Early Retirement of Coal Power Generation

Global coal-fired power generation capacity is over 2,000GW and provides 39 per cent of the world’s electricity (Bodnar et al., 2020; IEA, 2021). However, as one of the most carbon- intensive sources of power, there is a global push to shut down coal generation assets and thus curb emissions. Simultaneously, the generation capacity of renewables is growing, driven by supportive policy and improving costs relative to coal. This has resulted in many coal assets becoming unprofitable and at risk of being ‘stranded’. In countries with competitive power markets, owners of stranded coal assets have incentives to shut down these assets. Where the growth in renewables is not stranding coal assets at a rate considered fast enough, governments can use positive financial incentives to accelerate the shutdown process. Meantime, many would-be stranded coal generation assets are protected from market forces because they are either regulated assets or have long-term power purchase agreements (PPAs) with monopoly distribution and supply utilities. Ensuring timely retirement of these would-be stranded assets requires a shift towards innovative positive incentives, including new financial instruments and subsidies.

In Indonesia, the generation mix of the national power utility, Perusahaan Listrik Negara (referred to as PLN), is dominated by coal which made up 62.6 per cent of power generation in the country in 2019. As a result, power generation is responsible for 16 per cent of Indonesia’s greenhouse gas emissions. Renewables development in Indonesia has not yet reached the point where coal assets are forced out of the generation mix. While the domestic levelised cost of electricity (LCOE) for renewables in Indonesia is approaching parity with new-build fossil fuel generation, it is still not below the short-run marginal cost (SRMC)of existing coal plants and is not creating would-be stranded assets (IESR, 2019). Going forward, increasing renewable energy ambitions and international pressure to decarbonise are likely to stimulate renewable energy development in the country. This will reduce the levelised cost of energy below the short-run marginal cost of existing Indonesian coal assets and create a risk of these assets becoming stranded. However, coal generation is either owned and operated by PLN and shielded from becoming stranded as regulated assets or it is owned and operated by independent power producers who hold long-term power purchase and supply agreements. To decarbonise the Indonesian energy sector at a rate acceptable for global emission reduction ambitions and to protect customers from higher costs associated with the ongoing operation of would-be stranded coal generation, coal asset owners currently shielded from stranding need to be offered incentives to retire.

Early retirement of coal-fired generation is accelerating worldwide. Former coal-generating countries, such as Belgium, Sweden and Austria, have already gone coal free and many other nations have near-term coal exit targets. In jurisdictions where would-be stranded assets are shielded or where the relative economics of renewables is not yet stranding all coal-fired generation, governments are using innovative financial instruments and subsidy mechanisms to incentivise the early retirement of coal assets. Germany and the United States are two such examples. Germany is negotiating compensation payments with lignite coal plant operators who shut down their operations and holding annual closure payment auctions to accelerate the closure of hard coal plants. Meanwhile, the country is using a strategic reserve to maintain the security of supplies during the transition. The United States is using securitisation and coal-for-solar swaps in its regulated markets to incentivise operators to close would-be stranded assets and break power purchase agreements that are no longer economically competitive.

The following chapters of this report outline the core concepts behind the coal retirement incentives used in Germany and the United States, as well as the technology-neutral German strategic reserves. We focus on the economic incentives and financial mechanisms they have used to provide useful insights in conceptualising economic incentives for coal closure mechanisms in Indonesia. Given this focus on concepts, we do not explore the sources of funding to implement the mechanism in any detail. As a middle-income country, Indonesia will not have the same fiscal space as Germany and the United States to fund such instruments and it may need to call on donors to fill the funding gap.

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