Process, Not Product
Why Southeast Asia’s Energy Transition Mechanisms need time to evolve
Key Findings
2024 is shaping up to be the year when markets learn how Energy Transition Mechanisms (ETMs) will evolve in different Southeast Asian markets. ETMs are initiatives aimed at financing early coal retirement transactions. Their flexibility can be a strength if it improves policy alignment—and begins to deliver a pipeline of bankable deals.
The case for ETMs to change a country’s emission trajectory rests on clear evidence. ACEN’s 2022 ETM remains an important reference point for future ETMs, both for what it is and what it is not. With the introduction of transition credits, ACEN may now restructure its original ETM transaction to move up the retirement date for the South Luzon Thermal Energy Corporation (SLTEC) units from 2040 to 2030.
The pending Cirebon I ETM in Indonesia will be a valuable reference point moving forward. The independent power producer (IPP) refinancing deal has been carefully crafted to fit Indonesia’s evolving power sector restructuring plans. For Cirebon I, the Indonesian Government will set the tone—and the level of ambition.
Individual deals are setting the stage for broader market acceptance and policy innovation. Frameworks matter, however, it is important to keep a close watch on corporate strategies and debt capacity to monitor which issuers could be motivated to embrace ETMs as energy transition fundamentals change across the region.
After two years of focused policy work to advance the Just Energy Transition Partnerships (JETP) that were launched at COP26 in Glasgow, the landscape of Southeast Asian ETMs has yet to mature. Progress has been made on policy in the key markets—Indonesia, Vietnam, and the Philippines—but 2024 is shaping up to be the year we learn more about when and how ETM transactions can attract the capital needed to secure finance for early coal plant retirements. New financing instruments such as the transition credit initiative recently launched by the Monetary Authority of Singapore (MAS), with pilot project participation by ACEN, point to this evolution in efforts to attract new capital to support the shift away from high-carbon assets.
While the Asian Development Bank (ADB), the International Partners Group, and active philanthropies remain engaged, the question remains which coal project owners, bankers, and investors are motivated to step up to deliver new coal refinancing deals.
New ETM transaction structures
Launched in 2021 by the ADB, ETMs were envisioned as a tool for developing scalable transactions designed to support financing for early retirement of coal power assets and follow-on investments in renewables. When the ETM concept was first introduced, the market embraced the idea that such transactions would accomplish multiple operational and investment goals in a single coal retirement transaction. Much of the initial policy discussion assumed that a new buyer would purchase a facility, operate it for a limited period to accelerate shutdown, and then replace the unit with renewables of equivalent capacity.
Over the past year and a half, as the focus shifted to potential deals in Indonesia and deals proved harder to close, an alternative approach emerged: an existing project sponsor and operator would refinance the facility, creating a new financial structure that would align with early retirement and subsequent renewables investment. ADB has also added a corporate-level “portfolio model” that would channel ETM funding to a power project sponsor with coal assets and clean energy investment opportunities to accelerate coal retirement paired with a renewable investment pipeline.
The first two templates are still valid, but it is becoming clear that we may instead see interest shift to a portfolio model for those issuers with a diversified portfolio of power assets and renewables capabilities. This is more likely in markets where there are seasoned issuers with both old fossil fuel assets and a growing renewable asset base that can meet supply obligations. Depending on the pace of market development, the design of ETM transactions should be expected to continue to adapt to different market challenges, the emergence of new policy drivers, and the availability of capital.
The high-level case for ETMs remains strong, but tracking the catalysts requires local market insight
Coal retirement and ETMs remain a central part of countries’ emission reduction strategies, as this remains one of the few steps that can yield material emissions savings in the 2025 to 2035 timeframe when easy savings may be hard to realise. This dynamic is evident in TransitionZero modelling which demonstrates the potential of early coal retirement to make an outsized contribution to net zero pathway alignment and emissions reduction. Our analysis into Indonesia’s net zero road map to 2060 found that, compared to a current policy scenario, early coal retirement avoids 1.3 gigatonnes of CO2 to meet net zero.
Although the potential benefits are clear, transition roadmaps in many Southeast Asian countries are still in progress as stakeholders do the hard work to determine how and where coal retirement can have the greatest impact. Depending on the market, policymakers and clean energy investors have repeatedly come up against three constraints in securing coal retirement deals since the ETM program was launched:
Unlike the situation in competitive developed markets which frames the financial case for ETMs, Southeast Asia’s coal fleet is relatively young, and many facilities have not yet returned funding to debt providers;
In addition, many project sponsors face little stranding risk due to guaranteed PPAs which eliminate the impact of market incentives to replace higher-cost coal units with lower-cost renewables plus storage; and
Finally, over the past two years, high prevailing interest rates and a shift of risk capital out of emerging markets have scaled back the pool of capital providers for innovative transactions. This reflects the impact of a spike in inflation in 2022 and 2023 as economies emerged from the COVID-19 pandemic - which then triggered aggressive central bank interventions leading to significantly higher interest rates in most global markets.
These market-specific considerations have slowed the progress of early ETM deals in most markets. While deals themselves are shaped by the asset and associated cash flows, part of the issue is that building consensus on best-fit transactions requires a new commitment to a broader clean technology portfolio, as well as system planning with a more detailed focus on grid development and system services to maintain the stability and reliability of the grid. This requires sophisticated energy system modelling and new strategies for evaluating how the generation mix should evolve.
Some of this work is underway. For example, Indonesia’s Comprehensive Investment and Policy Plan (CIPP) focuses on a range of new power system management priorities and offers a template for understanding how energy transition priorities can shift from the initial ETM coal-to-clean if strategies like coal flexibility and biomass or ammonia co-firing enter the planning process.
In a privatised market like the Philippines, system planners are actively assessing new policy strategies that could encourage more ETMs and provide better economics for well-located clean energy assets that are poised to enter the market on a cost-competitive basis. The outlook, and the corresponding early coal retirement strategy, are sensitive to which system considerations are prioritised in the next five years, however. This includes the timing of grid investment and the availability of new revenue streams for storage. In addition, investors will also need to make a call on how new LNG-fired power units may reshape the market and whether they will encroach demand for renewables.
It’s also critical to have a pragmatic view of the power sector funding ecosystem to understand the motivations of bankers as well as bond and equity investors in an ETM. Leading domestic banks in most Southeast Asian markets, as well as the global investment banks active in the region, have solid sustainable finance credentials. Despite credit headwinds, investors have not turned their backs on the potential of ETM transactions. Rather, they seem to be waiting for deals that align with more tangible policy drivers and specific market opportunities which can be evaluated in tandem with company strategies—and the cash flows needed to service debt.
ETM financial innovation will be a deal-by-deal process
Taken together, the market constraints discussed above are the most common explanations of why Southeast Asia’s ETM track record is so limited and remains focused on only two transactions. The 2022 ACEN ETM deal remains the only market-based ETM closed, with a target retirement date of 2040 locked in. The pending Cirebon I refinancing remains in the pipeline for the first half of 2024.
These deals are worthy of careful examination because they offer helpful insights into the market drivers and financial engineering that may be required to deliver high-impact ETM transactions in 2024 and beyond. They also demonstrate the role of different groups in these ostensibly complex transactions. The ACEN deal was issuer-initiated with policy stakeholders working in support while the Cirebon deal owes more to the focus of the ADB and IPG. Either way, pragmatic financiers don’t work with a fixed formula if key risks can be managed. That’s why ETM transactions backed by a seasoned issuer with a compelling clean energy strategy or supported by meaningful concessionary capital will have a higher chance of success.
The market dynamic is also crucial. ACEN is on a shortlist of Southeast Asia’s fastest growing renewables companies, but commentators were initially cool to ACEN’s SLTEC transaction due to the long retirement time frame for the SLTEC units and the lack of clear market drivers. Nonetheless, from a financial and operational perspective, ACEN has built credibility around their Philippine market strategy and the deal has created new opportunities for them to innovate further.
The following characteristics of the 2022 ACEN deal stand out:
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The deal was structured to permit ACEN to withdraw PHP 7.2 billion of equity, transfer ownership to financial investors, and lower funding costs by increasing the debt-to-equity ratio. ACEN made a general commitment to recycle the PHP 7.2 billion for investment in renewables in line with their goal to be 100% renewables by 2025 and to reduce Scope 1 emissions by 74% by 2030. Within the deal itself; however, the proceeds are not ring-fenced, although given ACEN’s focus on RE, the probability of misuse of proceeds to fund carbon-intensive projects is low.
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The original PHP 11.0 billion 12-year debt package was replaced by a larger PHP 13.7 billion loan package at lower prevailing interest rates. When paired with the smaller equity capital base, SLTEC’s new debt package lowered the project’s cost of capital.
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The passive financial investors benefited from a tolling structure where ACEN retained all operating rights and risk exposures under their exiting PSA to deliver electricity to Meralco until 2029. This insulates InLife, a leading Philippine insurance company, and PGSIS, the Philippine government pension fund from operating risks and removes any need to renegotiate the PSAs that guarantee offtake until 2029 for Unit 1 and 2030 for Unit 2. ACEN remains liable for all operating costs including maintenance, fuel supply, and decommissioning. Taken together these steps de-risk both revenues and costs over the medium term, as well as lowered funding costs.
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A notable provision of the financing agreement that the market overlooked is a put-and-call option structure. The put option de-risks the structure for investors by giving them the right to sell their equity back to ACEN at a predetermined price. Meanwhile, the call option permits ACEN to buy back the equity and re-assume direct ownership of the units.
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The ETM reduced the 2x135MW (246MW net installed capacity) facility’s expected useful life by half to 25 years, with the retirement of unit 1 set for 2040 and unit 2 set for 2041.
Most notably, the deal continues to evolve on two fronts even amidst 2024’s market turbulence. At the time that ACEN’s ETM financing was finalised in mid-2022, the company had not yet made a commitment to a fully net zero-aligned position. With the release of their integrated report in 2023, the company unveiled new disclosures and comprehensive net zero commitments covering Scope 1, 2, and 3 emissions. It also detailed a 2,400 GW renewable pipeline with 700 MW planned in the Philippines. These disclosures confirm ACEN’s full strategy alignment with rapid energy transition and put the company in a unique position to participate in policy discussions with regional leaders including MAS on transition credits.
The company’s policy work on transition credits is material because ACEN is poised to consider a new SLTEC ETM transaction that builds on the first deal. This new transaction would involve unwinding the earlier ETM by exercising its call option and refinancing SLTEC with transition credits to support a 2030 shutdown of both units. It now appears that this small piece of financial engineering could permit ACEN to build on its market credibility with the sustainable finance community and tailor a financing package that would permit it to benefit from new sources of capital, achieve a benchmark coal retirement, and still meet SLTEC’s supply obligations from its growing portfolio of new renewables and battery assets.
The market continues to expect progress on the ETM transaction for Cirebon I in Indonesia. Marubeni, the largest shareholder, the plant operator of the 660MW Cirebon I facility, the ADB, the Indonesian Investment Authority (INA), and PLN signed a Framework Agreement on December 3, 2023, announcing the goal of completing the ETM transaction by the end of the first half of 2024. According to ADB, the proposed refinancing would reduce the plant’s life by seven years, and support a 2035 retirement. Key issues to watch are whether PLN will be able to support ETM deals with clear policies that link to the goals of international ETM investor frameworks or whether they stay focused only on homegrown system development challenges.
What’s notable here – and could be repeated in other regional markets as ETMs emerge – is that seasoned issuers with clear strategy alignment may be able to support a virtuous cycle where higher ambition unlocks new sources of capital. Throughout 2024, issuers like ACEN and Marubeni – the key player in the Cirebon I ETM – and the banks that support these transactions will have a chance to trial new approaches to the ETM market.
Not every deal will win immediate support from investors as the Cirebon I deal team has learned. Finding support from equity investors, even those with an impact orientation, can be difficult. Nonetheless, these two deals highlight the importance of nine key success factors that may prove influential as the ETM market matures.
The most important takeaways from the ETMs over the past two years are the importance of project sponsors’ motivations and how investors will evaluate the way that market design supports early retirement and renewables investment goals. As the strategic goals of leading Southeast Asian clean energy investors become clearer, it’s only natural to expect that ETMs will continue to evolve.
This blog is Part 1 in a Series of Blogs on ETM deals. Part 2 focuses on ‘ETM: Things to watch in 2024.’
