Market dynamics should see the end of coal without additional funding to retire the plants
SIMPLE IDEA
One of the easiest ways to eliminate coal from energy systems could be to offer plant owners a financial incentive to switch to renewables DOUBLE TROUBLE
Detractors worry such incentives are not needed because renewables are forcing coal plants offline anyway—and the prospect of handouts might entice some plant owners to delay closures KEY QUOTE
Why am I bailing out a shareholder who has made an investment and had a return? The quest to cut carbon emissions and remove polluting forms of generation from the grid is leading to novel financing concepts. One particular scheme offers financial incentives to companies to close their coal plants in exchange for renewable investment. A form of this strategy is gathering pace in the United States through a “solar for coal swaps” model in Colorado and New Mexico. In February 2021, the Climate Investment Funds (CIF), a trust fund, announced a similar concept in Chile—but even as the idea is spreading, so are worries that it might be misguided. Gerard Reid, of renewables investment advisory firm Alexa Capital, calls it “very dangerous,” while James Ellis, of BloombergNEF, the new energy finance and research division of media company Bloomberg, says “the potential for moral hazard seems real.” Closing coal plants early clearly helps cut carbon emissions. Consequently, providing financial incentives to do so makes sense in markets where coal is still cheaper than renewables—provided decisions are made on an economic rather than political basis. Furthermore, the incentives being offered in the United States and Chile seem to be working. In the United States, rural electric cooperatives are switching from coal generation to solar provided by Guzman Energy in Colorado and New Mexico. The cost of closing the coal plants is borne by Guzman, which initially charges a premium on its solar power. Once coal closure costs are covered, Guzman’s solar electricity can be offered at much lower rates than the coal generation it replaces. In Chile, a pilot programme being run by the CIF and the Inter-American Development Bank (IDB) aims to give power companies access to preferential concessional finance terms in exchange for coal plant closures. “The model works by putting a monetary value on the greenhouse gas emissions that are avoided by decarbonisation efforts,” says the CIF. “That means that when a coal plant is closed and replaced with clean technology production, the reduction in greenhouse gas emissions this entails will be calculated and offered to the company or companies responsible.”
ACCESS TO FINANCE
In practice, the scheme has allowed energy company Engie Energía Chile to access low-interest rates on a $125 million financing package that will be used to install 160 megawatts (MW) of wind power. In return, Engie Energía Chile agreed to bring forward the closure of two coal plants, with a combined capacity of around 270 MW, by 18 months. The closures will cut carbon emissions by 1.2 million tons, the CIF says. The finance is subject to the energy company ensuring a just transition for workers where possible. For observers such as Alexa Capital’s Reid, the problem with this kind of scheme is that the coal plants would have closed soon anyway because of market forces. And that is something the asset owner should have to deal with, not get rewarded for. “That goes against everything I stand for as a capitalist,” says Reid. “A capitalist society is: if you take risk, you get rewarded for it.” “Sometimes, you get punished for taking on too much risk. And I would say Engie is not being punished for taking on the risk. They have done damage to the economy. They created an externality and they are not being punished for that,” he adds.
PAST BAILOUTS
This is not the first time that private companies have been let off the hook for investing in coal assets, he says. In 2016, the Swedish energy group Vattenfall got the blessing of the German government to offload loss-making lignite mines and thermal power plants in East Germany to a Czech consortium. The Financial Times newspaper reported that Vattenfall had been caught out by falling wholesale electricity prices caused by a growing share of renewable energy on the German grid. Vattenfall gave its lignite assets for free to Czech power company EPH and PPF Investments, owned by oligarch Petr Kellner. Plus, the Swedish company left €1 billion on the balance sheet to offset lignite mine clean-up costs. In 2017, the Institute for Energy Economics and Financial Analysis, a market research group, calculated the total value of the assets Vattenfall gave away was at least €4.7 billion, while clean-up liabilities amounted to around €1.8 billion. But “then the German government goes in and pays that oligarch to close those assets down,” Reid says. “This is mad. Why am I bailing out a shareholder who has made an investment [and] had a return?” Even worse, he says, there is a danger that offering incentives to switch away from coal may lead to delays in plant closures. “Why would I, in Germany, close my coal plant when the German government is going to bail me out?” he asks.
CHILEAN AMBITION
Ellis at BloombergNEF also has misgivings about the concept. “In Chile, coal still provides 35% of generation, so if the country is serious about decarbonising—which it is—it is hard to argue with doing everything you can today,” he says. “On the other hand, I am not totally sold that this type of carrot from CIF is necessary. Chile has already committed to retiring over 30% of its coal fleet by 2024 and to fully retiring coal by 2040.” Ellis notes that another Chilean power provider, Enel Chile, has closed plants ahead of schedule and will have no more coal in its portfolio after next year. Chile’s mining industry, one of the biggest users of energy in the country, is also switching from coal to renewables. In August last year, the Escondida and Spence copper mines, controlled by mining giant BHP, paid $840 million for the early termination of coal power contracts with energy provider AES Gener. Chile is already a leader in Latin America on phasing out coal. The country does not have coal reserves and has to import all its fossil fuels. At the same time, it has some of the best wind and solar resources in the world. At the end of 2019, Chile had become Latin America’s third-largest renewable energy market, adding 1.6 gigawatts (GW) of wind and 2.8 GW of solar power in the half-decade from 2014.
COAL IN DECLINE
In 2019, Chile unveiled plans to phase out its 5 GW of coal generation altogether by 2040. At the time, Engie had just commissioned a 375 MW coal-fired plant but all of the country’s power companies had committed to halting further coal generation investments. Meanwhile, the economics of coal in Chile have been under threat since 2017 when an emissions tax of $5 per ton of carbon came into effect. According to a 2019 study by BloombergNEF, the zero marginal cost of renewable energy sources led to a 52% drop in spot prices on Chile’s Sistema Interconectado Central grid, which serves 90% of the population. Because of all this, Chile’s power sector emissions are thought to have peaked in 2016 and are now falling. “It does seem that market forces, working in concert with the country’s proactive policy framework, could very well achieve the desired outcome without subsidising coal closures,” Ellis concludes. Abhishek Bhaskar, of the CIF, acknowledges that providing incentives for coal plant closures is a complex issue. “That’s something we grapple with when we are designing programmes,” he says. “A lot of this depends on a case-by-case basis.”
CLIMATE GOALS
CIF says the pressing climate crisis makes the finance models a requirement. “If we are to meet our climate goals, we cannot wait for everybody to decommission as part of the economic progression of the market,” says Bhaskhar. Being selective about which plants might be eligible for incentives could also avoid the problem of plant owners keeping power stations open in the expectation of getting a reward, he adds. One of the aims of the CIF’s Chilean pilot programme is to evaluate the best way to structure incentives and how to include controls to make sure later programmes do not backfire. If the CIF and the IDB can get it right, the plan is to extend the concept to other regions around the world later this year. Bhaskar says offering incentives for early coal plant closures could be an effective way of helping to decarbonise economies in many middle-income countries, including India, Pakistan, Serbia, South Africa and Ukraine. “This is a pilot, one of the first efforts in the world, and the IDB and other MDBs [multilateral development banks] are definitely looking to see the replication potential of this model,” Bhaskar says. For now, it is clear that any programmes that do emerge will have to contain significant safeguards to ensure they work better than simple market dynamics. Instead, “what they could do—the easiest way to do it—is just go and build renewables,” says Reid. “You put low-cost debt into projects in Chile and you automatically kill coal.”
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Jason Deign