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Cashing in from closing coal

Private capital will be needed to accelerate the coal phase-out. Balancing public good and private profit will be challenging.

By Mark Nicholls

If the world’s power markets were purely driven by economics, coal-fired generation would be rapidly crumbling in the face of competition from cheaper renewables. However, in many markets around the world, the owners of coal-fired power plants are using incumbency and opaque long-term contracts to defy economic gravity and continue to operate, putting climate goals in peril.

According to the RMI, some 93% of coal plants are insulated from market forces. (Photo by Vadiar/ Shutterstock)

The response is growing interest in financial mechanisms that pay owners for closing their coal plants earlier than they would otherwise, recognising both the public interest at stake, and the rights of owners to receive compensation for forgone earnings. However, given the limited resources available to governments and development banks, private capital will be needed, raising thorny questions around sharing the value generated.

“Everybody treats economics as destiny, that if coal gets expensive enough and renewables get cheap enough, this transition will automatically happen,” says Justin Guay, the director of global climate strategy at The Sunrise Project, a civil society network to promote the transition away from fossil fuels. “The reality of the messy world we live in is that incumbents, with lots of political power, are capable of stalling the transition well past timelines that matter.”

Insulated coal

According to research from RMI (formerly the Rocky Mountain Institute), some 93% of coal power plants are insulated from market forces, including through long-term supply contracts, their ability to charge regulated tariffs, or through government subsidies. They also benefit from advantages, such as how grids have been built, or incentive structures within electricity systems, that make replacing them with cleaner and cheaper alternatives difficult.

To tackle some of these challenges, a range of financial mechanisms is being developed that typically combine three elements (see map below). The first is refinancing existing coal-fired assets with lower-cost capital, allowing lenders to be paid back more quickly and the plant shut down earlier than otherwise would be the case. While there is an important role for public finance in helping to provide low-cost capital, private funding is expected to make up the bulk of this finance.

The second is support for affected workers and communities to ameliorate the social impacts of the transition. This might include funds for retraining and unemployment benefits, and will predominantly be provided by governments. Some mechanisms, such as the Climate Investment Funds’ Accelerating Coal Transition programme, anticipate creating new sustainable enterprises that would create employment to replace coal jobs, and which could attract private finance. Others, such as South Africa’s $8.5bn (R134.5bn) Just Energy Transition Partnership, announced at COP26 are, thus far, backed exclusively by government funding.

The third part is building the clean energy infrastructure to replace the retired coal capacity. Given the economic viability of clean energy infrastructure, this is likely to be almost entirely privately financed, and the least controversial element.

Tens of billions at stake

The sums involved are potentially enormous. For example, the Asian Development Bank (ADB) is piloting its Energy Transition Mechanism (ETM) in three countries: Indonesia, the Philippines and Vietnam. David Elzinga, a senior energy specialist at the ADB based in Jakarta, Indonesia, says it would cost $30bn–60bn to shut down half of the coal-fired power capacity in those three countries, based on a cost of $1–2m per megawatt of capacity. As the Institute for Energy Economics and Financial Analysis has observed, “this is significantly more than the ADB’s $20bn COVID-19 assistance package”.

It is likely, then, that private sector financing will provide much of the funding. Elzinga says the ADB is hoping to raise $2.5bn-3.5bn for the pilot ETM fund; initially, 20% of that would be concessional public finance, with the other 80% provided “on commercial terms”. He would expect the percentage of concessional funding to decline as the concept was proved.

Similarly, Abhishek Bhaskar, senior energy specialist at the Climate Investment Funds (CIF), says its programme, which is initially focused on South Africa, India, Indonesia and the Philippines, will direct most of its funds towards decommissioning coal plants and repurposing the sites with green energy infrastructure. Between a quarter and a third of the money would support new economic activities for affected communities, with a smaller share going towards governance, policy formulation and stakeholder communications. The CIF has raised $2.5bn from donor governments, and Bhaskar expects this to mobilise eight to ten times in additional financing “from a variety of sources, particularly the private sector”.

Private investor interest

Certainly, there is substantial appetite from private investors. Prudential, Citi, HSBC and BlackRock have all been reported to be in discussions with ADB on its mechanism, although Elzinga declined to comment specifically, saying only that the bank is in discussions with private sector companies about what the financial structures might look like.

Citi was also reported to be working with commodity trading house Trafigura on a vehicle that would buy coal mines, pledging to shut them down before the end of their economic life.

“It is going to be really important to scale these mechanisms so, ultimately, we are going to need to [pay investors] a fair, risk-adjusted return,” says Tyeler Matsuo, a senior associate at RMI. “The main challenge is around… ensuring that the upsides of any transaction are contributing to societal outcomes.”

There is a critical tension at work between the climate benefit of shutting assets down as soon as possible, and the financial advantage of allowing them to run as long as possible. This creates “an important role for public institutions to provide some of the guardrails”, says Koben Calhoun, a principal at RMI. “I wouldn’t say there is no potential for a fully private kind of fund, but there needs to be really strong accountability and transparency,” he says.

Greenwash risk

Of particular concern to Guay at the Sunrise Project is the potential for private sector vehicles to greenwash coal investments. He singles out the proposed Trafigura deal, which appeared to involve “no public money, let alone oversight”, and which proposed running the coal mines to 2040. By promising to eventually close the mines, the deal offered “a very clever way to repackage thermal coal, which is fundamentally toxic to financial markets, as an ESG asset… That has to be shown the door,” he says.

A spokesperson for Trafigura said the deal would have provided investment in alternative employment and social programmes to support coal mining-dependent communities transition to a low-carbon global economy. "The concept was discussed with potential investors and a range of community stakeholders and received positive feedback," she said. However, it was decided not to proceed, "given the uncertainties of a rapidly evolving regulatory environment and the varying priorities of key stakeholders", she added.

Another key risk is in overpaying for any assets bought, notes Guay. He raises questions over prices discussed by the ADB for coal-fired power plants and the process of price discovery that would be involved in some of these transactions. This can be particularly problematic when working with state-owned plants, or those with opaque long-term power purchase agreements.

“It is going to be important for some of the stakeholders that own and operate these assets to make some of that information a little more transparent,” says Calhoun. He adds that there is value for them in doing so, in that it can allow for “more confidence in how the financing is structured”.

One means to achieve price discovery is to follow the German model. Here, the government is holding reverse auctions in which power plant owners can bid for payments to close down coal-fired capacity. Over four auctions held between December 2020 and December 2021, operators agreed to close almost 9GW of capacity, with bids averaging €66,000 per megawatt (/MW) in the first auction, rising to €102,000/MW in the third.

A role for regulation

The prices bid – which are considerably lower than those discussed in developing countries – is a function of other power system attributes, notes Philipp Litz, a senior associate at German think tank Agora Energiewende. One is substantial support for and growth in renewables. This is reducing wholesale power prices and undermining the economics of baseload power generators. A second is the EU Emissions Trading System, which penalises carbon-intensive generation. A third is Germany’s coal phase-out plan, which means those plants that do not bid in the auctions – currently scheduled to run until 2027 – will be forced to close without compensation.

“These measures are already making the operation of coal-fired power plants in the medium and long term very uneconomic,” says Litz. “The [auction] is complemented by these other mechanisms.” This makes direct comparisons with developing countries, where such regulatory interventions are more limited, difficult.

Elzinga at the ADB acknowledges, “we have a lot of work to do” on valuing coal assets in Asia. Part of the answer is looking for coal plant operators that want to transition towards cleaner energy. “We are not talking to the owners who say, ‘I want to maximise the return on this asset… and run it as long as I can’. We are going for the ones who want to make an impact.”

He adds that the ADB has been approached by owners that are “willing to take a bit of a haircut” and, on the investor side, he expects these mechanisms to be considered ‘impact investments’, attracting capital that is prepared to accept a lower return in exchange for measurable environmental and social outcomes.

Beyond divestment

Calhoun at RMI believes coal transition mechanisms could complement investors’ commitments to stop funding fossil fuels. “We have seen a ton of commitments from the private sector in terms of alignment with the goals of the Paris Agreement," he says. "Increasingly, there is an expectation that these should not just be about passive alignment or divestment, but about actively supporting the transition.”

Many mechanisms explicitly enable the transition. In South Africa, monopoly utility Eskom is so hobbled by debt that it is struggling to raise capital to invest in new clean energy capacity. The $8.5bn Just Energy Transition Partnership could refinance the company to enable it to fund a clean energy transition.

Transition mechanisms are complex to design, however, and time is not on our side. Not only is the world’s carbon budget fast becoming exhausted, but the window for accessing low-cost capital may be closing, warns Guay at the Sunrise Project. Many of these approaches are predicted on low interest rates that may not persist, he says.

Credits from carbon?

Carbon markets could yet come to the rescue. Monetising the value of emissions that are avoided by closing down a plant early could provide an additional revenue stream to support coal-plant closure. In February, the InterAmerican Development Bank announced a $125m (106.2bn pesos) deal with utility Engie Energia in Chile that, among other things, uses the value of carbon offsets generated by the early closure of the company’s coal plants to reduce the cost of the debt.

For the time being, says Elzinga, the ADB has decided to proceed without recourse to carbon revenues. “We are designing the fund to operate without them, because they are too uncertain at the moment,” he says. That could change once carbon markets using Article 6 of the Paris Agreement become established, he adds, “but our analysis at this stage indicates our approach can work without them”.

The next few years will be critical, says Calhoun at RMI, to ensure the first coal transition transactions create high standards and provide maximum climate benefits. To that end, RMI has set out a number of principles. Coal transition mechanisms should be: equitable in how benefits are shared; additional in that they support close-downs that would not have happened anyway; transformational, in terms of enabling the low-carbon transition; and replicable at scale.

If those principles are followed, “we see a real opportunity to ensure that the customers and ratepayers who are on the hook for these uneconomic coal investments can put their resources towards energy systems that are aligned with climate, environmental and societal goals”, Calhoun says. “This is a really important moment.”

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