Securitization a Useful Financing Tool for Transition From Coal

By Brad Handler and Morgan Bazilian

Nearly 75%  of electricity generated from coal in the U.S. could be produced more cheaply with renewables, strengthening the environmental arguments to accelerate the retirement of coal plants. Yet such transitions to renewable sources have to factor in the costs—incremental, stranded and most pressingly, societal—of shutting down existing plants, as well as the interests of communities and consumers. Financial instruments are being employed to help ease the burden of the transitions, including securitization.

COMMENTARY

While securitization may prompt analogies to the 2008 financial crisis in the mortgage markets, it has attractive features to help lower the costs of energy transitions in some cases. Securitization can facilitate raising funds for coal power plant closures, while lowering the costs for ratepayers. 

Strong investor demand currently for green/sustainability bonds suggests incrementally greater savings potential. More states will likely choose to follow recent peers in enacting legislation to support this financial tool. In doing so, they would be wise to enact more expansive authorizations, including flexibility in funding just transitions to help support affected workers and their communities.

Plenty of Precedent

Securitization involves issuing a new loan, collateralized by the (government-backed) promise of future payments from customers of the utility. There is ample precedent for U.S. utilities using securitization, with 66 bond issuances, totaling $51 billion,  since 1997. The tool offers electricity customers  significant savings, in large part because servicing this new low interest rate loan replaces them having to cover the utility’s much higher (after-tax) cost of capital. In one coal plant retirement securitization, for Consumers Energy in Michigan in 2014, a $390 million bond issue was expected to yield the utility’s customers $135 million in savings.

In the case of financing coal plant retirements, the loan proceeds are used to fund the costs associated with dismantling the plant, remediating and/or repurposing the site, and recovering the approved financial returns to the utility on its original investment. These low-cost financing options can—and should—also be used to assist displaced workers and the affected communities, as well as potentially to build replacement renewable power generation (a regulated utility will want to own this replacement capacity in order to retain its earnings power).

States have been active in considering authorization of securitization for coal plant retirement, including Colorado, New Mexico, and Montana ( which passed legislation in 2019), and Utah, Kansas, Missouri, North Carolina, and South Carolina, in which legislation has been proposed. There are important limitations in the recently passed legislation, however, including a narrow definition of what facilities can be included in New Mexico, and no provisions to mitigate community or worker impacts in Montana. These in different ways compromise the opportunity to save state residents money or fund community support.

Other Mechanisms

There are other mechanisms that have the advantage of not requiring passage of new legislation. One is green bonds, which are similar to securitization except they are issued by the utility directly (vs. creating a special purpose vehicle) and do not carry the legislatively-backed assurance of ratepayer repayment. Because they lack that assurance, green bonds are typically more expensive (have a higher interest rate) than securitization. Yet very strong investor demand for green bonds in today’s market suggests the incremental cost should be modest.

On the other hand, there are also mechanisms that can facilitate plant retirements that involve more direct government intervention. One example is known as a reverse auction, in which plant owners sell the debt and obligations associated with retiring a coal plant to a government or financial institution. In this way, a government is explicitly putting a value on decarbonization, albeit on a case-by-case basis. Another is loan guarantees for retirement projects (one path to this could be to  expand the parameters of a current U.S. Department of Energy program that supports greenhouse gas reduction).

Protecting communities impacted by the transition to clean energy is both a strategic political imperative and the right thing to do, but it does imply long spending horizons of significant funds. The expense should be shared with the private sector (in order to foster buy-in at the community level).

However, it will be very challenging for state and municipal governments to finance their portions because of the risk profile of these transitioning communities (and institutions are not developed to help public market investors perform due diligence). Financial tools such as securitization, green bonds, and government loan guarantees that leverage the savings afforded by retiring coal plants allows the country to take as much advantage as it can of the low-cost tools available to it.

—Brad Handler is a senior fellow at the Payne Institute for Public Policy at the Colorado School of Mines, and a former Wall Street Equity Research Analyst in the Oil & Gas sector. Morgan Bazilian is a professor of public policy at the Colorado School of Mines, and a former Lead Energy Specialist at the World Bank.