By - Jim Vess

Financing the cost of closing coal-fired power plants is a key to a clean energy transition, RMI says

Energize Weekly, September 26, 2018

A major obstacle in the transition from coal-fired power plants to cleaner energy generation is the “specter of financial losses” utility companies face in closing those plants. Solving that problem is a key to a quicker energy transition, according to the Rocky Mountain Institute (RMI).

In “Managing the Coal Capital Transition,” the RMI attempts to lay out the issues and strategies to manage the balance sheet impacts of coal plant closures, looking at the issue across the globe.

“Coal-fired power generation is in structural decline, and its role in the global energy mix will continue to diminish due primarily to economics,” the report said. “This erosion is structural, not cyclical, and is driven predominantly by cheap gas, inexpensive renewables, and the costs associated with complying with environmental regulations that seek to reduce air pollution and address climate change.”

In the U.S., 54 units at 27 coal-fired plants, with a total of 27 gigawatts (GW) generating capacity, closed or announced closure plans in 2017.

The “Beyond Coal” campaign of the Sierra Club, a national environmental group, estimates that 268 coal-fired plants have been retired or targeted for retirement in the U.S. since 2010 and that there are 255 plants still operating.

While this is largely driven by the market, regulations, such as states adopting renewable portfolio standards requiring an increase in renewable generation, are also forcing the transition.

Global coal generation peaked in 2014, according to RMI. Among the Organization for Economic Cooperation and Development’s 36-member countries, representing the world’s most advanced economies, a projected 198 GW of coal capacity will be phased out by 2030.

“With this transition, however, workers and communities are experiencing layoffs and the owners of coal-fired power plants are bracing themselves for hundreds of billions in write-offs,” RMI said. “The early retirement of coal plants across the world has enormous financial implications for asset owners, policymakers, and environmental advocates alike. Managing the exit of capital from coal-fired generating assets demands thoughtful and collaborative planning among these stakeholders.”

The prospect of those financial losses is slowing energy transition, and utilities are weighing their options as they try to value assets and project future performance. “For asset owners, proactive planning for the end of the coal era can preserve shareholder value and avoid financial shocks to equity and debt holders alike,” the study said.

The biggest risk is handling these coal plants as stranded assets. “The loss of value associated with stranded assets is an undesirable consequence that, while to some extent inevitable, should be actively mitigated to ensure that all stakeholders are on board with the direction of the energy transition,” RMI said.

It is in the interest of all parties—regulators, owners, environmental and community groups—to reasonably limit loss and appropriately allocate them, RMI said.

Plant owners have to accept that “some capital destruction associated with the early closure due to economic and regulatory stranding is inevitable,” RMI said. Regulators and environmental advocates have to realize that an orderly transition without financial shocks is needed.

“The way in which this economic stranding manifests itself depends largely on the region in which a plant is located,” RMI said. “In deregulated markets, the inability of coal plants to effectively compete with lower-cost generation in the market has led to the shuttering (or conversion to gas) of many coal plants. But in regulated states, coal plants are insulated from these market forces as they are permitted to recover the cost of their uneconomic plants from ratepayers.”

“The plants are economically stranded in both jurisdictions but, in regulated markets, the impact of economic stranding is absorbed by ratepayers (in the form of higher electricity rates) rather than by the utilities that own the assets,” the study said.

The RMI study outlines a range of financial and regulatory strategies, such as creating a regulatory asset to collect the costs of retirement, a “soft landing” in which an alternative revenue stream is substituted for the coal plant, accelerated depreciation and takeover and write-off.

Each strategy comes with a set of challenges and may not be applicable to all plants or all markets.

In the Canadian province of Alberta, for example, a government plan in 2015 called for all coal-fired plants to be closed by 2030. Twelve plants were set to close by then, but six others had retirement dates ranging 2036 to 2061.

Three companies—Capital Power, TransAlta and ATCO—owned the six plants. In 2016, an agreement was reached under which the province gave the owners of the plants “transition payments” from 2017 through 2030 equal to $75 million U.S. In exchange, the companies agreed to close the plants by 2030 with the allowance to switch them to natural gas.

The payment was calculated using the net book value through 2030 prorated by the number of years stranded by the regulatory requirement of the plan.

The province collects a carbon tax, and some of that revenue was directed to the program so that general taxpayer funds did not need to be used. “This high-touch approach may not be feasible everywhere, depending on the government’s resource capacity and the number of affected parties,” RMI said.

In the case of Xcel Energy’s proposal to close two coal-fired units in Colorado, the state’s Public Utilities Commission (PUC) granted the utility accelerated depreciation and the power to set up a regulatory asset in which the full costs of closing the plants would be gathered and then paid off. Xcel estimated the cost at $193 million.

Xcel residential customers pay 2 percent of their bills into a Renewable Energy Standard Adjustment (RESA) to fund renewable energy projects. The PUC allowed 1 percent of these payments to go into paying off the regulatory asset.

RMI noted that the ability to direct RESA funds to the program offered a ready-made financing source.

Another component of the Xcel plan was to replace the coal-fired generating capacity with 1,100 megawatts of low-cost wind and solar. In its filings to the PUC, it estimated the plant would save Xcel customers $200 million by 2054.

“Regardless of political debates and the prospect of painful adjustment costs, it is time to acknowledge that coal-fired power generation is in structural decline worldwide,” RMI said.

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