While everyone was focused on the ongoing COP27 in Sharm El-Sheikh, a breakthrough in energy transition financing happened in Asia on November 8 with the completion of the first-ever energy transition mechanism (ETM) by a small power plant in the Philippines that can be the model for other private sector ETM transactions.
For the unfamiliar, the ETM is a financing scheme launched by the Asian Development Bank (ADB) during the COP26 in Glasgow last year that will allow the owners and operators of a coal-powered power plant to transition to one powered by renewable energy.
The idea behind the ETM is that third parties, such as the ADB and other multilateral institutions, donors or private investors, provide financing to the owners and operators of the coal plant that will allow them to reduce the operating life of the plant and replace coal as the power source with other forms of renewable energy over a prescribed period.
ACEN, the energy platform of the Philippine-based Ayala Group, just did that when it announced the completion of its ETM transaction that enables the early retirement of its 246-megawatt South Luzon Thermal Energy Corporation (SLTEC) coal plant in Calaca, Batangas, and its transition to cleaner technology.
The ETM for the SLTEC plant involved 13.7 billion pesos (US$237.01 million) in debt financing provided by the Bank of the Philippine Islands (BPI) and Rizal Commercial Banking Corporation (RCBC), as well as 3.7 billion pesos in equity investment from the Philippine Government Service Insurance System (GSIS), Insular Life Assurance Company (InLife) and ETM Philippines Holdings, for a total deal value of 17.4 billion pesos. ACEN received 7.2 billion pesos from the transaction for reinvestment in the company's renewable energy projects. The balance of proceeds, according to a statement, was used for refinancing debt and transaction fees.
But behind these figures is the real story. The structure of the ETM is complex, but basically the ETM allows ACEN to reduce the coal plant’s operating life from 50 to 25 years in keeping with ACEN’s commitment to transition to cleaner technology by 2040. The plant will be decomissioned 15 years ahead of its technical life. This will also help ACEN avoid or reduce up to 50 million metric tonnes of carbon emissions.
The remarkable thing about this transaction is that it is being completely financed by private sector investors that are quite leery of coal investments because they have their own carbon reduction commitments as well. At present all forms of coal assets, whether power plants or coal mines, etc., are pariahs among investors, including financial institutions, banks and multilaterals.
The principal challenge for ACEN when it was structuring the ETM was convincing potential investors that they would be putting their money not just in any coal plant, but in a coal plant that is about to be transitioned.
From an investor perspective, the ACEN ETM transaction at its core is just an investment in a coal plant. While there is a commitment to transition the coal plant to renewable energy, at present, it is still just a commitment. This means any investor in this transaction has to have a lot of faith in ACEN, and by extension the Ayala Group, that this commitment will be fulfilled.
In their pitch to the investors, ACEN re-labelled the SLTEC coal plant from being just a “coal asset/carbon asset” to an “energy/carbon transition asset”. The main difference is that in the latter, there is a commitment for the coal asset/carbon asset to transition to renewable energy in exchange for the funds/investment.
Since the energy/carbon transition asset is a new concept in sustainable investing, it is understandable that many investors are still leery of the concept. The multilaterals, for example, had difficulty convincing their boards and investment committees to get on board the ACEN ETM.
The ADB, for example, although enthusiastic about the ACEN deal because of the fact that it was inspired by their thought leadership in ETM financing, did not participate because of internal constraints. Plus, the ADB have their own ETM models, which the ACEN ETM did not follow strictly.
In this case, for many investors who looked at the deal, when the ACEN coal plant was presented to them as an “energy/carbon transition asset”, all they saw was a coal plant or a coal asset/carbon asset. They could not appreciate the commitment to transition that is behind the energy/carbon transition asset.
But in the end, there were enough banks and investors who appreciated and bought into the ACEN coal plant as an energy/carbon transition asset, including BPI (which is part of the Ayala Group), RCBC, and GSIS and InLife, which are the biggest insurers in the Philippines. All four have their own carbon emission reduction targets, but were convinced that investing in the ACEN ETM was consistent with their achievement of these targets.
For these banks and investors, another factor that helped them decide in favour of participating in the ACEN ETM is the prestige and stature of the Ayala Group, one of the Philippines’ oldest and largest listed companies and whose operations extend into global markets.
Unlike many other entities of its kind in Asia, the Ayala Group has it's own carbon emission reduction targets, as well as, an excellent reputation in terms of governance, financial and business performance, something that will arguably ensure they stick to the commitments under the ACEN ETM.