TODAY’S STUDY: Ways To Cash Out Coal
Managing The Coal Capital Transition; Collaborative Opportunities For Asset Owners, Policymakers, And Environmental Advocates
Annie Benn, Paul Bodnar, James Mitchell, and Jeff Waller, September 2018 (Rocky Mountain Institute)
Coal was the preeminent fuel for grid-based electricity generation around the world for the better part of a century, but its time is coming to an end. With this transition, however, workers and communities are experiencing layoffs and the owners of coal-fired power plants are bracing themselves for hundreds of billions in write-offs. This report intends to start pragmatic conversations on the coal capital transition: the collaborative management of capital exit from coal-fired generating assets in line with their decreasing economic competitiveness compared to clean energy, and in line with the objective of limiting global warming to well below 2Cº.i
The early retirement of coal plants across the world has enormous financial implications for asset owners, policymakers, and environmental advocates alike. Managing the exit of capital from coal-fired generating assets demands thoughtful and collaborative planning among these stakeholders.
Coal-fired power generation is in structural decline, and its role the global energy mix will continue to diminish due primarily to economics. This erosion is structural, not cyclical, and is driven predominantly by cheap gas, inexpensive renewables, and the costs associated with complying with environmental regulations that seek to reduce air pollution and address climate change.
The clear downward trend for coal power increases the likelihood of widespread stranded assets and capital destruction. Coal-fired power plants around the world that were designed to operate for decades longer are under pressure to shut, in many cases before associated debt has been paid off. Whether these assets are stranded because of changing economics or regulations (or a combination of the two), coal plants worldwide are at high risk for creating stranded value for owners—that is, the assets’ actual financial returns will be less than what had been expected at the time of initial investment.
While economic trends are slowing the growth of coal capacity and leading to a significant amount of uncompetitive coal-fired capacity to shutter, these trends alone will not be sufficient to reduce global greenhouse gas emissions consistent with the Paris Agreement objective of holding warming well below 2 Cº. Leaving aside planned or announced coal plants not yet online, emissions from the existing coal power plant fleet alone exceed levels consistent with globally agreed temperature goals.
Under least-cost pathways for holding warming well below 2Cº, coal closures would need to begin immediately across all regions and be completed by roughly 2030 for Organisation for Economic Co-operation and Development (OECD)/European Union (EU), 2040 for China, and 2050 for the rest of the world. Based on the actual technical lifetimes of the existing coal fleet, significant early retirement of current capacity would be necessary, including 198 GW in the OECD, 844 GW in China, and 199 GW in the rest of the world. This holds the potential to strand hundreds of billions of dollars of value globally.
The specter of capital losses fuels opposition to policies aimed at accelerating the energy transition. From the perspective of asset owners, lobbying against climate and clean energy policy is an economically rational response to prospective stranding. As a result, the energy transition is happening in fits and starts. For their part, environmental advocates have focused on the adjustment costs for labor and communities associated with layoffs and the need for a just transition for labor. However, this problem-solving approach has only just begun to be applied to the prospect of write-offs. We recommend it be considered more consistently.
With a better understanding of an asset owner’s legitimate day-to-day business perspective, policymakers and advocates can better appreciate how coal plant owners assess their plants’ current and future financial performance. More importantly, a nuanced understanding of this financial perspective can help anticipate an owner’s likely business strategies, political positions, and amenable exit options, positioning them well to engage directly with owners to proactively manage the coal capital transition. The Asset Position Framework does this by classifying assets into one of four positions based on their current and projected future financial performance: continuing operator, short-term opportunity, exit opportunity, and wait and see. An asset’s position on the framework will determine an owner’s likely business strategy with the asset, political strategies, and asset exit options.
For asset owners, proactive planning for the end of the coal era can preserve shareholder value and avoid financial shocks to equity and debt holders alike. Policymakers and advocates focused on climate objectives are seeking ways to accelerate the transition of energy sector capital stock from brown to green, including through early retirement of coal assets. But stranding these assets is not—and should not be—the goal; the loss of value associated with stranded assets is an undesirable consequence that, while to some extent inevitable, should be actively mitigated to ensure that all stakeholders are on board with the direction of the energy transition. Instead, policymakers have an opportunity to understand and implement a new toolkit to spur faster energy transition through dialogue rather than adversarial approaches. And environmental advocates can advance their objective of accelerating the clean energy transition and avoid costly and lengthy conflicts with incumbents. Regardless of the region or market circumstance, it is in the interest of owners, policymakers, ratepayers, and other stakeholders to develop a managed plan for capital transition that can reasonably limit losses and allocate them appropriately.
This report is the first global survey of approaches that can help ease capital destruction for asset owners and their shareholders while offering policymakers a clearer path toward transitioning the power sector onto a below-2Cº pathway.
…[There are] 10 policy components for managing the capital losses associated with early retirement of coal-fired generating assets…[and] six factors stand out as especially important in shaping policy choice:
1. Power market type. Some policy options apply only to regulated markets.
2. Policymaker capacity. Some policies require significant decision-making authority on the part of policymakers, as well as technical and resource capacity for implementation.
3. Bearer of losses. Every approach improves the value proposition of asset retirement by either worsening the economics of continued plant operation or increasing the benefits of closure. This requires that capital losses are borne by some combination of government and/or asset owners.
4. Ratepayer impact. The application of some approaches may increase costs to ratepayers, which has important implications for policy design and implementation.
5. Investment climate. If policy actions are perceived as capricious or unwarranted, they can erode trust between regulators and business.
6. Moral hazard. Approaches where the government bears the losses—in the form of compensation to owners—typically carry a degree of risk of moral hazard.
COMBINING POLICY COMPONENTS
The 10 policy components for managing capital losses discussed above are presented individually to highlight the applicability and challenges of each. In practice, however, combining policy components provides flexibility both with the timing of policy implementation, as well as with the ability to allocate— or reallocate—losses across parties. For example, a comprehensive policy could include a future mandated coal phaseout date combined with components designed to alter the coal plants’ operating economics. The aim of these components could be to encourage faster retirement (e.g., by including environmental regulations that impose escalating costs) or to provide increased interim compensation to allow coal plant owners to maximize the return on their investment prior to the phaseout date (e.g., by offering alternative revenue streams). Four case studies of coal closures in Alberta, Chile, China, and Colorado demonstrate that there are no one-size-fits-all solutions. Complete policy packages are built from the ground up using policy components fit to their specific context.
Managing the financial implications of stranded coal assets requires a balanced perspective that takes into account the perspectives of three major groups: coal plant asset owners, who stand to bear the burden of capital losses associated with premature closure of coal-fired generating assets; environmental advocates, who seek to accelerate coal phaseout in line with the objectives of the Paris Climate Agreement; and policymakers, who must balance the environmental necessity of accelerated coal plant retirement with thoughtful, managed allocation of the associated capital losses.
• Understand the context. The economics of operating coal plants vary by geography and by plant. Depending on the financial position of individual plants or portfolios, asset owners may be looking for, or be open to, an exit strategy.
• Shift the conversation. The challenge is to present an alternative economic equation to asset owners that is sufficiently attractive to encourage acceptance rather than resistance to the notion of early asset closure.
• Know your options. The 10 strategies presented in this report are grounded in a global survey of approaches that have been formulated in various jurisdictions to address this issue.
• Customize. There is no one-size-fits-all policy solution. Components can be combined to create a package tailored to the needs of all stakeholders involved. Depending on the chosen approaches, the question of policy institutions’ technical and human capacity to design and implement the solution can be critical.
• Build support. Thoughtful, managed allocation of the associated capital losses through combinations of the strategies surveyed in this report—and others that have not yet been designed—can build support among key political constituencies. Key to productive dialogue is ensuring that outcomes are viewed as equitable among all stakeholders impacted by stranded assets.
• Balance risk. In formulating coal capital transition strategies, policymakers should carefully balance maintaining the credibility of the local investment climate with the serious issue of moral hazard.
• Acknowledge trends. It’s time to acknowledge that coal-fired power generation is in structural decline worldwide. While there are and will continue to be exceptions, eroding economics and declining load factors globally demonstrate this clearly, regardless of one’s view of the merits or durability of climate policy.
• Recognize that the risk of stranded value is real. While the decline of coal-fired power generation is at different stages in different geographies, some capital destruction associated with early closure due to both economic and regulatory stranding is inevitable.
• Leverage the benefits of planning. Proactive planning for the end of the coal era can preserve shareholder value and avoid financial shocks to equity and debt holders alike.
• Understand what’s feasible. Asset owners should acknowledge that from a policymaker’s perspective, they rarely have claim to compulsory compensation and that moral hazard is a real and legitimate concern. Still, policymakers also have a strong incentive for pragmatic dialogue.
• Build on existing dialogues. While they may feel frequently at odds with environmental advocates, coal asset owners should build on the principles for just transition of labor.
• Understand the owner’s perspective. To accomplish the early retirement of the coal fleet requires acknowledging that from an asset owner’s perspective, opposing policies that would cause such financial hardship is economically rational.
• Link to a “just transition.” If environmental advocates are serious about neutralizing political opposition to climate action, they need to look seriously at rational decisions motivating this opposition. Therefore, an integrated approach to addressing layoffs and write-offs associated with early coal plant retirement is essential.
• Manage trade-offs. Many of the solutions presented here come with difficult trade-offs, using funds that will undoubtedly be limited. Advocates must work alongside policymakers and asset owners to ensure that these trade-offs are being weighed appropriately. Once agreements are reached, advocates must enforce those agreements in the public sphere.