Paying coal plants to shut down seems nuts. But it could help the climate and save money … if it’s done right.
Coal buyouts are the hottest climate finance trend post COP26. Whether it’s HSBC and the Asian Development Bank building a fund for coal plant closures in Asia, Citi and Trafigura releasing plans for a global coal-mine closure fund, or Larry Fink, CEO of BlackRock, the world’s largest investor, calling for a fossil fuel “bad bank,” it appears buyouts are a necessary evil whose time has come.
The fundamental premise justifying these efforts is this: Utilities have invested billions of dollars in coal plants that must be closed as soon as possible to combat climate change.
Many coal plants are closing thanks to the shifting economics of clean energy, which is increasingly undermining their value and rendering them stranded assets. But according to RMI and Carbon Tracker, 93% of plants worldwide are insulated from market competition by long-term contracts and noncompetitive tariffs. They’re sheltered from the economic storm and can hang on well past the deadlines for closure indicated by climate science.
Buying out these financial liabilities could not only speed the path toward mass coal closures but also quickly turn costs into savings for customers and utilities alike. Those savings could then be put to use funding new clean energy to replace dirty coal-fired power and helping coal industry workers find new employment.
To make that happen, governments are looking to provide public funding to seed new funds or investment vehicles. Private-sector asset managers will be engaged to broker transactions, raise funds and provide overall financial management.
During COP26, a series of coal retirement funds were announced to buy out and permanently retire old coal assets. A coalition of donors made $8.5 billion available for a just transition beyond coal in South Africa, the most heavily coal-reliant country on the continent. The Asian Development Bank unveiled a plan to retire half of the coal fleet in Indonesia and the Philippines over the next 15 years. Initiatives like these will require scrutiny from watchdog groups to ensure they benefit the public, not the big banks, but there’s no doubt they augur a new era in international climate finance.
Buying out these financial liabilities could not only speed the path toward mass coal closures but also quickly turn costs into savings for customers and utilities alike.
But as ever, the devil is in the details of these commitments — which at this point seem scarce. Unfortunately, we have no time, or political capital, to waste. So we must get this first wave of coal buyout proposals right. Before we rush headlong down this path, we’re going to need strong principles by which to judge these pioneering funds so the necessary doesn’t get swamped by potential pitfalls and greenwash.
Coal buyout funds are getting a frothy reception from banks and fund managers
Here are five principles that policymakers would be wise to consider before committing public funds to coal buyouts.
1) Align incentives through public ownership.
There’s good reason to be uneasy about the frothy reception coal buyout funds are getting from some of the biggest banks and fund managers in the world. These private-sector moguls are motivated to make money while many of the rest of us prioritize solving climate change. Those motivations don’t always align. It’s not hard, for instance, to imagine a profit motive getting in the way of retiring an old coal plant or coal mine if market conditions change and there’s suddenly a buck to be made.
Those misaligned incentives need to be addressed upfront through the creation of new holding companies, endowed with public dollars, leadership and oversight, with a clear mandate for coal closure. A new entity created by an international financial institution like the Asian Development Bank or a new green bank in the U.S. would then be free to partner with the private sector to manage the funds. A publicly-owned entity would be in the driver’s seat, and it would be calling the shots.
2) Achieve market-based pricing through reverse auctions.
This is probably the most important thing to get right. If public dollars are used to overpay polluters, these funds are dead in the water. The problem is that estimates for buying old coal plants floated by some of the proponents of these funds are dramatically higher than the going rate in the market.
If public dollars are used to overpay polluters, these funds are dead in the water.
For instance, one proposal suggests 5 gigawatts of existing coal plants could be purchased for anything from $1,000 to $1,800 per kilowatt. But recent reverse-market auctions run by the German government to buy out and retire coal plants ended with average prices of $78 per kilowatt, according to Agora Energiewende –– less than a tenth of the cost. In India, utilities are estimated to save more than $1 billion per year by shutting down old coal plants, implying they have a negative value.
We need to be cautious about overpaying for stranded assets
Since these coal retirement funds are targeting soon-to-be-stranded coal plant assets that are likely worth a fraction of their book value, we need to be cautious about overpaying with the public purse. We won’t achieve that if private-sector companies lead as the ultimate beneficiaries of these deals. In that case, they would be incentivized to inflate asset values, juice returns and take advantage of public dollars. But if a public entity is in charge, we run reverse auctions, announce a limited total amount of public finance available and have the private sector play the role of brokering deals and encouraging sellers to compete. Then prices will fall and we all win.
3) Don’t use public dollars to juice private returns or game carbon markets.
Unless you’ve been hiding under a rock, you’ve probably heard the hype around blended finance, which is a way of using public dollars to de-risk private investment and ultimately increase private returns. There can be good reasons to use scarce public dollars this way — jump-starting new clean energy markets in places like Southeast Asia comes to mind — but this is not one of them.
We’ve already established that profit shouldn’t be the mandate of these funds. It follows that public dollars should never be used to increase investor returns, particularly on soon-to-be-stranded assets in desperate need of an exit.
We should also demand interim targets showing how terawatt-hours of generation capacity and tons of coal mined align with these final deadlines.
Moreover, in no world should the utilities that made catastrophically bad decisions to build new coal plants, or the private equity investors smart enough to buy them up on the cheap and demand a premium from the public for shutting them down, be allowed to hold us hostage in exchange for “market-based” returns.
That aversion to market-based returns includes being smart about how these retirement funds engage in carbon markets. A coal plant slated for early retirement could, ironically, become an asset that generates vast amounts of emissions credits — coal plants are the largest source of carbon, after all — and therefore revenue. We need to cap the returns these funds can make by selling credits into carbon markets so that they’re not in essence getting paid twice for the same action or flooding markets with vast volumes of credits from avoided emissions.
4) Buy time by accelerating our retirement schedule.
The only thing we can’t make more of as we race to deal with climate change is the thing we need most: time. The single most important goal for these funds is that they help coal plants retire earlier than they otherwise would have. That means aligning the funds’ mandate with the International Energy Agency’s net zero scenario and its crystal-clear deadlines for coal plant phaseout, which stand at 2030 in Organization for Economic Cooperation and Development (OECD) countries and 2040 in the rest of the world. These deadlines should be used to set the baseline retirement age against which we should be calculating payments for units that were not otherwise planning to retire.
Ending the zombie cycle of uneconomic coal plants is an economic opportunity
But given that we’re trying to make this happen faster than it might without intervention, payments should be prioritized that will force coal plants to retire well in advance of those deadlines. We should also demand interim targets showing how terawatt-hours of generation capacity and tons of coal mined align with these final deadlines.
5) Ensure a clean, just replacement.
Last, and certainly not least, we need to ensure these assets are replaced with clean energy and that workers harmed by their closure are taken care of in the process. Closing a coal plant and replacing it with new base load natural-gas-fired power is a pyrrhic victory. The International Energy Agency has made clear that gas must be phased out just five short years after coal is. That means we can’t afford to buy out coal and just a few years later turn around and buy out the gas plant we allowed to be built in its place.
Instead, let’s use these transactions to leverage the existing transmission and distribution infrastructure left behind — real value in a world in which transmission siting is nearly impossible — to replace fossil fuels once and for all with new clean energy. In addition to that value, we could be generating important new sources of clean energy investment by capping the revenue a fund can earn from carbon markets at, say, $10 per ton, and plowing any additional revenue earned in carbon markets above that strike price into new clean energy development and worker transition funding.
Ultimately, policymakers, international financial institutions endowed with public dollars, and foundations around the world have to go slow to go fast. Yes, we’re excited by the opportunity to end the zombie cycle of uneconomic coal plants being kept alive by regulated markets where they’re sheltered from the rapidly changing economics of the energy transition. But in that exuberance, we can’t be irrational. If we get the details wrong, we won’t get a second chance to get them right. With COP26 looming, let’s make sure coal buyout proposals pass muster and align with these principles before we bless them with acceptance or public dollars.
Note: An early version of this story first ran in Canary Media.