Exploring transition credits for early phase-out of fossil fuel power plants

Southeast Asia is key to global energy transition efforts. The International Energy Agency’s (IEA) decision to establish the Regional Cooperation Centre in Singapore to boost clean energy security marks a landmark moment. The centre envisages to improve “access to finance for clean energy investment” amongst others.

Regionally and globally, energy transition efforts require vast investments in innovative energy technologies. The recently concluded Singapore International Energy Week (SIEW) highlighted opportunities and challenges when it comes to innovative financial products – including for transition credits, says Somani, whose effectiveness in cutting the region’s reliance on fossil fuels will depend on how we can mobilise the supply and demand sides under a proper framework.

On the supply side, what’s needed is a strong pipeline of coal plants willing to phase down earlier than planned. Currently, Somani says, “not enough operators are coming forward” – though this could be overcome by addressing supply security and affordability concerned in addition to resolving demand-side challenges.

The demand side constraints include lack of relevant data and consistent methodologies that make it difficult to establish integrity of transition credits to meet the strict criteria for green financing. To address these, the first step is to measure and independently certify the eventual outcome of a plant closure. This entails developing a standardised, broadly accepted framework that calculates the quantum of the carbon emissions from each plant shutdown, and the economic value of the those reduced emissions.

This calculation should include the environmental benefits and the societal gains – the impact on individuals and communities along the energy-generation supply chain. Given the many variables and the importance of establishing the credibility of transition credits, projects also must be aligned with the principles of independent governance bodies. The next challenge is that the extended time horizon adds uncertainty to the value of transition credits. “If a coal-fired plant is scheduled to close ten years early, the closure may still happen fifteen years from now,” Somani says. “The question is: Should we issue transition credits and monetise them now, or should we monetise the credits only when the plants shut down? Monetising credits now will require a fair amount of confidence in the system and monetising credits later will make the incentive less attractive.”  These issues are being intensively debated and will need to be resolved to the satisfaction of not only energy producers and potential investors, but also governments and the broader ESG (environmental, social and governance) ecosystem of stakeholders. As Somani points out, transition credits will operate within a complex, interconnected landscape marked by competing priorities. “It won’t be an ad-hoc case of focusing on one plant, retiring it and forgetting about it,” he says. “It has an impact on the national energy plan, on growth and on jobs creation. It has an impact on renewable energy planning, and on the transmission and distribution infrastructure.” 

And, he adds, success depends on the support of governments, which is needed to encourage coal-burning plants to retire early, as well as the availability of concessional financing to help pay for it.  

“So, the retirement of coal-fired power plants has to be part of an integrated national masterplan, to give both investors and energy producers confidence that the government is fully committed to the scheme,” he says.

Determining the value of – and therefore the demand for – transition credits is not straightforward, Somani says. According to a national analysis prior to TRACTION’s launch, retiring a 1GW coal-fired power plant five years ahead of schedule would result in a financing gap of US$70 million.

Based on this projection the cost of a carbon transition credit was calculated to be between US$11 and US$12 per tonne of carbon. Somani believes this cost is feasible in Singapore due to its relatively high carbon tax. However, in other countries it might take longer for transition credits to become a mainstream instrument, and blended finance may need to play a bigger role for longer. 

Somani says the ultimate goal should be a “just transition” that considers the interests of not only plant-owners and investors but also of the workers at the plant, and, where applicable, the workforce involved upstream in coal mines and the related value chain. Consideration of these factors increases the price of transition credits to around US$30 per tonne.

With circumstances varying by country and by plant, Somani believes a customised solution will be needed in every case.

“A cookie-cutter approach won’t work,” he says. “Each power plant contract has different terms and end-of-life considerations. So, at least in the beginning, we’ll have to take extra care to ensure that no one is worse off. However, if we can address the key identified challenges, transition credits could offer a big opportunity in helping the world proactively phase out coal-fired power plants.”