Kickstarting coal retirements in developing economies
Innovative financing mechanisms for managed coal phase-outs are steadily emerging, writes Aurelia Britsch, head of climate research, Sustainable Fitch.
Financing the early phase-out of coal-fired power plants in emerging markets and developing economies will be challenging. But replacing them with clean energy is vital to reduce emissions in line with the Paris Agreement. With the effective financing frameworks in place, it could become a key area of sustainable finance for these markets, which often struggle to attract climate capital.
Asia Pacific accounts for over half of global thermal coal capacity. The region features a young existing coal fleet and a very large pipeline of new projects slated for construction. These plants could operate well into the 2060s, long after all coal power generation would need to have ceased under many Asia Pacific countries’ net-zero pledges.
These concerns are prompting sustainability-focused investors and other stakeholders to develop mechanisms to retire coal assets before the end of their normal operational lives.
New financing mechanisms surfacing
Innovative forms of financing for managed coal phase-outs that are suitable for EMDEs – which usually face higher borrowing costs and debt burdens – are emerging. They aim to reduce borrowing costs and create new revenue streams to compensate for the shorter economic lifespan of the asset that will be retired.
Given the high complexity of most of these projects, concessionary forms of finance will be required to reduce the cost of capital, de-risk projects and attract private sector sources of funding. This can be achieved via blended finance, which continues to gain traction as a solution to bridge the climate funding gap in EMDEs. Multilateral initiatives, including the Asian Development Bank’s Energy Transition Mechanism and various Just Energy Transition Partnerships, follow this model.
Finding substitute cash flow streams for coal phase-out entities can also be bundled into the MPO transaction to make it economically viable. For example, creating coal MPO carbon credits, to be traded on voluntary carbon markets, has been proposed by the Monetary Authority of Singapore, among others, as one new solution to raise revenue from the transaction. It would provide the entity with direct compensation for avoiding emissions from coal power plants’ early retirement. While promising, creating this new type of carbon credit is at a very early stage and is a very complex endeavour.
Credible investment frameworks key to attracting private investors
While private-sector investor participation in these projects is essential, asset managers and financial institutions are concerned about the implications of increasing their financed emissions as well as reputational risks and greenwashing accusations.
In response, several international bodies have recently developed frameworks setting out principles and detailed criteria to improve MPO transactions’ credibility and encourage investor support. The most notable are the draft Singapore-Asia and the Association of Southeast Asian Nations sustainable finance taxonomies’ relevant criteria and the draft Glasgow Financial Alliance for Net Zero’s voluntary guidance on financing early retirement of coal plants.
In retiring coal power plants early, it helps avoid potential stranded assets and reduces air pollution for local communities, among other benefits for EMDEs. However, it also requires decision-makers to consider just transition issues, including replacing coal with renewable energy to maintain energy security, more access to finance from developed markets and softening the blow to local coal-dependent communities.
Implementation challenges abound in piloting Asia Pacific’s early coal phase-out
Examples of actual early coal plant retirement and replacement with clean energy projects in Asia Pacific remain rare and multi-stakeholder initiatives are in their very early stages. Multilateral development banks, including the ADB, are particularly active in this space, working on projects in Indonesia and the Philippines, among others.
The journey from discussion and planning to implementation is beset with hurdles. The sheer variety of entities and stakeholders involved in, or affected by, coal MPO projects means they are likely to take several years to be ramped up. They will also be structured on a case-by-case basis for now, given the lack of a one-size-fits-all financing model.
For now, investors are likely to proceed with caution given the absence of stronger policy signals from national governments. Most Asia Pacific jurisdictions have not made explicit coal phase-out policy commitments. It is also unclear to what extent Asia Pacific utilities wish to retire coal assets early as coal power remains competitive in the region.