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Researchers propose improved climate risk insurance to drive the energy transition

Solar radiation is a variable unrelated to socio-economic factors (Photo: American Public Power Association/Unsplash)

21/10/2022
Agustín López

A UOC study designs a new method for calculating the insurance premium of projects generating energy with solar panels


The researchers have applied the model using climate data and historical solar radiation data in 40 cities of 13 Western European countries

Renewable energy generation projects are one of the cornerstones of the energy transition. The installation of these technologies by people who want to generate their own energy, primarily from solar power, for personal use – known as prosumers – has been on the rise in recent years. A study by Jorge M. Uribe, a researcher from the FM2 research group at the UOC's Faculty of Economics and Business, and Stephania Mosquera-López, from EAFIT University, has designed a new method to easily calculate the climate risk of this type of project and create insurance products that cover losses caused by decreases in energy generation due to climate variations. This method allows the insurance premium to be established on the basis of the price of energy and data on solar radiation and climate variables such as temperature, wind speed and precipitation. The results of this research, which have been tested using real data from 40 cities in 13 Western European countries, could aid the development of this type of renewable energy and help drive the European energy transition.

"The proposed method and our empirical results are of direct interest to insurance companies that are beginning to explore the market for insurance products during the European energy transition that is currently underway, but they are also of interest to electricity prosumers, because our results allow them to measure the generation risk – due to weather conditions – of any project that relies on variable renewable energy technologies, particularly solar power," explained Uribe.  

Therefore, the resulting type of insurance products could help "mitigate the risk associated with the climate factors implicit in these energy projects and would also encourage their implementation by households and blocks of flats, with the consequent positive impact in terms of the environment, the economy and sustainability for society as a whole".

 

Solar radiation, a variable unrelated to socio-economic factors

Climate risk is defined as any situation in which variations in the climate cause the radiation recorded on the Earth's surface to undergo significant changes that make it difficult or impossible to generate energy using solar panels. Against this backdrop, the method for calculating the insurance premium is primarily based on modelling the solar radiation recorded in a day on the Earth's surface. The reason for modelling solar radiation rather than energy generation or the cost of generation itself is that the radiation observed is public and only depends on the climate. "This makes it easier to establish the claim payment for an energy shortage and, at the same time, ensures that this will only happen as a result of certain adverse weather conditions and not as a consequence of other issues such as possible technology malfunctions or exogenous variables, such as the socio-economic situation, which have an impact on market electricity prices," said Uribe.

Statistically speaking, the new method is based on conditional quantile regressions, which make it possible to measure the effect on solar radiation of climate factors (e.g. temperature, wind speed and precipitation) in different scenarios, such as when the observed radiation is low, medium or high. "A quantile is a statistic that divides the range of a probability distribution into continuous fragments of equal length. In our case, we're interested in the lower quantiles of this distribution – minimum amounts of solar radiation – which would correspond to scenarios of low energy generation," the researcher pointed out.

Thus, in order to determine the price of an insurance policy designed to cover the weather risk of these projects, the researchers have created a statistic that allows them to estimate what the largest expected daily loss would be within the largest expected losses. "When the observed radiation is lower than the estimated value of this statistic, the insurance would be activated, and the consumer would be able to claim the payment agreed upon in the contract," added Uribe.

To put this methodology into practice, the researchers used daily historical solar radiation data for 40 cities in 13 Western European countries, including cities in Portugal and Spain, which exhibit the maximum levels and the highest averages of radiation in the sample, and Finland, Sweden and Norway, which exhibit the minimum levels. "By applying our methods to a variety of European cities with different weather patterns and segmented electricity markets (40 in total), we open up the possibility for insurance companies to diversify risk and operate in different geographic locations, thus minimizing the chance of facing a potential disaster event," he said.

 

A relevant methodology for Spain

To illustrate the application of the model and the impact on the insurance premium of different variables - primarily the number of extreme events - the researchers highlight the case of Birmingham and Leeds. "Both are cities in the UK, which have the same electricity prices. However, Leeds has the lowest premium and Birmingham has the highest in our sample. This difference is due to the fact that only seven of these extreme events occurred in Leeds, whereas 92 occurred in Birmingham in the same time period," noted the researcher.

The importance of electricity prices can also be seen by looking at the case of Aarhus and Lisbon, two cities that have the same insurance premium, but a different number of extreme events. "While Aarhus recorded 57 extreme events, Lisbon only recorded 40, but according to our model the premium would be the same, since in Lisbon the average electricity price is higher than in Aarhus, which offsets the lower number of breaches in the premium calculation," said Uribe.

According to the researcher, this method would also be "particularly relevant for countries such as Spain, where a high percentage of end users of electricity (around 40%) have their electricity bills instantly linked to variations in wholesale electricity prices".

 

Impact on climate change

A key element of the new method is that it can be easily extended to other technologies such as wind turbines, replacing the radiation variable with wind speed. Furthermore, it opens the door to future studies on the effects of climate change on the potential generation (at maximum capacity) of these technologies, as it allows "systematic analysis of the impact of climate variables under extremely low conditions of recorded solar radiation and the expected generation shortages of photovoltaic technologies," he concluded.

 

This UOC study supports Sustainable Development Goals (SDG) 9 on Industries, Innovation and Infrastructure and 7 on Affordable and Clean Energy.

Reference article:

Mosquera-López, S., Uribe, J. M. (2022). Pricing the risk due to weather conditions in small variable renewable energy projects. Applied Energy, 322. https://doi.org/10.1016/j.apenergy.2022.119476.

 

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UOC experts

Jorge M. Uribe

Jorge M. Uribe

Member of the UOC's Faculty of Economics and Business