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Making the energy transition mechanism meaningful: A case study from Pakistan

October 05, 2023
Haneea Isaad and Grant Hauber
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Key Findings

Pakistan’s tough political-economic circumstances and constrained transmission network present challenges for an early coal phaseout, but liquefied natural gas (LNG) or diesel power plants can be more suited to an energy transition mechanism (ETM) facility.

Medium-sized, middle-aged thermal plants like Halmore Power Generation Co Ltd, Saif Power Limited and Sapphire Electric Company Limited are potentially viable candidates for an ETM in the near future.

For the young coal fleet, IEEFA’s analysis suggests waiting until these plants have fully paid up their loans and are at least 10 years of age.

Ultimately, an ETM retirement facility would have to reach a balance of criteria from the government, potential investors, and plant owners to arrive at optimal candidates which meet the needs of all stakeholders, for it is only then that the mechanism could fulfill its true goals – ensuring a timely phaseout of high-carbon assets and, at the same time, the adoption of cleaner energy.

Executive Summary

Pakistan’s potential candidature for an Energy Transition Mechanism (ETM) facility under the backing of the Asian Development Bank (ADB) became apparent when the nation expressed its desire to be a part of the scheme at the 2021 United Nations Climate Change Conference. While Southeast Asian economies such as Indonesia have been deep in negotiations for an ETM, and the Philippines has seen a successful coal retirement transaction led by the private sector, it is recognized that each country has unique conditions which contribute to making an effective ETM deal.

Pakistan is going through an economic crisis, the scale of which it has never seen before. Under such circumstances, an ETM deal could face a host of challenges that may need to be overcome first, given the government’s competing priorities to ensure political and economic stability.

An ETM transaction as conceived under the ADB’s approach would seek an arrangement between incumbent plant owners, the government and ETM investors. While each stakeholder may come to the table for its own interests, the ultimate beneficiaries of the mechanism have to be the local citizens of Pakistan, therefore any savings, health or other benefits should be passed down to consumers.

From a public-sector perspective, a good ETM transaction asset would be one for which the government is willing to pay the least but from which it would benefit the most – financially, operationally and environmentally – through the asset’s removal from the grid.

From an asset seller’s perspective, the asset would be one for which the status quo ownership offers little prospective upside or has seen its market value diminish due to low dispatch or large upcoming capital expenditure, such that an early exit through participation in an ETM transaction would allow the highest potential valuation to be achieved.

From an incoming ETM investor’s perspective, a good asset is one that allows the investor to pay the least but from which they would earn the most in the shortest operating period.

This report by the Institute for Energy Economics and Financial Analysis (IEEFA) analyzes Pakistan’s thermal and coal fleet to come up with a list of potential candidates for an ETM facility using a discounted cash flow analysis (DCF) and associated carbon emission assessment.

The thermal power plants that came out as top contenders for an ETM retirement facility using IEEFA’s methodology included medium-sized gas or diesel-based power plants of 220-230 megawatts (MW), such as Saif Power Limited, Halmore Power Generation Co Ltd and Sapphire Electric Company Limited. Since these power plants have almost reached the midpoint of the contracted terms in their 30-year power purchase agreements (PPAs), an immediate retirement would put a price cap of US$47 million to US$51 million on their valuation. On the other hand, letting them operate for a few more years and shaving off the last 10 years of their economic lifetime in a premature termination would reduce the valuation to just US$17.5 million to US$18.6 million. The impact from an avoided emissions angle would be a total of 10Mt to 18Mt for all three plants.

By comparison, Pakistan’s coal fleet is very young, so IEEFA’s DCF analysis of an immediate retirement scenario for selected plants yields an economic valuation of US$1.1 billion to US$1.6 billion. On the other hand, if retirement takes place later, letting the power plants complete their debt servicing obligations significantly changes the situation as the DCF values for foregone profits are reduced to US$398 million to U$628 million. Further delaying retirement results in an even lower valuation, dropping to between US$111 million and US$174.8 million if the PPAs are terminated 10 years before the 30-year contract is over.

The environmental case for shuttering these plants is also very strong. IEEFA estimates that an immediate retirement could lead to an avoidance of up to 250Mt of carbon dioxide emissions per plant.

However, these power plants operate under intergovernmental agreements and sovereign guarantees, so any premature closure may hinge on high-level discussions being able to reach consensus. The challenge is for the authorities on both sides of a PPA to be fully on board with phasing out coal assets. This may require much time and effort, so depending on the priorities of the government, negotiations for an early closure may need to be started sooner rather later.

Whether Pakistan seeks support for near-term retirement of middle-aged thermal power plants, tries to reach a compromise on an early shutdown of Chinese-funded coal power plants, or looks to do both, it appears there are the makings of reasonable prospective deals drawing on ETM principles. With the right conditions bringing together willing parties, the transactions seem reasonable, where asset owners, ETM investors and the government all stand to benefit. More importantly, progress on the ETM will bring both fiscal and environmental relief to the people of Pakistan.

Haneea Isaad

Haneea Isaad is an Energy Finance Specialist at IEEFA. Based in Pakistan, she covers Asian energy markets with a focus on Southeast Asia and Pakistan.

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Grant Hauber

Grant provides strategic advice on energy and financial markets for IEEFA’s Asia Pacific team.

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