To get rid of coal power, we need smarter coal finance

Coal has long been climate enemy No. 1.

For decades, financial institutions have been under pressure to end coal power financing — first from activists, and more recently because of their own net-zero pledges. But simply divesting from coal will not close coal plants at the speed required to avoid the worst climate impacts. Instead, shutting down coal plants in the right way while ensuring communities and workers aren’t left behind will require billions in new, targeted financing.

But first, let’s be clear: There is no viable pathway to limit climate change to the Paris Agreement’s target of well under 2 degrees Celsius of warming without phasing out the world’s coal plants ahead of schedule.

Continuing to run existing coal plants until the end of their operational lifespans would nearly exhaust the world’s dwindling carbon budget. If new or planned coal plants are allowed to come online, the fallout could be even more disastrous. That’s why COP26 participants came together on the promise to ​“consign coal to history” in favor of cleaner alternatives. But in the year since the Glasgow climate conference concluded, demand for coal power has skyrocketed amid an unprecedented global energy crisis. Coal remains the world’s single largest source of emissions.

There are many reasons why phasing out coal has proven much easier for nations to pledge than to carry out. Retiring a coal plant can be incredibly expensive, complex and risky, especially where local economies depend on the industry. Utilities that own and operate coal assets are often already saddled with loan obligations, leaving little flexibility to forgo any expected profits or take on the significant costs of shuttering a coal power plant ahead of schedule.

At the same time, despite renewable energy being significantly cheaper than building new or operating existing coal assets, over 93% of global coal power capacity is shielded from competitive pressure due to long-term sales contracts, government subsidies and other incentives. Consequently, coal asset owners are often incentivized to continue operating their coal plants even when cheaper, more climate-friendly alternatives exist.

The good news is that viable workarounds exist, including innovative solutions that financing institutions can use to tip a coal plant’s economics in favor of an accelerated phaseout date. Still, all climate-focused financial institutions that opt to strategically prolong their coal investments in the short term so they can plan and execute a managed phaseout will have to grapple with two significant challenges.

First, financial institutions that invest in high-emitting industries are facing increasing scrutiny. Those with net-zero pledges are focusing on how they can reduce their ​“financed emissions,” or the emissions associated with dollars they’ve loaned or invested. Since coal plants are often among the highest-emitting assets in their financial portfolios, many financiers are feeling more pressure to divest from coal. Indeed, many net-zero-committed financial institutions have enacted policies that have ended or severely limited their ability to be involved with coal financing at all. But while this may help financial institutions lower their portfolio emissions on paper, these actions may not result in meaningful decarbonization in the real world.

Second, many financial institutions have yet to be convinced that coal plants can retire earlier than planned and still achieve the financial returns their investors are looking for. In the past, government funding has often been used to soften the financial blow of early coal plant retirements. But today different combinations of financial tools, transaction structures and incentives can make the early retirement of coal plants an attractive investment opportunity. What’s more, financial institutions that take this route can deepen their client relationships, reduce emissions in the real world (rather than just on paper), and help ensure a just and equitable energy transition for the most vulnerable communities.

On the other hand, if big Wall Street banks with net-zero pledges suddenly stop funding coal and climate-conscious investors bow out of the market, two bad things could happen. For one, with less money available, interest rate hikes could make it harder for coal plant owners to get the financing they need to shut down their plants ahead of schedule. Also, the new buyers of coal plants, such as private equity firms, might continue to run those plants for longer than their previous net-zero-committed owners would have — and with less external scrutiny from climate-focused shareholders. In Europe, private equity firms increased their investments in coal, oil and gas companies by over 83.5% in 2022 alone.

Although increasing financing to help phase out coal plants may seem inimical to the goals of net-zero-committed financial institutions and climate activists, a business-as-usual approach will not solve the world’s coal challenge. With new reports out on the tools available to help create and track managed coal phaseout plans, along with guidelines on how to distinguish credible phaseout deals from greenwashing, financial institutions now have an array of smarter strategies to choose from.

It’s time to close some deals. 

Alex Murray is an associate with RMI’s Center for Climate-Aligned Finance. As a member of the Center team, Alex is working to help transition the financial sector toward a decarbonized, climate-aligned future by enabling financial institutions to align their investing and lending decisions with climate goals. 

Shravan Bhat is a senior associate within RMI’s Center for Climate-Aligned Finance, working with the Alignment Insights Team. His areas of focus are the coal-to-renewables transition, decarbonizing heavy industries and blended finance. 

Drawing on our technical expertise in the energy sector, RMI has released several new papers on the coal transition, including Metrics and Mechanisms to Finance Managed Coal Phaseout, How To Retire Early, Financing the Coal Transition, Architecting Indonesia’s Record-Setting Climate Deal and Guidelines for Financing a Credible Coal Transition. (Canary Media is an independent affiliate of RMI.)