Accelerating the Early Retirement of Coal-Fired Power Plants Through Carbon Credits

October 26, 2023Published by Monetary Authority of Singapore and McKinsey & Company

The inclusion of a managed phaseout of coal in the taxonomies of Asian countries has unlocked interest in the early retirement of coal power plants. However, the lost revenue that results from early retirement has created a financing gap that threatens the viability of such projects.

In this joint paper, the Monetary Authority of Singapore and management consultancy McKinsey consider how high-integrity transition credits can be used to accelerate coal plant retirement projects.

Coal in the Asia-Pacific region accounts for 20% of global energy-related CO2 emissions, so cutting back coal power is a “critical priority”. To achieve net zero, the paper states that the region must retire two plants per week until 2040 and replace them with cleaner energy sources.

As coal provides 60% of Asia’s power and its fleet of power plants is relatively young with long-standing power purchase agreements, phasing out coal is socially and economically complex. According to the paper, transition credits can help facilitate this process by providing  an additional revenue stream..

Factors that may dampen demand for transition credits include the time lag between commitment to plant retirement and credit issuance, reputational risks and a lack of established credit guidelines. To foster demand, a high-integrity, scalable and “agile operating model” that provides principal protection, as well as stable and attractive returns, is needed.

To achieve this, integrated solutions are required across four key areas: economics of early retirement; designing transition credits as an instrument for early retirement; finance for retirement transactions; and project development and integrity.

Regarding design, the paper proposes that transactions are structured through bespoke special purpose vehicles which “facilitate the refinancing of existing debt” and “isolate financial risks and obligations”. Innovative insurance products, political risk guarantees and futures markets can provide further investor protection.

As voluntary carbon markets have been “plagued by controversies surrounding its integrity and credibility”, creating demand for coal transition credits is also “highly dependent” on the credit’s “quality and integrity”.

The authors say that developing common guidelines is key to building investor confidence and they put forward principles that can be used in such standards. The concepts draw on the core carbon principles framework and include additionality, ensuring the project would not have been executed without revenue from the transition credit, and permanence, meaning emissions reductions are irreversible.

Other areas that should be addressed are governance, transparency, tracking, double counting, third party verification, and robust methodologies for quantifying emissions reductions.

To assess the economics of early retirement of coal power plants, the authors present a model for pricing and cash flow effects. It distinguishes between two retirement scenarios: gradual and at a specified date. While a gradual approach allows for the earlier issuance of credits and higher emissions reductions, it is more transactionally complex.

Finally, the authors say appropriate safeguards for a just transition are key to establishing credit and project integrity, meaning the employment and energy security of affected communities should be safeguarded.

Effective resourcing, impact assessments, and monitoring bodies that engage a broad coalition of stakeholders such as NGOs and transition programmes are identified as essential pre-conditions in meeting just transition aims.

This page was last updated October 26, 2023

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