Can the next generation of coal power be banked?

Australian Energy Minister Josh Frydenberg said in the wake of power outages and grid malfunctions in South Australia, in particular, the government’s priority was to ensure reliable base load power – which in Australia currently is coal-reliant. (Bearing in mind Australian governments have also consistently committed to carbon emission reductions to combat climate change.)

"The regulator has now been more explicit than ever before, putting its charges in the financial services sector on notice."
Andrew Cornell, BlueNotes managing editor

"It's called the Clean Energy Finance Corporation not the renewable energy corporation,” the Minister said of the CEFC, emphasising the government’s recognition of the tension between a shift to lower carbon intensity power and the reliability and cost of supply.

Meanwhile, speaking at the Insurance Council of Australia Annual Forum, Australian Prudential Regulation Authority executive board member Geoff Summerhayes discussed climate change and its implications for prudential supervision and the financial sector.

 The speech,  “Australia's new horizon: Climate change challenges and prudential risk”, outlined APRA’s thinking following the 2015 Paris Climate Agreement and the Financial Stability Board's draft recommendation on climate-related risk disclosure released in December 2016.

“While climate risks have been broadly recognised, they have often been seen as a future problem or a non-financial problem,” he said.

 “The key point I want to make today, and that APRA wants to be explicit about, is that this is no longer the case. Some climate risks are distinctly 'financial' in nature. Many of these risks are foreseeable, material and actionable now. Climate risks also have potential system-wide implications that APRA and other regulators here and abroad are paying much closer attention to.”

The insurance industry indeed was one of the first to seriously respond to the impact of climate change given its long term liabilities and the kind of events which cause it loss are likely to worsen as the planet heats up.

But lending institutions too have become far more involved in modelling the impacts. On one front this is purely financial: lenders have to take a view on the risk of the assets they are lending too and, for example, in the case of fossil fuels that may include a loss in value of the asset or even a complete write-off as new technologies enter the market or government policy prices fuels like coal or even gas out – the ‘stranded asset’ phenomenon.

The governor of the Bank of England and chairman of the global Financial Stability Board Mark Carney gave a key speech two years ago on the challenge climate change posed for financiers “over the horizon”.

“The horizon for monetary policy extends out two to three years," Carney said. “For financial stability it is a bit longer, but typically only to the outer boundaries of the credit cycle – about a decade.”

“In other words, once climate change becomes a defining issue for financial stability, it may already be too late."

UNSAFE

Last week APRA’s Summerhayes said “it's unsafe for entities or regulators to ignore risks just because there is uncertainty, or even controversy, about the policy outlook. Like all risks, it is better they are explicitly considered and managed as appropriate, rather than simply ignored or neglected.”

For those in the regulated sector like banks, Summerhayes was quite explicit: “So what can you expect to see from us? Firstly, something you would already be aware of is a greater emphasis on stress testing for organisational and systemic resilience in the face of adverse shocks.”

“It could be the case that, just as we would expect to see more sophisticated scenario-based analysis of climate risks at the firm level, we look at these risks as part of our system-wide stress testing.”

For a prudential supervisor, stress testing includes assessing an institution’s capacity to absorb loss on assets and to sustain liquidity in the face of a withdrawal of funding. Thus regulated financiers must look at the credit quality of assets through the prism of climate change and potential policy change.

Investment in coal-generating capacity then is quite problematic. Coal is carbon intensive and technological mitigations of that intensity, such as carbon capture and storage (CCS, to prevent carbon dioxide entering the atmosphere) and new ‘clean coal’ capacity (which produces reduced carbon dioxide emissions) are expensive and unproven.

In analysis written for BlueNotes, Kate Mackenzie, manager, Investment & Governance at The Climate Institute noted “financial institutions are increasingly being asked by shareholders to measure and disclose their exposure to carbon risk”.

Mackenzie provided a critique on ANZ’s emission intensity data for power generation but commented more broadly on the banking sector.

She made some key recommendations:

• Several US and European banks (including Credit Agricole, Goldman Sachs, and JP Morgan) have declared they will not finance new coal-fired power capacity in developed countries unless carbon capture and storage is deployed.

• Australian banks could at least make this gesture, as in Australia even electricity generators acknowledge the future trajectory for coal-fired power is to close existing plants. A more meaningful approach would be to rule out re-financing existing conventional coal-fired plants.

• Encourage and support innovative ways to reduce emissions throughout the economy.

The challenge for new coal (and to a lesser extent, gas) generation is the cost and investment risk. Indeed, several Australian power generators have described greenfield projects in this field as ‘unbankable’. Obviously, as some senior government figures have noted, there are many vested interests at play.

Equally though a growing number of financiers, including for example ANZ and HSBC, have thresholds on the carbon emissions of new projects and will not participate in funding if they are exceeded.

On the other side, some in industry argue CCS would be viable if it was supported by government to the same extent as renewables. Clearly fossil-fuel supplier nations such as Australia and Canada have a particular interest in exploring the possibilities.

Both the Intergovernmental Panel on Climate Change and the United  Nations have published reports which suggest global warming cannot be limited to sub-2 degrees without CCS because it can be applied to manufacturing and other heavy industry.

In Australia, the CSIRO says bio-sequestering/CCS is the only answer with current technologies that will get Australia to a zero carbon future.

UNBANKABLE

An executive at Mitsubishi Hitachi Power Systems, among the world leaders in high tech coal power plants, told The Australian Financial Review’s Ben Potter the technology would probably cost more than thought in Australia and still emit relatively large quantities of carbon.

A viable generator may cost between $A4 billion and $A5 billion. Emissions reductions are around 25 to 35 per cent – insufficient under present regulation to qualify for CEFC funding. This is where the Australian government’s posited changes to the green bank’s mandate come into play.

But even if conventional financiers decide not to back these new generation coal power plants, that doesn’t mean taxpayers – via government policy - shouldn’t.

Commercial investors must deliver a return to stakeholders, typically shareholders, and regulators like APRA.

Governments on the other hand have much broader mandates. As Frydenberg and others have noted, the security and price of power supply are fundamental issues for the country – as indeed they are in other jurisdictions facing similarly complex challenges.

For Australian banks though, the regulator has now been more explicit than ever before, putting its charges in the financial services sector on notice: "the days of viewing climate change within a purely ethical, environmental or long-time frame have passed”.

The CEFC, the ‘Green Bank’ of course is not an APRA regulated institution, its mandate is the prerogative of the government executive and parliament.

Andrew Cornell is managing editor at BlueNotes