Late in 2021, Southern Company, the giant utility headquartered in Atlanta, announced it would pursue the retirement or conversion of 15 coal-fired generation units at its power plants, totaling nearly 9,000 MW of capacity. One Southern-owned plant was conspicuously absent from those plans: the Red Hills Generating Facility, a 440 MW lignite coal-fired power station in Ackerman, Mississippi.
Despite an uneconomic track record, Red Hills presents a particular challenge to those who would like to see it closed. The plant is protected by a complex arrangement of long-term contracts that insulate it from market competition. Red Hills is just one of 107 currently operating power plants in the United States that have long-term contracts in place with coal, gas, and/or petroleum suppliers. These plants represent ~8 percent of the total US fossil generating fleet and, if not closed, will emit 144 million metric tons (MMT) of carbon dioxide per year through 2030.
RMI has developed a novel approach to accelerate the transition of these plants to clean energy and provide fair compensation to impacted workers and communities. Such solutions will be critical for achieving an equitable clean energy transition.
Unlocking a Just Transition Opportunity
Our approach uses the valuable long-term contracts — such as power purchase agreements (PPAs) — in place at this class of coal plants to refinance the construction of more economic clean energy resources. In a new report, Structured Finance for Energy Transition, we tested this approach using publicly available data and project-specific documents to develop a solution for Red Hills.
We imagine restructuring the Red Hills project before the end of its current contracts, retiring the coal generator, and replacing it with a portfolio of primarily solar and storage projects. Our financial model shows that such a restructuring could realize the following benefits for all Red Hills stakeholders:
- $37 million in savings to electricity customers, who exit an above-market power contract and gain access to cheaper clean energy.
- $150 million to bondholders (mostly life insurance companies), in the form of a risk-adjusted balloon payment to exit their investment early.
- $255 million to the Mississippi Lignite Mining Company, which sells lignite coal to the facility under a long-term contract, for an up-front termination payment. This payment could be reinvested in clean energy, following the recent examples of Peabody Coal and Hallador Energy.
- $137 million to plant and mine workers, whose salaries are funded through a transition period.
Modeling a Red Hills Replacement
In purely financial terms, an asset should be retired and replaced when it is no longer economic — that is, when the long-term value from replacement exceeds the near-term cost of ongoing operation and retirement. In other words, if the economic benefits of inexpensive clean energy outweigh continued coal operation, it makes sense to unlock that value and replace coal with clean resources. Having examined the contracts that constitute the Red Hills project, we propose a restructuring package that adds value in total and leaves no worse party off on a risk-adjusted basis.
What does this all look like? Imagine a pie that represents the economic value freed up by replacing the Red Hills plant with a portfolio of clean energy technologies This pie is substantial because the Red Hills facility is so much more expensive to operate than an equivalent amount of clean energy (primarily solar and battery storage).
Our solution is to identify each of the stakeholders in the Red Hills facility today that rightly expect to receive some piece of the economic pie. And then we estimate how much of the pie they’d have to receive to justify a resolution that closes the plant and aligns with a 1.5°C climate trajectory.
These stakeholders include:
- Ratepayers of the Tennessee Valley Authority. Under the terms of a 30-year PPA, TVA currently buys power from the Red Hills facility at a much higher cost than it could obtain elsewhere. Our model shows TVA’s ratepayers receiving $37 million in lifetime savings from an early closure of the facility in favor of cheaper energy sources.
- Red Hills was financed via long-term notes that have already been restructured once, causing bondholders to take a haircut on their expected return. Even after restructuring, credit ratings agencies continue to warn of insufficient revenue to service debt and potential for default. In our model, bondholders, including prominent life insurance companies like Prudential and Pacific Life, would exit their investment and eliminate the risk of default with a $150 million balloon payment.
- The coal company. A single mine, owned by a subsidiary of a mining company called NACCO, supplies all the coal used by the Red Hills facility. NACCO would receive a termination payment of $225 million, which, reinvested at a 10 percent return on equity, would be equivalent in value to the Red Hills coal contract in our model.
- Plant and mine workers. As has happened elsewhere over the past 10–15 years, the Red Hills facility could enter bankruptcy and shut down at any point, meaning the hardworking employees of the facility and its related mine could face abrupt termination. Already, the future prospects of the plant are grim, but with a proactive restructuring, workers can be rewarded for their hard work and provided for even as the plant retires. Our model sets aside $137 million for continued wage payments beyond the plant’s retirement date to support plant workers in the transition.
RMI invites Southern Company, TVA, the Red Hills bondholders, NACCO, and its employees to further discuss our model with us and with each other. More broadly, we believe this type of workout — a fair, green deal, relying on the very long-term contracts that make some coal plants so difficult to retire — may be of broader relevance to the United States and other countries grappling with the financial implications of the clean energy transition.
This transition is already well underway, driven by the economics of clean energy and the urgent need to retire polluting fossil infrastructure. It’s essential that we navigate it in a way that leaves no one behind.
By Nachy Kanfer, Ben Serrurier, Uday Varadarajan
© 2021 Rocky Mountain Institute. Published with permission. Originally Posted on RMI Outlet.
Report: Structured Finance for Energy
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