Category: Sustainable Finance Lab Post

The Recent Reshaping of Renewable Energy Investment

Exhibit: % of Renewable Energy by Finance Source, 2013-2020

Source: CPI

Key Points: Renewable energy (RE) investment shifted to commercial lending/securities from project finance in the 2010s, reflecting growing comfort with solar/wind technologies as well as a China industrial policy tool. The shift likely helped RE growth in 2021-22 in the OECD. “Direct” institutional investment is seen as a key enabler in developing economies.

A detailed study of renewable energy finance trends. In late February, the Climate Policy Initiative (CPI) and International Renewable Energy Agency (IRENA) published their third biannual report of investments in Renewable Energy, segmenting by region, technology, source of financing and grid/off-grid. The data and analysis concentrate on 2013-2020, although there is some data available through 2022.

No significant growth in RE investment in 2014-2020… The value of investment in RE from 2014 through 2020 was relatively unchanged, fluctuating between $260 Billion (B) and $350B (see figures at the top of the Exhibit for annual detail). A step-up in RE investment began in 2021 and reached $500B in 2022 (please see this recent Payne blog for discussion).

…But there was a change in where the money came from to make the investments. The composition of the financing sources, however, shifted considerably, to a mix of 56% debt/44% equity in 2020 vs. 23% debt/77% equity in 2013. The shift occurred largely as project-level (project financed) equity was replaced by balance sheet (i.e. corporate) debt. Project-level equity fell to 10% of total sources by 2017 from 30-40% in 2013-2016; balance sheet financing, in which a company borrows from commercial lenders or securities markets, grew to 30% of total sources by 2020 from 0% in 2014 (see Exhibit).

The maturation of solar and wind technologies allowed for the shift. The growth in commercial lending and marketable securities, which are less expensive and much more broadly available than project financing, reflects increased comfort with solar and onshore wind technology. The growth in lending was, however, not all driven by market forces. It also reflected policy decisions — the most important example being in China, which established a Feed-in Tariff to encourage wind development and directed Chinese state-owned financial institutions to lend to wind projects.

Institutional investor direct project investment is well below 1% of total financing. The study notes the very limited role institutional investors, including pension funds, insurance companies, sovereign wealth funds and endowments and foundations, play in directly funding RE investment. These entities combined to invest in a range of $300 Million to $1.3B per annum over 2013-2020.

These institutions do provide capital support, investing through established capital markets (i.e., they buy listed stocks and bonds). But with their collective tens of $Trillions of assets under management, their direct participation in projects is seen as a powerful tool in fostering significantly more RE development in developing economies. It is perceived that direct investment is required for developing economies given relatively immature capital markets and lending institutions in these countries.

The argument that this group might be interested in making these direct investments is based on the idea that they have:

longer investment time horizons,
stated goals to decarbonize their investment portfolios, and
(arguably) some willingness to earn more modest rates of return (as long as the risk profile is commensurately lower).

Spurring more direct investment from these entities, however, involves overcoming a number of hurdles, including providing local knowledge and country- and project-specific risk amelioration; it likely also requires them making specific changes in their investment mandate to include more tolerance for longer term, less liquid holdings (i.e. to be willing to hold onto their investments for a long time).

3/6/2023

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Energy Transition Investment Tops $1 Trillion in 2022

Total Investment in Low Carbon by Category, 2022 ($Billions)

Source: BloombergNEF

Key Points: Global spend on energy transition hardware was US$1.1 Trillion in 2022, up 31% from 2021, per BloombergNEF. Another $350 Billion went towards power grids and manufacturing capacity. China continues to dominate, reflecting its ambition but also highlighting geopolitical/supply chain risk. Net Zero investment modeling suggests far more spend is needed.

BloombergNEF cites US$1.6 Trillion put or raised toward the energy transition in 2022. In its latest annual study of energy transition investment, BloombergNEF tallied $1.1 Trillion (T) of spending globally on specific hardware related to the supply and demand for low carbon power (with a sliver of spending on carbon capture); $274 Billion (B) on power grids to support growth in electrification; and $79B in Supply Chain & Manufacturing (=investments in factories/capacity to build low carbon equipment). See Exhibit.

It also counted $119B of equity capital raise (public and private) for companies in the energy transition space. This category is a bit of an orphan. It does not jive with the other figures, which are of spending, and it doesn’t reflect equity raised by, say, legacy firms that also engage in non-climate tech activity but that have raised money to invest in low carbon energy. It can, however, offer some perspective on spending capacity and prospects for new technology development and trends over multiple years may be telling.

Just under 90% of the $1.1 Trillion in energy deployment spend on renewables or electrified transportation. Renewable energy comprised $495B (45%) of the $1.1T spent; electrified transport (which includes EVs and charging infrastructure) spend was $466B (42%). See Exhibit.

China accounts for ½ of the $1.1 Trillion; India is the only other non-OECD country in the top 10. BloombergNEF tallies $546B in energy transition spending by China in 2022, or 49% of its global total (excludes the grid and the supply chain spending categories described above). The U.S. ranked second with $141B and Germany third with $55B. Of the rest of the top 10, only India (8^th place with $17B) was not in the OECD.

Supply Chain & Manufacturing spend dominated by China; skewed to batteries. Global Supply Chain & Manufacturing spend rose 44% in 2022 to $79B. By target, $45B (58%) of the total was directed at batteries followed by $24B (30%) at solar. China accounted for over 90% of the spend, up from ~70% in 2021; the mix was impacted by year-over-year decline in Europe after strong spending on battery manufacturing in 2021 partially offset by growth in the U.S.

Net Zero Studies have estimated that far more needs to be spent per annum. BloombergNEF notes in this current study that the approximately $1.4T spent in 2022 (hardware plus grid) pales in comparison to the average $6.4T in annual spend that it has calculated separately will be required for the world to achieve Net Zero emissions by 2050. Its estimate is in the ballpark with McKinsey’s estimate, made ~one year ago, of $5.5T of required annual spend on mobility and power to achieve the same. Such estimates suggest dramatically higher spending will be required for much of the world outside of China.

1/30/2023

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Environmental Debt Issuance’s Very Strong 2022

Exhibit: Annual “Impact” Bond Issuance by Type (US$ Billions), 2018-2022

Source: Intercontinental Exchange (ICE)

Key Points: Green bond issuance fell 1% year-over-year in 2022 to US$487B, a stark contrast to overall debt issuance’s 20% drop to $52 Trillion. Sustainability bonds fell 25% to $152B. Sustainability-Linked Bonds appeared to fall around 25% as well, suggesting that integrity concerns did not weigh meaningfully on this segment, despite financial outlet narratives.

ESG bond issuance fell 13% year-over-year (yoy) in 2022 vs. total issuance down 20%. Per statistics from the Intercontinental Exchange (ICE), Impact bond issuance fell 13% yoy to US$771 Billion (B) in 2022. On a percentage basis, declines were led by lower issuance of Social bonds (-32% to $132B) on lower pandemic-support. See Exhibit.

Green bond issuance was most resilient (-1% to $487B), supported in part by growth in China and Germany, but also by relative resilience among corporates (corporate Green bond issuance fell by only 4% yoy to $289B).

Per Bloomberg data, total global bond issuance fell 20% to US$52 Trillion (T). The decline was driven by the dominant government sector, which fell 21% to $39T. (US Dollar strength no doubt aggravated declines in 2022; there is no attempt made herein to adjust for currency when comparing Impact bond issuance with the overall market.)

Evidence mixed on whether Sustainability-Linked bond (SLB) issuance was affected by integrity concerns. Issuance of SLBs appears to have fallen in line with Sustainability bonds. Assessments varied across different financial outlets but arguably coalesce around a 25% decline — e.g., a tally by Bloomberg suggested SLB issuance fell 17% to $86B in 2022 from $103B a year earlier while Environmental Finance reported that it had fallen 26% to $70B in 2022 from $94B a year earlier. (ICE did not report data for this SLB segment.)

These outlets and others wove into their commentaries that SLB issuance was weighed down in 2022 by integrity concerns (both inadequately ambitious targets for decarbonization and weak penalties for missing targets). EF noted in the same report that corporate SLB issuance fell 32% (to US$62B) and so governments (e.g. Chile, Uruguay) partially offset. And given the dramatic growth in SLB issuance in 2021 — roughly 10x from 2020 — one might have expected continued growth simply from annualizing or from having more entities get up to speed on the tool. Yet SLB’s relatively comparable decline with the overall debt market suggests that the impact of additional scrutiny was likely modest; perhaps it will have more of an impact (either in issuance volume or the Key Performance Indicators in the bonds) going forward.

January 23, 2023

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A Global Public Good Push for the World Bank

Key Points: The World Bank Evolution Roadmap includes expanding focus to include climate change and pandemic response and changing operations to mobilize more private capital. Ideas for the latter, most being revisited, include expanding what can be considered WBG equity capital, diversifying from providing senior debt and selling off loans to recycle capital.

The World Bank issues Evolution Roadmap Paper to broaden its mandate. In early January, the press reported seeing a leaked World Bank Group (WBG) document called the Evolution Roadmap Paper. This strategic and operations review, which was prompted by its government shareholders, considers (more formally) including in its mandate (1) broader poverty alleviation (beyond extreme levels) and (2) funding investment in “Global Public Goods” including climate change and pandemic preparedness and response.

Multilateral Development Bank (MDB) watchers appear to generally agree with the strategic shift to include these global challenges. On climate funding, however, some have raised concerns about the WBG’s historical inefficiency, i.e., greenhouse gas reduction per dollar spent, and that climate-related financing to middle income countries might “win out” over poverty eradication in poorer countries. Regardless, changing incentives for MDBs to provide more (and more effective) climate finance, which can include being measured on transformation (and climate impact), is a critical starting point.

Operationally, much of the emphasis is on mobilizing more private capital. The WBG paper points to a shortcoming in legacy MBD concessional lending in terms of attracting private capital (i.e., catalyzing or mobilizing private investment). This shortcoming has been recognized for years, including by the MDBs themselves.

The Evolution Roadmap offers several ideas to mobilize more private investment without spreading WBG capital too thinly and thus sacrificing its strong credit ratings. Suggestions include giving explicit value to contingency capital that is callable from shareholder governments, innovation in mechanisms to provide concessional support (e.g. issuing debt that is subordinated to private lenders, greater use of guarantees, etc.), mechanisms to bring in private capital into MDBs and selling off/syndicating loans (for more on these last two, see below).

Multilateral Development Banks (MDBs) mobilize capital indirectly and directly. The late-2022 announcements of JET partnerships illustrate the potential indirect impact of public/MDB funds: if they support local government institutions, it can unlock private capital. This can involve technical education/support — for example assistance in loosening power market regulations that might give new renewable energy (RE) generation more commercial opportunities. Or it might be infrastructure-related — such as helping to fund a national utility expand transmission and distribution capacity to accommodate new RE generation.

MDBs can also have a direct catalytic impact through co-financing: with an MDB providing a tranche of lower cost debt and perhaps some form of risk assumption (e.g., taking losses first), it supports private entities co-financing the project at (reasonable) market rates.

Selected ideas include new types of investment opportunities for private capital. We note three ideas, which include recommendations of an Expert Panel tasked by the G20 to boost MDBs’ investment capacity, that explicitly involve deploying private capital. The first two allow MDBs to do more of what they do today; the third ties with an indirect/facilitator role.

Introducing non-voting capital. This is envisioned as equity or perhaps hybrid/interest-bearing instruments provided to WBG (and so is not project-specific) by private investors. Such investments could help these private actors boost/meet ESG or sustainability commitments in their portfolios.
Selling off loan portfolios/securitization. WBG would continue to originate and administer loan portfolios but would either sell off parts of the loans or engage in some form of (synthetic) securitization. This has been trialed successfully by the African Development Bank.
Support development of VCM, including being a “trusted intermediary.” WBG is currently sponsoring a blockchain-based ecosystem for warehousing credits registered in various markets and is supporting development of a centralized, digital infrastructure that connects various registries’ systems.

January 17, 2023

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Voluntary Carbon Markets Softened in 2022

Exhibit: Carbon Offset Credit Issuance by Project Type, 2021 and ~10 Months 2022

Source: Berkeley Voluntary Registry Offset Database (VROD)

Key Points: With data through early November, VCM offset issuances (supply), retirements (demand) and pricing are poised to have weakened in 2022 vs 2021. The reasons vary but include processing logjams and correlation with equity markets. A more than doubling of corporates making decarbonization commitments in 2022 supports an outlook for strong multi-year growth.

2022 YTD credit issuances down 19% vs. the same period in 2021. Voluntary Carbon Market (VCM) issuances of 217 million tons of CO₂-equivalent (CO₂e) offset credits year-to-date (YTD) in 2022 are down for two reasons (for details on the database see the last paragraph). First, there is a logjam in processing project approvals. Per Trove Research, a consultancy, the pipeline of projects pending approval from the VCS and Gold Standard registries had risen 118% year-over-year (yoy) by the end of 3Q22 to 421 million tons. Second, there have been moratoria put in place by certain countries in issuing Forestry & Land Use credits as these countries assess the impact of issuing voluntary credits on their ability to meet their future decarbonization (Nationally Determined Contribution or NDC) commitments.

For context, although the comparisons are imperfect because we compare all of 2021 with YTD 2022 (through November 9^th), the reduction in total credits issued in 2022 is led by Renewable Energy (down 35% yoy) and Forestry & Land Use (down 33%) (see Exhibit).

With respect to the project logjam, Verra has cited labor scarcity as a factor, as is the rapid increase in number of project requests. Verra’s efforts to ‘break through” the logjam include training new hires, establishing a new verification oversight team and implementing new automation to streamline the project review process for faster as well as proper substantiation. Verra is the parent of VCS, which is the largest project registry (with approximately 2/3 of issuances this year in the database).

2022 YTD retirements down 24% vs. all of 2021 at 122 million. The decline in retirement demand can likely be attributed to lack of company confidence generally — Trove, for example, has calculated a strong correlation between retirement demand and equity market (S&P500) performance over the last two years — as well as to possible concern regarding quality of the credits given the very public conversation about raising overall project integrity in the market.

Pricing also looks to have fallen. From an average of $9.50/ton of CO₂e in Dec-2021, average offset credit prices fell more-or-less steadily (barring spikes related to project mix) to $6.40/ton by late October 2022. This decline occurred despite a consistent trend of “younger”, i.e., more recent, vintages being purchased through the course of 2022, which, all else equal, command higher prices as they are perceived to be of relatively higher quality than older vintages.

Increase in corporate commitments to decarbonize suggests medium term demand growth. The total number of companies This suggests significant growth in demand for carbon offsets through the current decade as most, if not all, of these companies will take action to neutralize residual emissions beyond their value chains by purchasing high-quality credits for removal.

Background on the VCM data. The Berkeley Carbon Trading Project recently released the latest version of its Voluntary Registry Offsets Database (VROD), with data through November 9th, 2022. The VROD contains all carbon offset projects, credit issuances, and credit retirements listed globally by the four largest voluntary offset project registries: American Carbon Registry (ACR), Climate Action Reserve (CAR), Gold Standard, and Verified Carbon Standard (VCS).

December 19, 2022.

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Hess’ Massive Guyana Carbon Offsets Commitment

Exhibit: Hess Operated and Equity Scope 1&2 Emissions, 2019-2021

Source: Hess

Key Points: Hess committed $750MM over 15 years to buy forest preservation carbon offsets in Guyana. The annual purchase is to equal Hess’ operated Scope 1 CO₂e emissions in 2021 and 2% of last year’s entire Voluntary Carbon Market value. Hess is taking 30% of this first jurisdictional REDD+ credit issuance under the ART-TREES standard, which has claimed an integrity high ground.

Hess Corporation commits to US$750MM+ in carbon offset purchases from Guyana. Announced in early December, Hess is to purchase 2.5 million (MM) carbon offset credits per year for the years 2016-2030 (each credit of a carbon offset reflects 1 metric ton (tonne) of CO₂ equivalent [CO₂e] avoided or reduced). The company has committed to minimum pricing, which starts at US$15/tonne for the first five years (2016-2020), $20/tonne in 2021-2025 and $25/tonne in 2026-2030; Hess also agreed to pay to Guyana 60% of the difference between the minimum price and a “market price” in any given year. Further the company has committed to buy its 12.5MM allotment of the credits covering 2016-2020 within 18 months.

Annual purchase commitment = Hess’ 2021 operated Scope 1 CO₂-equivalent emissions. Hess reported 2.5MM tons of operated Scope 1 CO₂e emissions in 2021, a decline of 0.7MM from a year earlier, and 0.4MM tons of operated Scope 2 CO₂e emissions (flat year-over-year). See Exhibit. As a point of reference, on an equity-ownership basis the company had 3.8MM tons of Scope 1 + 2 emissions and 43.4MM tons of Scope 3 emissions. This Guyana commitment goes well beyond its stated commitment in its most recent Sustainability Report (2021) to offset its Scope 2 emissions with either Renewable Energy Credits or carbon offsets.

Hess is buying 30% of the authorized/expected credits being issued from 2016-2030. The Guyana program anticipates issuing a total of 125MM carbon offset credits through the 15 years ending 2030 (Hess is committing to buy 30%, or 37.5MM). The first block of credits, covering 2016-2020 and totaling 33.47MM, were issued earlier this month.

The credits are being issued to Guyana under the ART-TREES jurisdictional framework. The Architecture for REDD+ Transactions (ART) registry is issuing these ART REDD+ Environmental Excellence Standard 2.0 (TREES) credits to Guyana. Conditions for ART-TREES credits include independent verification of meeting United Nations social and environmental safeguards. (For further reference, REDD+ is an acronym for Reducing Emissions from Deforestation and forest Degradation plus sustainable management of the forests.) This marks the first issuance by ART of credits for successfully preventing forest loss or degradation.

Note that this is not the first issuance of jurisdictional REDD+ credits. A different registry run by the Coalition for Rainforest Nations, a little confusingly called REDD.plus, has now issued this type of credit to Papua New Guinea; REDD.plus expected to issue credits to Gabon in November. The REDD.plus registry has been criticized for lacking some of the safeguards of the TREES standard, including how baselines for comparison are set, not provisioning for unexpected forestry loss (e.g. with set-asides of credits) and Gabon’s use of proceeds.

The credits contribute to funding Guyana’s LCDS 2030. Guyana has committed that proceeds from the sale of ART-TREES credits will be invested in the country’s Low Carbon Development Strategy (LCDS) 2030. The strategy prescribes that funds will be put toward, among other areas, renewable energy for specific communities, land titling for indigenous communities, repairing canals, climate adaptation and community-led programs.

December 14, 2022

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ETMs Progress and Appear to Evolve

Key Points: November’s MOU for an Energy Transition Mechanism to accelerate closure of a coal fired power plant in Indonesia marks progress on the second ETM and the first to use concessional capital. Notably, it does not involve a change in ownership, which suggests greater capital efficiency. The first ETM, in the Philippines, was executed in early November.

Memorandum of Understanding signed to accelerate the retirement of coal plant Cirebon-1. The Asia Development Bank (ADB) signed the MOU with plant owner Cirebon Electric Power (CEP), the Indonesian utility Perusahaan Listrik Negara (PLN) and the Indonesian Investment Authority (INA). Executing on an agreement to close the coal fired power plant (CFPP) would mark the first use of concessional capital to fund the financial mechanism, known as the Energy Transition Mechanism (ETM). Concessional capital is expected to be an important element (to lower financing costs) in adding scale to ETM-based CFPP closures. See last paragraph for an ETM concept description.

In a change from the original ETM concept, CEP appears set to remain the owner. With details still needing to be sorted, ADB did provide some general guidelines in its communications. These included an indicative closure year of 2037 (25 years after operation start vs. a notional life of at least 40 years) and indicative new financing of US$250-300 Million. (We understand further that the final terms may be adjusted over time as it will depend on decommissioning and/or repurposing costs borne by CEP, which will be decided as it gets closer to the plant’s decommissioning date.) ADB indicates that it is providing the funds, including concessional capital (some of which is from the Climate Investment Fund) and from its private sector operations department.

It appears there is to be no change in ownership and new funding would all be in the form of debt, which makes it different from the original ETM concept and the recently executed ETM transaction in the Philippines (see below). Thus, it is (only) the interest expense savings from the refinancing that compensates CEP for profits foregone due to early plant closure. (We can imagine the interest arbitrage has narrowed given higher recent borrowing rates; presumably that has a bearing on closure timing and/or how much concessional capital is required.)

With that said, we note with interest INA’s involvement, which suggests that equity could play role in the final terms. Private capital is actively monitoring ETM progress, but the announcement seems to confirm the supposition that private investors are more likely waiting on the model to be established — and perhaps for a few deals to be executed and for clear taxonomy “accepting” coal transition financing.

There has been one completed ETM transaction to date. ACEN Corp., a subsidiary of the Ayala Group, sold the South Luzon Thermal Energy Corp (SLTEC), which owned a single CFPP, into a special purpose vehicle (SPV) called ETM Philippines in early November for US$129 Million (~US$500/KW of capacity). The plant is to be retired by 2040, 15 years ahead of its technical life, and repurposed. ACEN has indicated it intends to use the proceeds from the sale to invest in more renewable generation. Notable in the transaction was that it did not include any concessional funding (from multilateral development institutions).

ETM description. An ETM is a financial mechanism that seeks to offset the foregone profitability for the owner of early closure of a CFPP. As originally envisioned, the plant is sold into a Special Purpose Vehicle, which creates the potential for new ownership and a payout to the current CFPP owner, and recapitalized — plausibly from a traditional structure that has considerable equity to one that is debt-heavier. And it envisions using concessional capital as needed to lower the cost of borrowing to save on financing costs. An ETM may include a separate structure to build replacement (renewable) power generation; it is plausible that such an additional element may create more opportunity for the investors to earn a return on their capital.

December 6, 2022

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Proposed Clean Energy Credit Support for India

Exhibit: Facility to Raise Ratings; Facilitate Domestic Bond Issuance

Source: Council on Energy, Environment and Water, World Economic Forum

Key Points: A recently proposed credit-enhancement facility can help renewable energy projects access the Indian bond market — a nice example of a targeted financial mechanism to catalyze private investment. Its proponent, CEEW, believes the facility can have a 16x multiplier effect on the concessional capital and recycle bank capital for other energy projects.

Background: India’s Council on Energy, Environment and Water (CEEW), a think tank, and the World Economic Forum (WEF) engaged in a study to identify financing mechanisms and policy tools that could help foster more clean energy development in India. The team ultimately proposed ways to encourage more (debt) capital for (1) the development of utility-scale renewable energy (USRE) and (2) energy storage projects. This blog focuses on the proposed solution for USRE. It references the CEEW/WEF’s report and is informed by our recent webinar conversation with CEEW Director of the Centre for Energy Finance Gagan Sidhu (a replay of that conversation should be available in early December).

Indian banks appear tapped-out in terms of power sector credit exposure. The required investment in RE in order to reach stated RE capacity targets in India is more than double recent levels — ~$20-27 Billion (B) annually vs. $10B in the last few years. Thus, greater access to capital is required. Domestic financing for the Indian power sector is dominated by banks and non-banking financial companies. These sources appear to be near their limits in terms of credit exposure to the sector. As evidence, CEEW notes that the commercial bank credit exposure was roughly steady at ~$75B from 2015 through 2021 whereas bank credit to non-power sectors rose 40% over that period.

The domestic bond market is not (quite) open to Utility-Scale RE. India’s $450B domestic corporate bond market has seen some limited USRE activity. However, the overall market is limited in that issuances effectively require a AA rating to participate. USRE credits generally receive grades below that, a function at least in part of a somewhat checkered past in the sector that has included bank lending to fossil fuel-based power developers that lacked purchase commitments from an off-taker (one of India’ distribution companies) and contracts to secure access to fossil fuel inputs. However, USRE project debt ratings have been rising as a lower risk profile and supportive policies are recognized. CEEW catalogued that while no solar projects received an investment grade rating (BBB- or above) in 2012, by 2020 90% received one and 60% received an A or above. This progress is important, as it is expected to lower the cost of the credit support facility being proposed.

Proposed credit support facility. CEEW/WEF’s proposal is to create a facility that provides credit support for USRE projects. It would offer enough of a guarantee such that the projects receive a AA rating and thus can raise funds in the domestic bond market. In so doing, the facility would expand domestic capital access, both directly (as project developers use the bond markets) and indirectly (bond issuance can repay bank loans and thereby “recycle” constrained bank capital to be used in new projects). See Exhibit. CEEW/WEF believe the “multiplier,” i.e., the ability to raise commercial funds on the back of this concessional facility may be 16x, making it an effective tool in stimulating more private capital investment.

The proposed facility is now entering a phase in which stakeholders will consider how to “operationalize” it. CEEW/WEF note that factors influencing the facility include the type of capital used to fund the facility and the nature of the guarantee.

12/1/2022

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Retiring Coal? The Prospects Are Brighter Than They Appear 11/17/2022

Retiring Coal? The Prospects Are Brighter Than They Appear

Payne Institute Program Manager Brad Handler and Director Morgan Bazilian write about how as COP27 draws to a close, the conference is proving to be a disappointment for environmental advocates focused on eliminating the planet’s number one emitter: coal-fired power. In the tumult of international uncertainty, governments have looked to coal as a security blanket of sorts. Coal’s ability to deliver power 24/7 compares favorably to some renewable energy, like solar and wind, that is variable and, at least to some degree, unpredictable. November 17, 2022.

The Energy Transition Accelerator’s Potential

Source: Forbes

Key Points: The recently announced Energy Transition Accelerator has promise as another funding avenue for the energy transition in developing economies. Such additional funding is likely necessary given vested interests. The mechanism may be complicated by determining baseline emissions rates. We encourage lower thresholds for more company buyer participation.

Overview. The U.S. Government/Rockefeller Foundation/Bezos Earth Fund proposed Energy Transition Accelerator (ETA) envisions awarding credits for emissions reductions tied to transitioning a developing country’s power generation to clean/renewable from fossil fuel-based. These credits can be sold, through fixed price advanced purchase commitments, and thus can secure financing from a source, corporations, that would not otherwise be able to help fund the necessary investments. It is hoped this can catalyze activity, helping to mobilize private lenders and investors that will provide the bulk of the funding given the support it can give to projects’ economics.

Integrity framework. Particularly given the cloud overhanging voluntary carbon offset credit markets, the ETA seeks to ensure integrity with some key provisions:

Jurisdictional scale. The ETA is envisioned as operating at either a national or sub-national scale, as opposed to on a project basis. In so doing, it can avoid concerns of leakage, e.g., that the avoided emissions from closing one fossil-based power plant might simply be shifted to a different fossil-based plant in the country’s network. In this way, the concept is like approaches gaining in traction in forest preservation including the ART-TREES standard.
Funder constraints. First, it is being considered that only companies that have committed both to have Net Zero greenhouse gas emissions by 2050 and that have set interim targets in line with the Science Based Targets Initiative (SBTi) will be allowed to participate. Second, it is to be considered if the company can only use these new credits to support mitigation above their interim targets.
Including social safeguards. The ETA is committing that the participating jurisdictions will have to demonstrate energy transition strategies that include social safeguards for affected communities (aka Just Transition support). It also seeks to help countries develop Sustainable Development Goals, including greater energy access within the jurisdiction.

Retiring fossil-based plants lends themselves to emissions reduction credits. We have held for some time that retiring fossil-based activities can serve as a basis for emissions reductions crediting. Accurately determining emissions reductions is more straightforward than it is for nature-based solutions. That is particularly true at the jurisdictional level since, as noted above, it obviates leakage risk.

It is also logical that some additional financial support will be necessary to effect retirement. Different existing ownership structures all raise challenges and the cost of retirement. To offer just one example, plants owned by Independent Power Producers (IPPs) that have long-term contracts with their utility “off-takers” will expect remuneration in line with what their contracts provide for. This suggests that concessional, i.e., lower interest rate, funding may not adequately support the economics of a retirement scheme.

However, setting the baseline (to compare to the reductions) is harder. A country’s “business as usual” case for its emissions from power generation will have to be decided, or more accurately, agreed upon. Developing countries prioritizing economic growth and greater energy access are assuming greater energy consumption over time, which fossil-rich countries argue can justly be met at least in part with fossil-based power. On the other hand, some countries are taking steps that might end up lowering their emissions; one key example is liberalizing power markets, i.e., opening them up to more competition, from which one should expect declining coal-based consumption given that it is often more expensive to produce than energy from renewables. Thus, we submit determining how many credits to award will be a political decision/negotiation vs. a science-based one.

Our bias is to allow more companies to participate rather than fewer. We can appreciate the sensitivity of any carbon offset program to accusations that it lets emitters avoid pursuing their own emission reduction. Yet it is the role of transparent reporting rules to make it clear that a company isn’t reducing its self-generated emissions and thus overly relying on offsets. We would rather be able to attract larger pools of capital towards ETA and other emission reductions tools and thus would prefer to not limit participation to, for example, SBTi signatories.

11/15/2022

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