Scrap, sell, auction or repurpose? What's the best business model for coal plant closure?

The imperative to decarbonize, coupled with the declining costs of renewable energy (RE) based power generation, has led to a focus on accelerating the retirement of the coal-fired power plants across the globe. With various business models and financial mechanisms available, how governments, banks and utilities should best proceed depends on several factors. These factors include a plant’s utilization prospects, its contractual position and ownership, the financial health of the utility and the host government’s commitment to closure.

The economic rationale and principles for any of the business models to accelerate coal-fired power plant (CFPP) closure are broadly consistent. It is often less expensive to generate electricity with RE than coal. Repurposing equipment and the site for clean energy production can help provide services, such as stability, to the utility grid, lessen the cost of CFPP retirement and retain at least part of the workforce. That said, adequate provisions must be made to support affected coal plant workers and communities — generally known as the Just Transition (JT) support.

Further, it must be accepted that the current owner of the CFPP requires some compensation for lost profits. This certainly applies to independent power producers (IPPs) holding contracts to sell power. But utilities or state owned enterprises (SOEs) also typically will need some support to recover their outlay of capital.

Financial mechanisms can lower the funding cost of the closure, site repurposing and JT. These mechanisms may include concessional tools, including loans at below-market rates that are “results-based” such as tied to decarbonization commitments. Alternatively, the mechanisms can galvanize competitive forces, as in Germany where reverse auctions are being used in tandem with a coal retirement policy.

Meanwhile, capital structure can also offer some savings potential. Placing a coal plant into a separate legal entity can allow funding for the retirement to be more weighted to debt which lowers the expected financial return. Examples of this are the Energy Transition Mechanism (ETM) being implemented by the Asia Development Bank and ratepayer-backed securitization in the United States.

And finally, the potential issuance of carbon offset credits to the owners of the CFPP, based on retiring it vs. business-as-usual emissions, offers still other access to private investment.

The decision of what type of buyout structure a utility should pursue depends greatly on the location, age and other characteristics of the plant, its ownership, its utilization, its contract with the off-taker(s), and the financial health of the utility. The following 'decision tree' offers a high-level view of factors and applicable business models and financial mechanisms.

Here are two examples of coal-fired power plants across the globe and what business models for accelerated retirement are recommended for them:

Background: Indonesia's utility provider PLN has employed 25-30 year Power Purchase Agreements (PPAs) with IPPs that are based on capacity. PLN has also consistently overestimated demand, yielding overcapacity in the country. The result is that PLN is paying for capacity that the country doesn't need. The PPAs are generally structured as a Build-Own-Operate-Transfer, in which plant ownership is 100% IPP until the expiration of the PPA when it transfers to a PLN subsidiary.

Suggested business model: PPA buyout, with RE-for-coal swap, repurposing the existing coal plant site and equipment to the degree possible

Primary funding source: Green or sustainability-linked bonds

Buying out the PPA accelerates the transfer of ownership/control of the CFPP to PLN, enabling it save money vs. PLN’s current PPA payments (that are largely fixed and not tied to power generation) and to accelerate retirement. By coupling the buyout with a PPA for newbuild RE, PLN can build some of the termination payment into the new RE PPA, delaying and perhaps negotiating a reduced termination payment. The role for concessional funding: foreign government/multilateral institutions’ (MDB) support can encourage the retirements via low-cost funding (to PLN or Indonesia’s government) at a plant (individual PPA) level or at a fleet level.

Background: India has a large 210 GW coal fleet of which roughly a quarter is over 30 years old. A significant share of these plants is owned by SOEs that see low utilization, bringing down the overall utilization of the SOE-owned plants in India below 50% in 2020-2021. Retiring this capacity in the short to medium term is critical for India to scale up its 100 GW of RE capacity to over 400 GW by 2030. As the operating cost of this older and inefficient coal fleet is typically higher than the cost of solar and wind – it should be economical to retire these units even without considering any cost of carbon. The vast majority of the coal capacity is tied up with state-owned distribution companies (DISCOM) through long-term PPAs but these tend to be more flexible.

Suggested business model: Staged closure of plants at a larger site

Primary funding sources: Reverse auction if national policy is enacted

As there is a growing requirement for flexibility in the system, several of the incumbent coal plant sites can also be good candidates for a mixture between renewable energy and flexibility (RE+FLEX) centers to support the 500 GW RE target. These projects may typically be eligible for concessional financing and may create public-private opportunities. Most of the coal plants in India comprise units of different vintage, which opens up the possibility to start the process by retiring and selectively repurposing some of the units into RE+FLEX centers, thereby rebalancing the generation across the remaining units. Implementing a reverse auction system at the national level can spur SOE owners to actively engage in finding the least expensive plants to retire and repurpose to serve their grids.