Texas’s swaps meltdown highlights the systemic impacts of climate change

If you want a chilling example of how far-reaching the unintended consequences of climate change can be, look no further than the meltdown in the swaps market underpinning renewables projects in Texas, following February’s extreme winter weather.

These hedges were a hitherto unremarkable component – some might call them a tax-equity requirement – of US renewables financings for projects with merchant exposure. They work by fixing a price for an agreed amount of hourly electricity sold by a project to the bank providing the swap. They broke spectacularly in Texas, and became a major liability, when the winter storm left projects unable to generate power. This left the projects’ backers fully exposed to power bought on the open market, sometimes for days on end. Given the – how shall we put it? – ‘idiosyncrasies’ of Texas’s deregulated power market, the purchase price was set as high as $9,000/MWh.

In a letter to the Texas regulator signed by leading renewables GPs – including Capital Dynamics, Copenhagen Infrastructure Partners and Fengate Asset Management – the consequences of this market failure were laid bare: “It appears that at least 46 mostly wind projects totalling 9GW would suffer severe financial losses as a result of the $9,000/MWh HCAP [real time settlement point price point at the high offer cap] prices during the power market crisis.”

Those potential losses are amply evident in the legal dispute between JPMorgan Chase and the Canadian Breaks wind farm, one of the Green Investment Group’s first US projects, now owned by Northleaf Capital Partners. The bank, which had contracted swaps with Canadian Breaks, says it is owed a total of $79 million because it was forced to buy power on the open market to offset client obligations for “$8,980.45/MWh more than JPMorgan would have paid if Canadian Breaks had performed”. Canadian Breaks claims it was unable to deliver because the storm paralysed its operations, a force majeure event. Its forecast revenue for this year amounts to $15 million.

And so you have the whole crippling chain of events: extreme winter weather – made more common by climate change, scientists say – broke power projects, many of which were inadequately winterised, thus preventing them from generating and transmitting power. That, in turn, broke Texas’s power grid, plunging millions into the cold darkness for days on end. It also broke Texas’s power market, setting prices unimaginably high. And that, finally, broke the swaps underpinning the Lone Star State’s renewables projects, threatening to bankrupt many of them.

That’s climate change for you. It just breaks and breaks and breaks.

But the events in Texas also raise the question of how aware managers and their LPs were that a seemingly unremarkable component of their financing arrangements potentially gave them a level of market exposure that could backfire so dramatically. Because that might help break perceptions of how manageable merchant risk is, at least in certain markets.

When people talk about the systemic impact of climate change, this is exactly what they mean – even if they can’t pinpoint all of its unintended consequences.

Now ask yourselves this: how many ticking ‘swapsgates’ are out there across sectors and asset classes, waiting to be detonated by climate change?

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