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 Climate Change

Finance
Published on: Feb. 14, 2020, 12:12 p.m.
With careful planning, India is likely to be a beneficiary of the global energy transition
  • Two-thirds of electricity generation capacity in India is coal-based. Source: PxFuel

By David Nelson. The author is Executive Director, Climate Policy Initiative, Energy Finance Practice

Recently, Mark Carney and François Villeroy de Galhau, the governors of the Bank of England and the Banque de France, issued a warning to the global finance sector – help prepare your economies for the transition to a low carbon economy, or watch the failure of the companies and industries that drive your prosperity.

At Climate Policy Initiative Energy Finance, we have been grappling with “transition value at risk” for a number of years. We define transition risk as the reduction in the value of assets or income that is lower than expected because of climate policy and market transformations, such as the shift away from coal-fired generation. This may be concentrated in a select number of companies and industries but the interconnectedness of the global economy, and the risk to financial sectors that drive the connections, could spread the impact across the entire global economy.

Based on global emissions, sectors with the greatest concentration of risk are likely to include energy (power, coal, oil and gas, mining, transport, industry) and land use (agriculture and agricultural products, forestry, real estate). Finance, industrial goods, and manufacturing are also potentially subject to risk, but this risk is usually derived from energy or land use through investments or serving the related markets.

In South Africa, the first country case study in our sovereign risk programme, we found that its dependence on coal exports contributed to $124 billion in transition risk over a 2017-2035 timeframe. Most of this risk results from South Africa’s exposure to the seaborne coal market, which has shifted focus from Europe to developing countries, such as India and China.

While we found that only 16 per cent of the total risk “explicitly” flows to the South African government via lower taxes and reduced royalties, this could more than double, once “implicit” transfers and contingent liabilities are taken into account – via potential company and municipality bailouts, guarantees, and worker transition assistance.

In India, the transition risk story may be similar in some ways because two-thirds of its generation capacity is coal-based and it is the world’s third-largest coal producer.

However, India is likely to be a net beneficiary of the global energy transition. As an example, a transition may reduce fossil fuel imports and drive down the global price for those fossil fuels that continue to be imported. Fossil fuel imports (coal, crude oil and gas) represent almost a quarter of India’s total import bill, so falling prices and reduced imports could help India’s balance of payments and stabilise its currency.

Nevertheless, there will be a significant concentration of transition risk in certain industries and sectors, particularly for owners of mines, coal-fired power stations and rail infrastructure.

In the power sector, thousands of MW of coal-fired plants are already facing financial distress and are up for sale, but few buyers are interested as power prices fall and coal plant are under-used, partly driven by renewable energy deployment and over-capacity. Coal India and Indian Railways, which transports the coal, are among the largest employers in the world and with over 70 per cent ownership lying with the government, a significant source of royalties.

Such risk concentration and subsequent financial failure could lead to loan defaults and systemic problems in India’s industrial and financial systems. Recent efforts of the Reserve Bank of India (rbi), to shore up the Indian financial sector by reducing loan defaults and delinquencies, have hit coal-fired power plants particularly hard, categorising almost Rs2 lakh crore of power sector debt as non-performing and requiring additional provisions from banks.

In the case of South Africa, this exposure means that the government faces a potential downgrade of its sovereign rating, which would increase borrowing costs.

But our analysis in India is only starting, and we have yet to see whether a similar impact would be felt on the sovereign. However, it’s likely that with their concentrated exposure to coal-fired power, the State Bank of India, the National Thermal Power Corporation, Coal India, Indian Railways, the State Electricity Boards, and commercial banks, investors and ports will see a significant downside of the transition. As government ownership is strongly represented in this group, the impact on the government of India could also be strongly felt.

What we can say so far is that the costs of an unmanaged transition will always exceed those of a well-managed and orderly transition to a low carbon economy. With careful planning, India’s governing institutions are still in a good position to make the most of the likely upside of the transition while mitigating the worst impacts on market participants where the risk is most concentrated. The time to start planning is now. 


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