Sustainability Premium for the Early Retirement of Coal Plants with Evidence from Indonesia

For fulfilling climate commitments and attaining net-zero emission goals, there is a global effort to retire coal-fired power plants (CFPPs) early. Given their unique business model and public welfare missions, development finance institutions (DFIs) have a crucial role to play in facilitating early retirement of CFPPs.

What are the costs associated against three scenarios of business-as-usual (BAU), where the plant operates for its expected life, early retirement (RE) without any substitute and early retirement with the replacement by an alternative renewable plant (AR)?

In a new working paper, Bahar C. Erbas, Niccolò Manych, Kevin P. Gallagher and Rishikesh Ram Bhandary develop a Cost-Benefit-Analysis (CBA) framework for early retirement of CFPPs applied to the Tenayan Riau CFPP in Indonesia. The authors find that the welfare losses of keeping that power plant in operation are close to seven times larger than retiring the plant earlier and replacing it with alternative renewable sources.

Key findings: 

• When taking local, national and global social and environmental costs and benefits into consideration, CFPPs generate major welfare losses to society. Those losses can be significantly reduced through the early retirement of coal plants, with the lowest losses achieved when plants are replaced with renewable energy sources.
• When retiring CFPPs, a systematic approach should be adopted, using the CBA to account for idiosyncratic aspects of each plant, thereby enabling prioritization amongst the coal fleet.
• The results of the CBA can be used to impute ‘sustainability premiums’ that would be needed to make early retirement financing schemes more attractive and effective. These premiums could be considered by DFIs while raising the required carbon credit price to compensate debt and equity holders.

The paper illuminates a way forward for future research and policy, pointing to the broader sets of data that will be needed to conduct such CBAs as well as to how governments and DFIs should incorporate CBAs into their decision-making processes and climate change policies.