Coal bailouts are not the only choice
With coal ‘phase down’ making the headlines at COP, investors should be wary of expedient bailout solutions
There is growing momentum around coal industry (mining and electricity generation) bailouts, with banks jumping on the bandwagon and even US NGOs like Sunrise (US branch) and Rocky Mountain Institute making proposals.
These structures would specifically target responsible investors and market themselves as part of the solution to climate change. However, there are clear moral hazard implications (e.g. are we signing up to also bailout the much bigger oil and gas industry that is still expanding activities?), and there are alternatives that actually raise money for the public purse. Responsible investors need to tread carefully due to the potentially negative impacts and consequent reputational risks.
Bailouts can work in practice, there is often ample capital and interest from politicians. But they are not issue free. The history of bailouts is tainted with the payment from the government to British slave owners to compensate them for the loss of their slaves. It was a sizable chunk of GDP and wasn’t matched with any payment to the slaves. The US Superfund scheme, designed to clean up post-industrial sites, was initially paid for with a tax on the petroleum and chemical industries, but as the scheme aged more of the responsibility fell on the public purse. This means responsible investors might join a ‘reasonable’ bailout fund that ultimately looks very unreasonable from a public perspective. We have also seen more recently ‘bad banks’ that stop the spread of systemic risk and speed up recovery, but where the senior management often escape without significant penalties. We can see that a bailout might work technically, but that it doesn’t occur in a vacuum with consequential impacts for its actual and perceived success.
Similarly, coal bailouts could work but there are multiple associated risks. First, if we set up structures to bailout coal we are effectively underwriting any future investments in expanding the much larger oil & gas industry. This is excellent news for those arranging these deals. But, the moral hazard is self-evident as is the risk to the climate and government finances. Second, bailout funds are run by talented but ambitious people and this type of person is probably an empire builder. Consequently, there is a risk that the asset is passed from one entity to another without speeding up closure. Large bailout funds could also be big enough to be as politically influential as fossil fuel companies, putting the speed of closure at risk. Finally, there is a danger of legal challenges based on the cost, structuring, speed of decline, etc. This would just be another part of the ever-expanding climate litigation space. For a current example of the issues with bailout funds see the response from NGOs to the Asian Development Bank proposals here.
A statement stands out: “The glaring question thus remains as to whether the ETM [Energy Transition Mechanism] will effectively support the expansion of coal-fired power generation, even as its goal is to reduce it.”
Typically, bailouts are compared to the status quo - clearly not acceptable – or to nationalisation, which has the same issues as bailouts but on steroids. However, there is a suite of tools that policy makers can use as an alternative to any of these options.
Every piece of fossil fuel infrastructure in place today was built after climate change was confirmed as anthropogenic. Exxon and Total knew that in the early 70s, and the rest of business and finance had ample information by the late 80s. This means every investment was made with the knowledge that climate policy could strand those assets. It is therefore reasonable for governments to apply a price to carbon, mandate closure, change regulations, remove subsidies, and make border adjustments, etc, as ways to close facilities. Many of these approaches would raise funds that western governments could use to support clean energy in the developing world, which would give those countries an additional incentive to close their polluting industries (the carrot to go with the sticks such as border adjustments).
Impact on finance
The financial system would suffer losses from this approach, but it is unlikely to be systemic if regulators act well in advance; we are, after all, talking about a managed decline rather than closing down coal tomorrow. Plus, this approach also sends a clear message to the oil and gas sectors that there are no bailouts and that their assets will be stranded; their financiers will also hear this message and start managing their exposure sooner!
Bailout proponents also say it is a way to ensure a fair transition for fossil fuel workers. However, the alternatives I propose above actually raise money (carbon price, removal of subsidies and border adjustments), which could partly fund worker retraining and relocation.
Role for special purpose vehicles
As 90% of electricity production from coal is not in competitive markets, the first step is to liberalise these markets to speed the low carbon transition. However, in these situations, and also with the alternatives to bailouts outlined above, there will be situations where it is cheaper for owners to shut down coal generation before new supply fully meets demand. Regulators will need to put in place pricing structures that encourage the use of coal for baseload power, but without discouraging low carbon replacements. It may sometimes make sense to move the coal generation assets to a separate entity, for example, to encourage incumbents and state-owned generators to focus on low carbon alternatives. This makes for a much smaller role for special purpose vehicles (SPVs) than the bailout proponents advocate for.
The role for bailouts in mining is even more limited as the managed decline of generation should factor in a fair price for the coal. Particularly with international agreements this could make the price of coal stable compared to historical gyrations, which would (combined with very few new mine openings) make planning and financing much more straightforward.
Governments need to start by liberalising generation markets, remove coal subsidies and put a price on carbon with a border adjustment on imported power. If the low carbon transition isn’t fast enough then they will need to change power market regulations and set closure dates. As outlined above, the only place for SPVs is if retaining them in incumbents slows the transition. By doing all this governments will avoid moral hazard, delays due to empire building, rising taxpayer costs, public perception issues and a host of other issues that make bailouts an undesirable option.
Bailout funds are not the only way to put coal into managed decline. Responsible investors should say clearly that they will not support them, but instead advocate for alternative policies.
Joel Moreland is a Principal Consultant for Social & Environmental Finance