Addressing climate change is not something that any single actor can do alone. Progress comes from cooperation among governments, companies, financial institutions, research organizations, and consumers. Each stakeholder plays a distinct role and must move forward together to solve the most pressing climate challenges. Among these actors, financiers have become especially prominent in recent years. At CERAWeek, many sessions were held on investment and financing. This article considers how finance puts decarbonization into practice through a concrete example of the early retirement of coal‑fired power plants.
Issues Surrounding Coal-Fired Powered Plants
Coal-fired power plants are one of the largest sources of CO₂ emissions in the power sector. The Paris Agreement calls for OECD countries to phase them out by 2030 and for non‑OECD countries to do so by 2040 so as to keep the 1.5°C target within reach. In practice, however, many coal-fired power plants have long lifespans and have not yet recovered their initial capital investment. For instance, the average operating coal-fired generating unit in the United States is 45 years old. Many asset owners make investment decisions based on the assumption that coal-fired power plants will operate for several decades in order to recover their costs. Local employment, regional economies, and energy security also depend on these facilities. As a result, they cannot simply be shut down overnight, and financial institutions and creative financing mechanisms play a central role in making the early retirement of coal-fired power plants possible.
Financial Mechanisms That Enable the Early Retirement of Coal-Fired Power Plants
A leading example of how financing strategies can support early decommissioning of coal power plants is the Energy Transition Mechanism (ETM) now underway in Indonesia. The Asian Development Bank (ADB) leads this scheme. The ADB purchases existing coal-fired power plants, restructures them with low-interest financing so that repayment becomes feasible, and closes them earlier than originally planned.
Indonesia has many coal-fired power plants that were built relatively recently and were designed to operate for twenty to thirty years. Shutting these plants down without any ability to recover costs would create significant losses for the power companies and disincentivize the retirement of heavy polluting energy sources.
In the ETM structure, domestic power companies sell their existing coal-fired power plants to investors. The plants are purchased at a “transition value,” which is lower than market value. This value reflects the asset’s remaining lifespan, projected cash flows, and the losses associated with early closure. The plants are then retired ahead of schedule. The ETM fund combines public and private capital. ADB and participating governments take on the higher-risk portion under subordinated terms (i.e. Funds are distributed to the other participants on a priority basis ahead of ADB and participating governments if repayment is delayed or defaults occur). Their role is to absorb risk and attract private investors. International banks and institutional investors provide capital to the lower-risk portion and receive stable returns. This partnership between public and private actors is known as blended finance. At its core, the ETM is not only a source of funding, it is a redesign of risk and cash flows. By replacing high-cost private capital with lower-cost public capital, ETM reduces the weighted average cost of capital (WACC). As a result, early closure becomes economically viable.
The defining feature of this scheme is that it is designed to provide benefits for all stakeholders. For the government, it accelerates emissions reductions and limits fiscal burdens by leveraging international support. Utilities can avoid the risk of coal-fired power plants becoming stranded and can use proceeds from asset sales to facilitate a shift toward renewable energy investment. Private financial institutions can secure stable risk-adjusted returns and achieve portfolio decarbonization. International financial institutions can provide tangible support for the energy transition in developing countries and expand impact by taking advantage of private capital. For the citizens, a more just transition is ensured. This delivers social benefits such as easing job losses and stabilizing the electricity supply, and the reinvestment in clean energy sources provides opportunities for new jobs and a cleaner environment.
In fact, similar cases exist in other countries as well. For example, in South Africa, the gradual phaseout of coal-fired power plants is being pursued through a scheme known as the Just Energy Transition Partnership (JETP). In the Philippines, ACEN, which is one of the largest utility companies in the Philippines, is developing a model in which coal-fired power plants are retired earlier than scheduled, and the resulting emissions reductions are converted into carbon credits known as Transition Credits. In both cases, sophisticated financial mechanisms play a pivotal role.
In this way, the phase out of high-emitting assets becomes feasible only when finance simultaneously performs three functions: reallocating risk, redirecting capital flows, and managing social impacts. Finance is necessary to move sectors in ways that technology and policy alone cannot shift. And this is not unique to coal; it represents the essential role of finance across all areas of the energy transition.
How to Unlock the Potential of Finance
Whether the global push for decarbonization succeeds or fails will depend heavily on the quality of financial scheme design. To unlock the potential of finance for global sustainability implementation, two elements are essential.
The first is the stability of long-term government policy. The shift toward next-generation technologies, such as SAF, hydrogen, and CCS, as well as the early retirement of coal-fired power plants, requires investment recovery periods spanning 20 to 30 years. If carbon pricing or subsidy regimes fluctuate every few years — as seen in some countries — private finance cannot make a serious, full-scale commitment. When a government establishes rules that will not change for decades, it is more than just a policy decision; for investors, it is equivalent to a granting of credit. For instance, the UK Contracts for Difference (CfD) scheme, the government guaranteed electricity sale prices over the long term, which enabled the expansion of offshore wind capacity and cost reductions through economies of scale.
The second is the standardization of transition pricing. In early retirement schemes for coal-fired power plants, the purchase price of assets varies across projects and transparency remains limited. Under such conditions, investors face difficulty in assessing risk. If international financial institutions take the lead in standardizing methods for valuing residual assets, early retirement of large emitting plants will shift from being an exceptional project type to an investable asset class.
Both points are prerequisites for finance to fully perform its fundamental role as a provider of long-term capital. These issues are not unique to Asia. They can also be applied to the transition of coal-fired power in the United States and to investment in transmission infrastructure. In each case, the design of financial mechanisms and the role of financial institutions have a big impact on the success of the energy transition. Sustainability will vary greatly in both speed and feasibility depending on how effectively the power of finance is mobilized.
Reader Question:
What changes in policy and market design are needed to unlock finance’s full potential in driving the energy transition?