Phasing Out Fossil Fuel Power Generation Assets and the Value of Debt and Equity

The fight against climate change starts with the rapid reduction of carbon emissions globally. One of the primary sources of such emissions is the generation of power from the combustion of fossil fuels, starting with coal, natural gas, and diesel. Forcing the closure of legacy systems, some of which still hold a significant residual economic value and guarantee the energy security of emerging economies that are growing fast, is a complex task. The purchase of power is contracted via long-dated power purchase agreements, financed by long-term loans guaranteed by national entities or export credit agencies with strong credit profiles. Closing such profitable contracts and replacing them with new contracts formed on different types of technologies is not straightforward. At first glance, it involves additional costs and the need for concessional capital. Yet, when one models the economics of a phaseout for a fossil fuel-based power generation asset and its replacement with a renewable energy source, the superior returns of such an alternative make it an attractive proposition. Existing literature is limited to the evaluation of the cost of financing existing assets in the energy transition. In this chapter, we propose a new idea of evaluating the economic viability of switching one polluting asset and replacing it with a new clean one, while introducing the price of the pollution as the driving factor to make such a transition economically viable. In particular, we review the conditions of an early phaseout of a power generation business based on fossil fuels and its replacement with renewable energy and show that it is attractive for investors to deploy capital in such transition projects.