The Tortured Transition Department

Summary

2024 will be a year of crosscurrents for the energy transition in Southeast Asia. With political risk running high, it’s time to dig into the technical debates and developments that will determine how fast regional analysts and system planners fill the gap between high level policy statements and the functional roadmaps that markets need.

TransitionZero’s 2024 watch list is framed by the basics: targets, prices, and money. Across Southeast Asia, we see a new climate of debate and engagement in research, policy, and practitioner fields about each of these topics.

Targets: With NDCs due for an update in 2025, national governments will be doing the groundwork across ministries to come up with new, and more integrated targets. As the power development plans that underpin targets become more consequential, look for more commentary and questions about which metrics are being used and whether they match the indicators that investors will use to monitor progress and allocate capital.

Prices: How much new technology, fuel, and services—and at what price—will be available for the energy transition will continue to be a topic of research and debate. New and better ways to approach complex questions about the cost of large-scale LNG and about how transition credits may be priced to provide funding are finally coming into public view as policymakers and system planners weigh options.

Money: The energy transition funding debate—with its focus on headline global numbers—will continue to rage. A better strategy for Southeast Asia is to keep an eye on deals and new mechanisms used by sovereign and sub-sovereign issuers to seed developers and funders on the ground.

The case for practical questions

2024 is set to be a turbulent year for energy transition in Southeast Asia as the focus on the promise of Just Energy Transition Partnerships (JETPs) and ETMs is layered with questions about when national governments are going to declare their intentions on the next round of major power system investment choices. Nothing is likely to come easily as political transitions in Indonesia and Vietnam push policy implementation to the sidelines and funding flows remain too sluggish to support innovative deals. That’s why this is the year to be cautious about majoring in high-level policy reforms and to focus instead on the often-overlooked mechanics of transition.

Details matter in power system planning and analysts are waiting for answers about how the many new standards, technologies, and financial instruments that have emerged over the past two years will come together to reshape Southeast Asia’s diverse power markets. The intersection between global norms and regional fund flows, has resulted in power development and investment plans that signal a direction but don’t guarantee action. That’s why it’s so important to stay curious about the practicalities that need to line up to see real progress.

What’s the target?

In 2024, countries are expected to start revising their Nationally Determined Contribution (NDC) targets to be submitted for the next stage of the COP process in 2025. Since the last revision in 2021-2022, many countries’ approach to the energy transition has changed significantly. As a result, the NDC revision process will shed light on the steps they may need to prioritise in power system design to align with economy-wide decarbonisation. Although developed countries need to show more leadership in their commitments, Southeast Asia will not get a free pass due to its young and still growing fossil fuel power fleet. The targets used by Indonesia and Vietnam are currently rated by Climate Action Tracker as “critically insufficient”, while the Philippines’ plan is rated “insufficient.”

These labels may not influence policymakers, but the integration of climate and transition risk into financial disclosures and planning could see weak NDC targets become a barrier to new sources of capital needed for energy transition. This is where two issues related to targets could be critical to sustained progress on climate finance in 2024.

Open

The first issue is the need for more transparency and updated analytics on NDC targets. This needs to be supplemented by much-needed disclosure on how they are linked to the domestic policy targets that guide power sector investment and system management. In theory, NDC targets should be a direct reflection of a coordinated national target-setting process. But in the complex bureaucracies that govern energy, power, industry, and agriculture, these responsibilities are often overseen by different arms of the government and weak implementation can be the result.

This disconnect offers a partial explanation for how different arms of the Indonesian government could simultaneously make commitments to the JETP backers on a tougher 2030 emissions target but support the development of 20 GW of captive coal to power the fast-growing mineral smelting industry. More recent reports suggest that Indonesia’s National Energy Council may cut its renewables targets by 26% for the National Energy Plan which would undermine both the 34% target highlighted as part of its JETP commitments and the scope for improvements in the future NDC. A target revision of this scale implies not just a lack of confidence about new solar projects, but execution challenges to the much bigger pipeline of large-scale hydro projects.

Energy intensity targets may also be losing traction across the region because slower economic growth has interrupted easy gains as the structure of economic growth shifts. As opposed to absolute targets, energy intensity targets avoid hard choices by creating incentives for structural energy efficiency shifts in the context of growth. China has led the way in using energy efficiency targets to drive energy intensity gains, but in early 2024 their broad-based target was restructured to cover only fossil fuel consumption. This has raised practical questions about the significance of the metric because the old targets were also retained. Meanwhile, the rapid rise of energy intensity in Vietnam hints at a lack of coordination between different arms of the government. It’s hard to predict how this target revision process will play out, but headline announcements on new targets will require more careful review in the context of carbon budgeting.

The second issue with targets stems from the challenge of discerning the correct financial signal from noisy Southeast Asia datasets. Bankers and policymakers continue to debate the correct way to define climate targets and metrics so they can be linked to the transition financing needed to support more meaningful transition investments. Although taxonomies have the potential to reduce uncertainty about the investability of specific assets, investors have become less tolerant of poorly constructed metrics and efforts to cherry-pick achievable targets.

Who will drive change in this arena? It should be issuers, but this is still a nascent market, and it may fall to the bankers—who can be good at tough love—to deliver the message to issuers that soft metrics and weak implementation will come at a cost. As developed market researchers shine a light on how non-performance on targets can reprice sustainable bonds, it’s only a matter of time before Southeast Asian investors follow in their footsteps. This is something that finance ministry officials will need to monitor as less rigorous Southeast Asian taxonomies begin to face a market test.

What’s the price?

One of the most notable trends of the past three years has been debate about the cost of the different technologies that dominate Southeast Asian energy planning discussions. Whether it’s the capital and operating cost of LNG, hydrogen, biomass co-firing or CCUS, many industry and policy commentators rely on simplified assumptions about the system-level cost of deploying and operating these technologies at scale. Part of the problem stems from the use of generation-only capital investment cost estimates which overlook the associated operating and system costs which can include fuel and feedstock costs, efficiency losses, and required infrastructure.

As a result, modelled outcomes for markets like the Philippines have featured untested cost inputs that contain dated capital and operating cost profiles. The gremlin in the numbers is also illustrated by the tendency of Southeast Asian gas advocates to reference LNG cost norms in mature North Asian and European gas markets, where the gas value chain with LNG regasification terminals, storage, and gas pipelines is already fully amortised and the system cost of an incremental combined cycle gas unit can compare favourably to renewables depending on the system configuration.

Developing accurate fuel cost estimates has also been an issue. For example, it’s not uncommon to find LNG proposals in Southeast Asian markets that continue to reference USD 7 per MMBtu as a baseline cost of LNG for gas-fired power plants. These estimates typically overlook how contract structures influence long-term pricing profiles and shape the ability of offtakers to manage LNG price volatility for consumers.

This information gap is something that regionally appropriate gas supply cost curves along with realistic infrastructure development plans can help mitigate. Investors will also have to drill into any soft assumptions about the structure of fuel supply contracts—whether short- or long-term—and the funding roadmap for associated infrastructure. The financial calculus is layered with risk management challenges due to the fixed take-or-pay obligations common in LNG supply contracts and guaranteed offtake provisions for related gas power units that may be project financed.

The complexity of this planning work can easily slow decision-making and it's tempting to guess that some of the delay in finalising commitments to large-scale LNG complexes in markets like the Philippines and Vietnam may be due to political uncertainty about whether domestic power consumers are prepared to accept a sharp increase in fuel price risk in their power tariffs. Simply allocating this price risk to national energy companies—a plan that has been debated in Vietnam—rather than power consumers may shift the risk but fail to solve the problem of how the economic impact of LNG price risk should be managed to protect consumers and taxpayers from costs that they are poorly placed to hedge.

A second price conundrum can be observed in the discussion of transition credits. Singapore’s Monetary Authority (MAS) has kick-started the development of implementation pathways for transition credits to meet demand potentially coming from developed countries like Japan. There could also be well-organised potential suppliers of credits in Southeast Asia as viable managed coal phase-out and renewables projects emerge.

Sitting in the background, however, is a crucial question: how will these credits be structured and priced? This is a problem that only market forecasters can love because of the long history of price volatility in both compliance and voluntary credit markets. In 2024, more mature carbon markets started on a subdued footing. Seasoned regulatory compliance markets like the EU ETS traded in the USD 60 – 80 per tCO2eq range since the beginning of 2024. Younger carbon markets in China and South Korea rely on generous credit allocations and are only slowly developing rules to support more aggressive emissions abatement and trading to support price signals.

By contrast, the perceived value of voluntary credits has suffered in the past year and prices are now commonly less than USD 10 per tC02eq. Some of the quality problems that have afflicted the voluntary credit market could ease as new standards improve, but the real market test will come when investors can assess the quality of the first round of transition credit deals and whether they meet a high level of transparency.

The outlook for Asia’s transition credit market rests on how the pipeline of managed coal phase-out deals matures. Early tests may come this year if progress is made on the two pilot projects that have been announced in the Philippines, one involving ACEN’s SLTEC project and a second involving work by the Asian Development Bank with the Philippine Government in Mindanao, southern Philippines.

McKinsey published a report in September 2023 that provides a preliminary estimate of how credits may be priced to support projects based on a hypothetical Indonesian coal retirement transaction. Their modelling work priced the credits needed to accelerate retirement by five years at USD 11-12 per tC02eq. Risks to the forecast include delivery failure as investors would be buying credits that could require a 10-year wait before the emissions reductions would commence. Questions have also been raised about providing certainty that any coal capacity retired would be replaced by renewable energy capacity.

Both issues are material to the question of how transition credits should be structured, and how much engagement will be needed to support the price discovery that may be required before accurate pricing indications are locked in. Analysts will also be hoping for a more detailed roadmap building on the first iteration of the MAS Singapore-Asia Taxonomy to shed light on how different types of voluntary credits—both for phase-out and renewables—can be paired to support transition deals.

Where’s the money?

The debate about how much energy transition will cost and where the money will come from has been front and center for the past two years with a particularly bright light cast on the urgency of funding-accelerated transition in emerging and developing markets (EMDEs). Indonesia’s JETP CIPP estimates that they will need an estimated USD 96.1 billion in investment from 2023 to 2030. Vietnam’s JETP-aligned scenario is expected to require “several times” the USD 15.5bn amount that has been committed by the international partners to date.

If 2023 was the year that Southeast Asia climate policy observers learned how to talk about the cost of capital, 2024 has the potential to be the year that we start to see new—and potentially significant—energy transition funding trends in Southeast Asia. While the global funding dynamic is largely driven by private market financing—a combination of debt and equity—the Southeast Asia scenario is still dependent on leadership from government and state-owned enterprises in markets like Indonesia and Vietnam. The Philippines, with its largely privatised market, is a notable outlier where funding depends on leading corporations with the government taking the role of defining programs and policy.

Tracking the funding flows in Southeast Asia is not easy, however, and there are few comprehensive metrics that capture all relevant energy transition funding activity or make it possible to compare like with like, especially as the young fleet of conventional energy and power assets age and are replaced by more clean energy and distributed power systems.

There are also meaningful differences in how capital is mobilised in different Southeast Asian countries. For example, in markets like the Philippines, large corporates often rely on internal cash flow and parent company banks relationships to fund initial forays into attractive new opportunities in renewables, storage, and EV charging.

In addition to traditional bond financing for utilities, it’s notable that major Southeast Asian banks have increased their sustainable finance capacity in recent years. Many banks have developed a track record with new green bonds and sustainability-linked bonds and loan products by first reaching out to their oldest clients rather than innovative clean energy issuers. This has resulted in a lot of “light green” financing with some of the biggest green bond issuers coming from the property and transportation sectors rather than from the high-emitting sectors most in need of transition finance.

In the meantime, one area that deserves more attention is the growing activity of sovereign and sub-sovereign issuers in the region, including the national platforms that have a government mandate to partner with MDBs and domestic banks on transition finance deals. They matter because sovereign green and sustainable bonds have the potential to raise large pools of capital at preferential sovereign interest rates that can support domestic projects and the efforts of domestic financial institutions that are well positioned to channel funding to catalytic projects.

One good example of this trend is the USD 700 million sustainable loan deal that Indonesia’s PT SMI completed in September 2023. PT SMI is fully backed by the Government of Indonesia and has evolved rapidly as a government-backed development bank, partnering with global MDBs and private sector banks on infrastructure project financing. It serves as the country platform manager for ETM deals to be undertaken under the JETP initiated in 2022. The sustainability-linked loan, which was lead-managed by a syndicate of Singapore and Hong Kong banks, was oversubscribed more than two times and carries KPIs linked to progress on sustainable infrastructure and related employment metrics.

Building this kind of domestic project finance capacity matters. Not only does PT SMI have the government backing to play an important role in energy transition funding, but they can also set the right tone for domestic banks and issuers that need to meet global sustainability standards to access new pools of concessionary capital. PT SMI has followed up on this with a long list of collaboration projects with global banks and organisations including the European Investment Bank, Germany’s KfW, the China-backed Asian Infrastructure Investment Bank (AIIB), and Bloomberg Philanthropies.

New development bank platforms like PT SMI cannot solve Southeast Asia’s transition finance problem on their own, but they have the potential to be an important part of a new funding ecosystem. Indonesia is fortunate in having an investment-grade debt rating which has permitted PLN to fund at extremely attractive rates despite its strained financials. If PT SMI can also tap favourable debt pricing and build credibility with global funders by identifying projects with broad institutional support, 2024 will be the year to see if it can become a key partner for investors looking for credible ways to support transition finance in Indonesia. The next question will be whether Vietnam and the Philippines will support similar funding platforms that can match transition finance flows with quality ETM, grid, and renewables projects.

For climate finance experts, the challenge in 2024 will be to appreciate the way that high-level policy capacity in Southeast Asia remains constrained as policymakers juggle conflicting political and energy policy challenges.

This is the year to stop painting Southeast Asia with one brush and learn the rhythm of each market—as well as their defining differences. Stay practical, ask about the details, and look for local leaders!

This blog is part two in a series of blogs on ETM deals in Southeast Asia