Early closure of coal-powered energy plants will hasten the achievement of global climate targets — namely net zero emissions to contain rising temperatures to 1.5-2 degree C higher than pre-industrialisation averages. But cutting the lifespan of a plant is a costly affair. Enter ‘transition credits’ as a potential solution.
According to a report by the Institute of Energy Economics and Financial Analysis (IEEFA), transition credits are a proposed new category of carbon credits. The aim is to monetise the reduction in emissions achieved through early closure of coal-fired power plants, and their replacement with clean energy sources. According to the report, these credits could potentially bridge the economic gap in Asia’s clean energy transition.
Though there are carbon markets, there’s no market right now for abated carbon through early shutdown of coal plants. But that is because many countries have not shut down coal plants early.
India currently has 195 thermal power plants in operation. It has shuttered 56 coal-powered plants, according to data from NITI Aayog.
The IEEFA report shows that early closure of coal-powered plants faces ‘substantial economic hurdles and extensive financing requirements’.
Cause of Inertia
Most coal-fired energy plants operate in highly regulated markets. “This often insulates plants from market forces due to government ownership, long-term power purchase agreements, or subsidies,” says the author of the IEEFA report and the institute’s Sustainable Finance Lead (Asia), Ramnath N Iyer.
Power-purchase agreements sometimes extend to 25 years. Shuttering a plant could trigger penalty clauses and other locked-in financial costs, leading to significant losses for investors and lenders. For profitable plants, it also entails forgoing future cash flows. Investors would need to be compensated to spur investments in replacement plants that use renewable energy.
Transition credit flow
Assigning a financial value to emissions saved by shutting down a plant early, helps create a new financial instrument with varying income potential, says Iyer. The income “could be distributed to investors based on their risk-return preferences” when transitioning from coal-fired plants to renewables, according to the report.
Transition credits could be used as collateral for loans, attracting both equity and debt investors for new projects.
But the success of the mechanism would hinge on the pricing of the credits.
Pricing credits
The valuation of a transition credit would depend on the switching costs, and the age and emissions profile of each plant, says Iyer. “Based on various studies and pilot projects, the estimated range for these credits is $11-52 per metric tonne of carbon dioxide equivalent (MTCO2e) avoided,” he adds in the report.
Iyer suggests that with the falling cost of renewable investment and energy, the early shutdown of coal plants and replacement with clean energy is becoming increasingly economical. “Transition credits can be particularly useful in situations where the levelised cost of energy for a new fossil-based plant is higher than that of a renewable project, but the short-run marginal cost of an existing fossil-based plant is lower. This is especially true for older, almost fully depreciated coal-fired plants, where the immediate profitability decline in switching to clean energy might otherwise lead to the plant’s continued operation.”
Despite their potential, transition credits may face several challenges. “Establishing consistent and scalable mechanisms for replicability and pricing could be difficult. Also, accurately estimating the social and economic costs associated with the transition, ensuring a just transition for affected communities and workers — would be the other challenge,” Iyer says.
Enforcement of rules
Operationally, challenges may crop up with regard to authenticity of applicants. After all, if a coal-based power plant owner shuts his unit, earns credits, and sets up elsewhere or sells his equipment to others, wouldn’t that defeat the purpose?
“Maybe we should think about it. But for now, what we are concerned about is the (prevention of) use of coal as a source of energy,” Iyer says, while also calling for ‘strict monitoring of this potential for diversion’.
“Such a robust monitoring mechanism needs to be overseen by some authority,” he says.
Second, governments must come forward to offer assurances. Iyer says: “The real test is whether there would be some kind of underwriting. Let’s say, does a country’s central government or a local one guarantee (the shift)?”
If the beneficiary of a transition credit mechanism violates the terms, at whose door does the blame lie? “That’s a very complicated process, requiring a guarantee from the host government. What is clearly needed is for the various parties to come on board. It needs the buyer, the seller, the third-party verifier, and it needs the authorities.”
Trading credits
Transition credit is meant to be treated on par with any other carbon credit, says Iyer. “It doesn’t have to be bought only by a coal mine, or a power plant. You are saving the emissions going out into the atmosphere... if somebody wants to buy it as an offset, that’s okay.
He points out that the Singapore government has ruled that up to 5 per cent of an entity’s carbon tax can be paid by buying offsets, so long as it’s a recognised offset.