Paying coal power plants to switch off
Paying the owners of coal power plants to turn themselves off is an increasingly popular idea among development finance circles. Plant owners wants to get their money’s worth from their investment. If a project was only built, say, ten years ago, and has another thirty years of useful life, they would be missing out on a lot of potential revenue. To induce them to switch off the coal power plant, they must be offered a deal more financially attractive than continuing to operate. Structuring such a deal, however, is more challenging than it looks.
Take the example of Medupi coal power plant in South Africa, an almost 5 Gigawatt (GW) behemoth large enough to power something between all of Sri Lanka and Bosnia. $3.75 billion of this project was financed by the World Bank in 2010, out of a total $7.7 billion. The plant’s six sections came online between 2015 to 2019, and are due to operate until 2071. That’s a lot of years to compensate.
To work out what you might offer Eskom, the owner, to switch off this coal plant, you could start by building a model of the cashflows of the plant to generate its expected lifetime value to the owner. Agreeing a reasonable discount rate would be the first challenge, since the higher the discount rate, the lower they will be compensated for cashflows in the future. South Africa’s bond yields were trading between 700 and 800 basis points (bps) around the time the first plant was commissioned. Now they are above 1,000 bps in the wake of the election. The second challenge would be agreeing power prices and reasonable profit margins for the utility, forty years in advance.
The problems with paying for decommissioning really arise when you step away from the financial model. The plant has a 40-year contract to buy coal from a local mine, that employs over 2,000 people. The payer would thus also be obligated to honour the coal purchase contract. This might mean they need to buy out the mine as well, at great expense, and put 2,000 people out of work. Or, they could assume the offtake agreement, but sell the coal somewhere else, thereby not actually reducing coal consumption. Decommissioning the mines and finding employment for their workers is a key part of decommissioning the coal plants.
The next real-world problem is how Eskom will replace almost 5 GW of power on its grid. With the proceeds from its coal plant, would it be expected to build renewables to replace them at its own cost? Or would a top-up for replacement capex also be included in the payer’s offer? Then there is the question of the time it would take to build the new capacity, and where it can be built so that it connects to the grid. The best renewable energy resources are not always in the same location as coal power plants or existing transmission infrastructure.
If donors are paying to turn coal power plants off, there are also concerns around conflict of interest and value for money. The World Bank has funded almost half of the $7.7 billion total cost for this power plant. Whoever buys out the project ensures that the capital of its investors is duly compensated. It feels strange that the donor community can justify making itself whole on assets they’ve funded in the name of saving the environment, when they knew the potential for climate damage when investing in the project in the first place.
It is even more alarming that donors from rich countries would buy out projects with private debt and ownership. British banks, HSBC and Standard Chartered, lent $1.5 billion to coal projects in Vietnam, including some that are majority owned by American sponsor, AES Corporation. If donors pay to stop these plants from operating, they are protecting investors from their own countries in the process.
It also seems like paying companies to switch off coal is not the best value for money. If governments instituted carbon prices, power companies would plan their production and investments according to the new costs of each fuel source. While this seems unlikely to happen any time soon in South Africa given the dominance of coal in their power grid, it may be a possibility in other places.
Donors could also offer funds for clean energy projects, such that so many are built that coal becomes uneconomic to operate. This might require the same amount of investment, but induce the closure of coal plants through market forces, by making it cheaper to buy electricity elsewhere.
As I learn more about this murky space of buying out coal plant operators, I may find that there are myriad reasons why this is the best way to decarbonise our coal-based electricity grids. But my incoming view is it seems self-serving, if the investors that benefit from the compensation are from the same countries that provide the donor funding to buy them out. It also seems to be more costly than alternatives, and it’s unclear whether it puts the people that work in the coal mining and electricity industries at the heart of the solution to coal decommissioning, and not just powerful companies.