The World Bank Partners with Uruguay to Execute Largest Public Weather and Oil Price Insurance Transaction
December 19, 2013
WASHINGTON, December 19, 2013 - The World Bank announced today that it has completed a $450 million weather and oil price insurance transaction for Administración Nacional de Usinas y Transmisiones Eléctricas (UTE), the Uruguayan state-owned hydro-electric power company. The transaction insures UTE for the next 18 months against drought and high oil prices, both of which have had negative financial impacts on the company in the past.
When lack of rain lowers the volume of water in reservoirs which feed UTE’s power plants, the company must turn to thermal generation, which has a higher cost and requires oil purchases. And when the price of oil is high, generation costs become even more expensive. That creates problems for consumers and for the national budget, since the state provides financial support for UTE.
“Uruguay is vulnerable to climate and oil price volatility,” said Uruguay's Minister of Economy and Finance, Fernando Lorenzo. However, he said “we need to manage these challenges and do it in a creative way. This transaction is a positive step forward since it helps us to manage risks which have a big impact on individual consumers, on businesses, and on the public accounts.” Lorenzo added that “This transaction is complementary to the Energy Stabilization Fund Established in 2010.”
Over the past several years the World Bank has pioneered a number of customized risk management transactions around the world. It is expanding this work to respond to increasing demand from clients looking for practical solutions to complex financial problems.
“This transaction, which is one of the largest the market has seen, is unique.” said Madelyn Antoncic, Vice-President and Treasurer of the World Bank. “Combining protection against the risk of drought and high oil prices is something that works particularly well for hydropower companies, and it’s the first time we have seen a public utility use this type of tool. This transaction is a good example of how we can focus our financial and technical expertise, combined with experiences in other countries, to deliver solutions that meet specific client needs.”
UTE’s hydropower is dependent on water levels in two river systems in Uruguay and Brazil: the Rio Negro and the Rio Uruguay. In order to measure the extent of a drought, the transaction uses rainfall measurements at 39 weather stations spread throughout the two river basins. Rainfall data is collected daily to measure performance against a pre-determined level set as the trigger for the contract. If rainfall is lower than the trigger, the contract will pay up to $450 million. The size of the payout will depend on the severity of the drought, and on oil price levels. If oil prices are high, the payout will be larger to offset the high cost of fuel purchases.
The size of the contract is large because the financial risk is significant. In 2012, water shortages meant the company needed to purchase other sources of energy. That year the costs of supplying demand for electricity reached a record of US$1.4 billion, far exceeding the company’s original projections of $953 million. In order to cover the gap, UTE borrowed funds from the market, drew down the country’s US$150 million Energy Stabilization Fund, and increased rates to consumers.
In the short term, one of the objectives of this contract is to protect consumers from the risk of high and volatile electricity costs. In the long term, UTE is fully committed to a national plan for reducing vulnerability in the energy sector. It is investing in wind and natural gas in order to diversify the production base, in addition to using market tools to transfer risk.
“This coverage is for three semesters, because once other sources join the system, such as wind and combined cycle natural gas, the vulnerability of the overall power system will go down,” said UTE’s President Gonzalo Casaravilla "While the likelihood of cost overruns continues to exist, they will be lower, and the premium that the company is willing to pay for coverage will be recalculated.”
The World Bank’s involvement in this transaction is driven by its commitment to helping countries reduce vulnerability to natural disasters and financial risks. In addition to technical support on market protocols and data collection, the Bank is UTE’s counterpart for the transaction, offsetting its risk with two re-insurance companies selected on a competitive basis: Allianz, through a partnership with Nephila, and Swiss Re.
“Financial risk management is an important part of the overall picture for countries concerned about energy security.” said Hasan Tuluy, Vice-President for Latin America and the Caribbean. ” But the solutions that our clients need are not always standard or straightforward. This is especially true for middle income countries such as Uruguay with a more complex set of demands.”
Intermediation by the World Bank has a number of advantages. Drawing on financial experience and market presence, its involvement has helped to strengthen confidence in the transaction and the data collection protocols, both of which have served to crowd in market participants. Technical support has also involved lengthy discussions with UTE about the level of coverage needed, and how to deploy market tools with other financial approaches such as a stabilization fund and contingent loans.
The World Bank is a leading pioneer in developing innovative risk management financial solutions for global problems that affect countries. Treasury’s cutting edge innovations helps clients mitigate financial risk and the financial impact of catastrophic risk such as hurricanes, tsunamis, earthquakes, and droughts, creating fiscal buffers for countries to use in the event of a disaster. Other powerful examples of nonstandard solutions includes Treasury’s recently executed first-ever capital market insurance transaction covering cyclone and tsunami risk for six Pacific Islands through the Pacific Catastrophe Risk Insurance Program and the Caribbean Catastrophe Risk Insurance Facility covering sixteen islands against earthquake and hurricane risk.