Reducing coal use around the world is critical for decreasing air pollution and addressing climate change, yet global coal consumption continues to grow in some regions. At the recent U.N. climate negotiations, countries agreed to “phase down” coal use. More than 40 countries — but not the United States or China — pledged at COP26 to phase out coal completely by 2030-2040, all while supporting affected communities, investing in clean alternatives and ensuring universal electricity access.
Achieving these goals won’t be easy, or cheap — and that’s where innovative financing comes in. Our research suggests that getting the right financial structures in place can help countries bring the dirtiest forms of power offline faster and accelerate new clean energy deployment. But shifting away from relying on coal may require governments and multilateral organizations to take a closer look at four types of financial solutions: refinancing, securitization, carbon avoidance bonuses and investment portfolios.
Why financing plays a critical role
Climate-focused financial mechanisms aim to incentivize the owners and operators of coal-fired plants or factories to either retire them ahead of schedule or sell these assets to others who will. (Options for financing the retrofitting of plants with carbon capture or co-firing capabilities may also be appropriate in certain contexts.) To provide that incentive, a financial mechanism addresses the specific financial interests of the current owners and stakeholders.
Generally, this involves raising capital at a lower cost of borrowing, with the goal of generating funds to recoup the owners’ original investment, as well as savings that can be put toward recovering expenses associated with plant retirement, site repurposing and support for impacted communities. This community support is known as facilitating a Just Transition and includes efforts to help a fossil fuel-dependent community and its workforce transition to a more environmentally sustainable, and ideally a more diverse, economic base.
Governments or government-supported entities can help lower the cost of borrowing by providing a portion of the loan at lower interest rates and applying some form of loan guarantee. And it’s also important to encourage private capital investment in these plants. That typically includes offering investors a clear understanding of how their loans will be repaid, how their investments will earn them an adequate financial return and what sorts of risks they must assume.
And to be effective, our research found, the proposal itself should fit into a broader scheme incentivizing (or requiring) the owner to replace the coal power with a clean alternative and ensure that grid stability and power supply are not compromised.
How do these specific financial tools work?
Various financial institutions are working with governments to develop financial tools to encourage early coal plant retirement that satisfy these requirements. Key examples fall into four main categories:
Refinancing is one approach, offering low-cost loans for energy transition activities like retirement of coal facilities, clean energy investment and Just Transition. One example is the Just Transition Transaction for Eskom, South Africa’s government-owned utility. This will be a corporate-level loan, likely from a combination of government-sponsored and private lenders and capital markets.
Eskom’s high debt burden makes it harder to access the capital the utility needs to invest in electricity infrastructure and sustain the country’s power supply. The utility’s debt also puts the South African government, which has issued loan guarantees, on the hook for significant payment obligations. This refinancing should allow Eskom to invest in transitioning away from coal and strengthen its long-term financial viability.
Carbon avoidance bonuses offer a way for governments or financiers to establish incentives for a utility or power plant owner to decarbonize. In one example involving Inter-American Development Bank funding, a loan package to ENGIE Energia Chile lowered the interest rate based on how much carbon the utility avoided by retiring its coal plants early and replacing fossil-fueled power generation with wind power.
However, bonuses can also take the form of credits issued per unit of carbon avoided or reduced, and these credits can then be sold in carbon markets to companies looking to offset their own carbon emissions. The goal of expanding carbon markets got a big boost at COP26, where negotiators laid out a framework for global implementation.
Investment portfolios, a third approach, create ways for investors to purchase coal-fired assets that they commit to retire early. These portfolios can also include investments in renewable energy to replace the coal generation being taken offline. One example currently under development, the Energy Transition Mechanism, is led by the Asian Development Bank and is backed by a coalition of public and private institutions.
The group plants to buy out coal plants in Asia, committing to retire them ahead of schedule. With access to a lower cost of capital due to the participation of public banks and foundations, this financing group will be able to repay debt obligations faster than the existing plant owners, allowing it to close the coal plants early and invest in replacement power.
Securitization is another financial tool, and one that utilities have used for years to fund various types of investment. This approach differs modestly from the others as it relies on a legislative framework rather than funding support.
Here’s how this works in the United States, using ratepayer-backed securitization. A state’s legislature authorizes a utility in its jurisdiction to charge its ratepayers to repay the loan. The utility uses this “guarantee” to raise low-cost debt that it can use to fund costs associated with transitioning away from coal, including recovering its original investment. What is notable, however, is that the ratepayers generally do not pay higher utility bills, because the low-cost financing (and perhaps the lower operating cost of renewable power vs. coal-fired power) offset the cost of the additional debt.
These financing solutions are crucial tools in the climate fight. They enable governments to incentivize utilities and other power producers to bring coal offline faster, and help the private sector multiply the impact of limited public funding.
Brad Handler (@bhandlerenergy) is senior researcher at the Payne Institute for Public Policy’s Energy Transition Finance Lab.
Katie Auth (@katieauth) is policy director at the Energy for Growth Hub.
Morgan D. Bazilian (@mbazilian) is director of the Payne Institute for Public Policy and professor at the Colorado School of Mines.