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