a way to get around it. But has effects on the market in ways that are maybe hard to predict. Sure, bifacial thing is somewhat interesting because I'm putting together a discussion on the duck curve, which is much, much later in the course. And people are saying, well, if you do bifacial, we'll flatten that thing and it'll work out much better. That's an interesting new way of looking at things, not to try too deeply. You talked about product development. Is there anything in the pipeline that you might give a hint about, I don't want to take away, steal your IP here or anything like that, but any hints that other things you might want to cover off or you might get into business of, Yeah, maybe I'll just say areas that are probably right for innovation, some of which we're looking at. I view my business, I'll call it performance assurance type of products, and have more physical risk products. In the performance assurance world, there's a lot of new technology that's coming out that people aren't really sure how it's going to work. If it will work, we get a lot of requests for things like storage and is that going to generate the revenue? It's hard to underwrite. Still, pretty emerging technologies, we get a lot for that. I wouldn't necessarily this is a new technology, but curtailment, we get a lot of requests for other ways to manage curtailment, particularly in Texas in a more efficient way. But as hydrogen, as other technologies become much more prevalent, I think we'll see a bigger need for risk transfer within my property or physical risk business. There's some natural extensions like usually they call it property and casualty Insurance. Casualty is the liability side, basically, if you burn down your own system, that's property. If you burn down someone else's house, hurt them on site, that's casualty. All right, we're looking at that. Other types of extensions of the business that we can distribute through our existing channel and add value to ultimately the end user who's the owner of these assets. We're always thinking about ways to use these other very large, honestly, trillions of dollars of insurance capital to help enable other capital to flow into the industry, Right? All right, exactly. Are there any roadblocks you see in the transition to developing more renewable energy? Just from your perspective? Yeah. I mean, there's always road blocks, honestly. One of the big ones right now is labor, whether that's talent doing the financing. I mean, there's like challenges on the bank side, getting the human talent to get capital out the door. There's labor challenges on the insurance side of people that know how to underwrite all this stuff. And there's labor challenges for people out in the field, right? Building and operating all this equipment. Labor challenges is certainly one. The market is pretty efficient about siting, about permitting, about all this stuff. It's just to me, I feel like the industry scaled very quickly and it's hard for me to fathom what it's going to look like to double the installed base in five years, right? So we're going to have a lot of growing pains. I think even 15 years after I thought I was entering a mature industry, right? Sort of my macro thesis is that with the Inflation Reduction Act and the transferability of tax credits, one of the things that sort of pushed our market into having more large owners of these assets. Aggregating assets, tax equity, like they only worked with the biggest, most sophisticated companies that goes away, right? You can democratize who's building this. You could be a smaller developer or you could be a smaller asset owner. One of the challenges I see is how do you get best practices in the hands of all these people about how to build, how to operate all this equipment? We publish that solar risk assessment in part to share best practices with the industry, but that, to me, is going to be like one of our biggest challenges. We're going to have an influx of talent, much needed. We're going to have an influx of people that are interested in renewables, doing work for the right reasons but just are new to the industry, don't know all the works that we have and don't know what to avoid or what to do to do things the best way. And how do we permeate and disseminate best practice information out to the industry to say, hey, you're going to be developing a project in the Midwest, you've got to think about hail, and here's the right ways to think about it. Or hey, if you're building a project, here's how to think about a string inverter versus a central inverter. And here's how to manage your supply chain and here's how to think about their parts. And he's like, there's a lot of stuff that it takes to build and operate the stuff. If I look forward, that's probably going to be one of our industry challenges. And it's a little bit of who's the right company to do it, who's the right entity to do it, you know, There's no natural answer to that, I guess. Right? Or what's the right hub to even distribute this information and the technologies change in every six months even when you think you know what you're doing. Even for those of us who have been doing it 15 years, right, I learn something new every day. Like we're surprised by how things change. I view that as a macro challenge for us is if we're really going to build all this infrastructure which we need to build, how to make sure we do it just in a way that's building resilient assets. That's my latest thing is we can build really cheap assets and we do it pretty well. How do we build more resilient assets that are going to last 30 years that they should be designed to last, Right? Even though right now we've got stuff that hasn't been even through its entire life cycle yet. Most of the stuff that was put in when you came into the industry still has useful life on. It's difficult to make that decision when everything changes so quickly and at the same time you don't even have a lifecycle yet. Very interesting times thinks is very specific to my industry or to my business. But if you're insuring an old asset, let's say one of the ones I built 15 years ago, they don't even make that technology anymore. It's like 600 bolt systems. Now, everything is 1,500 bolt. The modules are 130 watts. Now everything's 500 watts. They don't even make it anymore. So you have a problem on the site building a new site. You have a problem on the site. Like what tech even knows how to work on that? Yeah, but it should work. You're right. I mean, assuming nothing goes wrong is designed for 2030. 40 Ellie's, what's interesting about it is we know the electric generation business. It's fossil fire. We have 100 years of how, how those things work, even though technology has changed a little bit. Ge frame seven. Ge frame seven, and has been for 30 years. We know what that looks like. This stuff you don't even know, 15 years ago, it's completely different. So it's an interesting problem. I think, I think a common misconception is because it doesn't have a spinning turban, that Solar is easy, right? Like you put it out there and you don't touch it, all right? And that's very far from the truth. I think that's probably the biggest gap is like what could go wrong? And then you start working in the industry and you're like, oh, everything can go wrong, everything go wrong. That's probably like my biggest learning from early on is it seems very easy on the outside. But when you're in a global industry with physical hard assets and you have contractors that are building it and you have guys that are spend all day at the site and you have vandalism. You have bugs in the boxes. You have weeds that grow. I mean, they think some little things but they all matter when it comes to the quality of the underlying asset. Exactly. So do you have any advice for our students who be considering a career in the energy sustainability business? Yeah, I think for me the first question I like to think about what is like, what's the technology that most excites you? Maybe it's at least a useful starting point. I'm a solar guy, I guess for better or worse, I've found my way into this industry. There's more established growth industries like solar, and then there's very emerging technologies that have been enabled by some legislation. There's a whole segment around direct air capture. Whole segment now, and a lot of excitement and hydrogen, but that list goes on and on. I think the dynamics of each of those is similar but different enough. Probably a good starting point if you're looking to get a job in. My next thing is then go become an expert and at least a part of it read the news. If you're going to an interview, you want to be able to speak eloquently about what you think about the space and where it's going. Right. That's not hard read the news, follow the blogs that are specific to what you like. There's a two by two, I guess that I'd like to think about careers. On one side you have your industry, you can call it renewable energy, you can call it hydrogen. On the other axis is your function. If you're a earlier career person, go experiment. I think the first seven years of a career is basically experimentation. Go try a bunch of stuff and see what you like and see what you don't. If your later career at least try to fit your function that you have experienced in within the industry and then you can try to adapt into something that might be a better career for you. Yeah, there's a lot of opportunity, a lot of different needs whether that product finance, construction project management, If you have a skill, there's a way to put it into renewable energy. But it will look different depending on to me, depending on what technology you want to deploy it with. Any other points you'd like to add, Jason? No. Go work in renewables. If you're taking this class you're probably thinking about it. So we need all the talent and all the experienced people we can get. Great. Thank you, Jayson. Really appreciate your time.

  Interview with J. Kaminsky by M. Kleinginna © Penn State is licensed under CC BY-NC-SA 4.0

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What is due for Lesson 7?

This lesson will take us one week to complete. Please refer to the Course Calendar in Canvas for specific due dates. Specific directions and grading rubrics for assignment submissions can be found in the Lesson 7 module in Canvas.  

• Complete the assigned readings and viewings for Lesson 7
• Complete Quiz 5
• Project work - Risk Management Measures

Questions?

If you have any questions, please post them to our Questions? discussion forum (not email). I will not be reviewing these. I encourage you to work as a cohort in that space. If you do require assistance, please reach out to me directly after you have worked with your cohort --- I am always happy to get on a one-on-one call, or even better, with a group of you.