How governments and financial institutions can accelerate the transition from coal in places like Indonesia, Vietnam, and Pakistan — and make investors whole
Some countries are making bold plans to eliminate coal. Recently, Indonesia’s president announced that the country will retire all coal and other fossil fuel plants by 2040. This tracks with projections that say coal power — the most polluting fuel source — must be completely phased out by 2040 to avoid the worst impacts of climate change.
But governments aren’t the only ones with a say in the matter.
In developing countries, coal plants are often financed by foreign investors. To attract funds for these costly projects, host governments sign contracts promising investors lucrative returns for years to come. Ending coal power by 2040 would mean shuttering many such plants years or decades ahead of schedule, conflicting with these promises.
Common wisdom holds that investors are most at risk in this scenario — that they will be forced to divest from or repurpose power plants to avoid further losses as the world moves away from coal. But new research from WRI finds that a much bigger share of the burden could fall on host governments.
There are viable pathways to keep rapid coal phase-out in reach if host governments, investors, and other stakeholders come to the table to negotiate.
We examined dozens of coal plant contracts and found that all of them require host governments to compensate investors, especially foreign ones, for actions that would drive early plant closures — creating a major disincentive for shifting to cleaner energy.
But these countries are not without options. There are viable pathways to keep rapid coal phase-out in reach if host governments, investors, and other stakeholders come to the table to negotiate.
How contracts can lock in coal power
Investment contracts for power plants are not unusual. The most common varieties include Power Purchase Agreements (PPAs) — long-term contracts where an off-taker, such as a utility company, commits to purchase energy at an agreed price — and Government Support Agreements (GSAs), in which host country governments provide investors with guarantees or other explicit support.
These contracts serve an important purpose. By offering predictable, stable returns, they’ve helped attract much-needed foreign investment to meet rising energy demand in developing countries. But where contracts are used to attract fossil fuel investment, they’ve also hampered governments looking to launch more ambitious climate action.
The problem is especially thorny in Asia, where many nations still rely heavily on coal power. We analyzed investment contracts in Indonesia, Pakistan, and Vietnam, where 40%-70% of coal plants are backed by foreign investors. These countries’ fleets are also very young. In Indonesia and Vietnam, the average coal plant age is under 11 years; in Pakistan, it’s just four. Considering that the typical lifespan of a coal plant is around 50 years, many of these plants will need to be shut down 10–30 years ahead of schedule to align with global climate goals.
In Indonesia and Vietnam, the average coal plant age is under 11 years; in Pakistan, it’s just four…. [M]any of these plants will need to be shut down 10–30 years ahead of schedule to align with global climate goals.
In theory, governments have a range of policy options to drive early coal retirement. They can mandate plant closures, enact more rigorous environmental standards, tax power plant emissions, or reduce operation hours. In reality, our study finds that any of these policy actions could trigger terms in a PPA, GSA, or other project contract that would require the government to compensate investors for their revenue losses.
For example, if Pakistan’s government plans to impose a national carbon tax, it would have to reimburse a coal project company for the increase in operation costs. If a plant is forced to close early, governments may have to pay back shareholders, outstanding project debts, and lost future equity returns.
The actual sums involved will be difficult to calculate, but it is clear that the cost to compensate investors could be immense. The estimated remaining value of existing coal plants in Indonesia amounts to nearly $15 billion. And the total amount would be higher still when future returns and unpaid interest are added in.
Host countries navigating budgets with limited fiscal space generally can’t afford such upfront costs. And they likely won’t attempt to break contracts outright, as these are backed by powerful international courts for settling disputes between investors and states. Appeals to these courts are lengthy — demanding resources countries may not have — and can result in massive settlements that strain governments and their standing with international investors.
The key principles for renegotiation are to involve everyone, to ask everyone to compromise, and to start early.
Going back to the negotiating table
To accelerate the coal power phase-out, governments will need to renegotiate these contracts to make early plant closures financially feasible. This is largely untrodden territory, but there are some cases already in development that can illuminate the path forward. The key principles for renegotiation are to involve everyone, to ask everyone to compromise, and to start early.
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Who will be at the table?
The first principle is to involve all stakeholders. Host country governments should be in a leading role; however, they will need support from multilateral development banks (MDBs), home countries of foreign investors, and other international investors to successfully renegotiate coal plant contracts.
Data shows that parties from China, Japan, and Korea account for the largest foreign coal investments in South and Southeast Asia.
Who will be on the other side of the table? Data shows that parties from China, Japan, and Korea account for the largest foreign coal investments in South and Southeast Asia. State-run banks such as the Export-Import Bank of China and Japan Bank for International Cooperation are top players. Behind these are the privately owned commercial institutions (such as Sumitomo Mitsui Banking Corporation).
It’s worth noting that development banks from China, Japan, and Korea have already stopped lending for new coal projects abroad, but they were some of the last to do so. Ending further lending for new coal projects should be a baseline for financial institutions worldwide.
What can parties offer one another?
Researchers and practitioners have discussed some mechanisms for financing early retirement. A coal plant could be refinanced with a new loan at a lower interest rate, purchased by a new entity at a lower cost equity, or financed by “transition credits” (generated from the early retirement). Closing a plant early entails a loss of revenue given that the plant will not be used to the end of its life. Under all these scenarios, every stakeholder needs to be willing to take a haircut or compromise for the negotiation to succeed.
With a total refinancing package worth $325 million, the (Cirebon-1) coal plant will be retired by the end of 2035 — five years before Indonesia’s coal phaseout target and seven years before the end of its useful life.
In Indonesia, the Asian Development Bank (ADB) and a local independent power producer agreed to a framework to retire the Cirebon-1 coal plant early. Japan and Germany provided grants and highly concessional funding through ADB, which will also help leverage finance from commercial creditors. With a total refinancing package worth an estimated $325 million, the coal plant will be retired by the end of 2035 — five years before Indonesia’s coal phaseout target and seven years before the end of its useful life. This deal allows investors to make back their investment, as ADB helped ensure that the financing package will not result in any loss or gain in present value for the coal plant owners. At the same time, it reduces emissions and encourages investors to redeploy capital towards clean energy.
Another example is a coal plant in Chile that was retired early with the help of the Inter-American Development Bank (IDB). The bank provided a loan to the original investor of the coal plant, Engie Energia Chile, to finance new renewable energy development — but the interest rate on the loan was tied to phasing down emissions from a specific coal plant. This helped retire the coal plant early while also bringing cleaner replacement capacity online.
What else could help enable the shift?
Developing and finalizing these specific plans will take time, and many challenges must be addressed — not just the legal ones we’ve detailed. But we know there could be several scenarios in which:
- Host country governments set clear targets to retire coal power stations early, aligned with global climate goals and national action plans, and prepare for early coal retirement on the regulatory front. They’d recognize the legal obligation under current contracts but negotiate to reduce the compensation owed to investors — perhaps by offering them other investment opportunities, such as expedited permits for converting coal plants to renewable energy.
- Companies and their backers foresee changes in policy and regulation and could waive certain compensation in exchange for more sustainable opportunities. This is especially relevant in cases where coal power plants already aren’t generating expected investment returns due to external factors (such as surging coal prices).
- Governments, from host and home countries, work with development banks to provide monetary incentives — such as lowering the cost of funding for refinancing existing loans — with the criteria that contracts will be shortened to allow for early retirement or repurposing to renewable energy plants.
Moving forward, it is crucial that legal frameworks used for energy investments do not hinder countries from pursuing sustainable development and climate action.
To scale up early retirement efforts regionally and globally, someone with a dedicated mandate and capacity needs to facilitate. In addition to their role as financiers, MDBs and other development finance institutions can fill this role. As a potential bridge between private finance, government, and affected communities, development finance institutions can help engage key stakeholders in an open and timely fashion. They can also provide legal support for contract renegotiations that seek alignment between parties. In the long term, they can help governments develop policies and provide finance to enable broader energy sector reforms.
Moving forward, it is crucial that legal frameworks used for energy investments do not hinder countries from pursuing sustainable development and climate action. Instead, they should encourage foreign investment in low-carbon technologies and a just clean energy transition.
To support this, countries and investors need to jointly assess the impacts of international investment agreements and the dispute settlement mechanisms that cover foreign investment in many countries. These weren’t designed with global Sustainable Development Goals and climate targets in mind. Alternative approaches, such as the use of risk insurance for investors and state-to-state mechanisms, may be useful. In the long term, a United Nations working group is taking a closer look at a possible reform of investor-state dispute settlement.
With coal’s end date fast approaching, acting now is key
Governments, especially in Asia’s coal-dependent countries, need to start retiring coal plants at a much faster pace than they’ve done to date. Legal protections for investors present a major hurdle, but one that it’s possible to overcome.
The key is to start now. With immediate support for renegotiation and early retirement actions, stakeholders can clear the way for a rapid shift to clean energy in one of the world’s most fossil fuel-intensive regions — a shift that will affect the whole world’s climate future.
This article was first published by the World Resources Institute. WRI is a global research organization that turns big ideas into action at the nexus of environment, economic opportunity, and human well-being.
To learn more, see WRI’s new working paper: Legal Implications of Early Decommissioning: Case Studies of Foreign-Invested Coal Power Plants in Asia
Featured photo: Indonesian President Prabowo Subianto. Credit: Flickr / Presidencia Perú
