Coal exporters wake up to the financial risk of the climate transition

South Africa faces perhaps the thorniest dilemma of all the coal exporters.

Words

Matthew Huxham

This article was featured in The Beam #10 – Local Heroes of the Energy Transition. Subscribe now to read more on the subject.


 

Countries dependent on fossil fuel exports have been among the slowest to respond to the climate change agenda, but that may be changing in some countries like South Africa now that the impact of the energy transition is starting to threaten their balance sheets. 

On the face of it, you might think that even if the war on coal was not yet won, significant blows have been dealt with an industry now in terminal decline. Alongside divestments by mining giants like BHP Billiton, Rio Tinto and Anglo American, more than 100 banks and insurers have stepped away from the sector in the last five years. The diplomatic effort is also bearing fruit and the number of countries joining the Powering Past Coal Alliance, which aims to accelerate the phase-out coal-fired power, is today approaching 100.

Yet when it comes to eliminating coal from the energy mix, victory is not assured, and there is much more work to be done, particularly when you look at the significance of coal export revenues for the largest miners of the commodity. In recent years, Indonesia, Australia, Russia, South Africa, Colombia and the USA, the world’s largest coal exporters, have felt the impact of the developed world’s (particularly the EU’s) decisive shift away from coal-fired power and trained their sights on faster-growing markets in China, India and the rest of south and south-east Asia. With increasing uncertainty even in these markets about coal’s long-term future, competition for a slice of an ever-shrinking pie has intensified, causing significant price volatility.

Ordinarily, the rise of cheaper, cleaner alternatives might lead to the collapse of the coal export business and advocates who campaign for a world without coal could breathe a sigh of relief and move on to the next sortie on the path to net-zero. But as long as coal exports remain systemically important for exporters willing to prop up their struggling coal mining industries, the goals of the Paris Agreement will remain beyond our reach.  

For thermal coal exporters, the price of saving coal mining jobs in the next two or three years could be an increase in exposure to ‘climate transition risk’ in the next five to 10 years, meaning direct financial exposure (eg, increased public debt) resulting from a fall in profits from exporting the commodity. This might be manageable for large diversified economies like the USA, but for developing countries, the effect is likely to be more pernicious and make it harder to finance a ‘just transition’ for mining workers and regions.

"The notion that climate transition risk could pose a threat to financial stability in a country like South Africa is one that has only been seriously considered in the last few years by progressive central banks."

The South African dilemma

South Africa faces perhaps the thorniest dilemma of all the coal exporters. It is only the fourth largest exporter, but its power sector is much more dependent on coal than other larger miners (more than 80% vs only 50% in Australia and Indonesia). Furthermore, the country’s fragile socio-political and economic situation, with the highest levels of income inequality in the world and persistently high levels of unemployment (30%), makes it hard to implement any major reform that might result in the loss of jobs.

Our analysis at Climate Policy Initiative Energy Finance and published in Understanding the impact of a low carbon transition in South Africa found that the country’s ‘value at risk’ in the energy transition could reach US$125bn by 2035 in present value terms (or one-third of 2018 GDP) between now and 2035. Worse still, more than half would fall on the public balance sheet, potentially causing the government to lose its investment-grade credit rating, which could have serious knock-on effects for the rest of the economy, including a more volatile currency and higher inflation that would make its development goals much harder to achieve.

The notion that climate transition risk could pose a threat to financial stability in a country like South Africa is one that has only been seriously considered in the last few years by progressive central banks, who set up the Network for Greening the Financial System (NGFS) in 2017 to devise coordinated policy responses. However, in South Africa, an ongoing political crisis stretching back to the government of former president Jacob Zuma has severely constrained the political space for radical policy action.

How a South African just transition could benefit the whole economy

Thankfully, there are significant opportunities arising from the transition, as well as risks. Electrification of transport would reduce South Africa’s oil imports and reduce volatility in the balance of payments. Exports of coal would fall but could be replaced by exports of some of the most important minerals required by low carbon technologies eg, platinum (used in fuel cells), manganese and vanadium used in batteries. However, this opportunity will only exist if South Africa moves quickly to shift investment into these new sectors and away from those, like coal, that face decline.

Fortunately, the private sector is starting to take climate risk seriously, under pressure from international shareholders and lenders to disclose more information about the risks they face and from an increasingly strident civil society. However, decisions by NedBank, Standard Bank and others in South Africa to restrict lending to new coal-fired power stations have put the private sector in direct conflict with the government, which has been seeking to use major new infrastructure projects to lure inward investment. Up to US$25 billion in priority investments would become stranded, ie not economic, in a world that met its Paris commitments.

With the private sector stepping back, carbon-intensive sectors will become more dependent on national development banks (and the public finances, more generally). These institutions increasingly face a conflict between their mandates to execute government policy and the additional financial risk they would take on in doing so, which in turn would restrict their capacity to invest in lower-carbon sectors and in supporting the just transition. 

Photo by Tim Johnson on Unsplash Photo by Tim Johnson on Unsplash

The limits of South African capacity to finance the transition

If the global climate transition stretches the capacity of the South African public banks, then the level of investment required to support the domestic transition may be beyond the capacity of the country to finance by itself.

South Africa’s Nationally Determined Contribution (NDC) envisages no material decline in coal use before 2030. And as new solar and wind farms are already cheaper than new coal plants, meeting the NDC might not be too much of a stretch for the financial system. However, if South Africa is to increase its current climate ‘ambition’ (as expected by the international community), the bill could be much higher.

A more ambitious NDC would address the Secunda coal-to-liquids plant, one of the largest single-site sources of CO2 in the world, which produces nearly twice the annual GHG emissions as Europe’s largest coal plant. However, as producing fuel from coal is currently significantly cheaper than from oil, closing it early could impose significant incremental costs on the South African economy. Without significant international climate finance support, South Africa and other developing world fossil fuel exporters may struggle to square deep decarbonisation with development objectives.

How climate finance can help South Africa and other coal exporters transition

The first opportunity for the international community to put their climate finance commitments to better use might come from the need to rescue Eskom, the state-owned monopoly utility, which is in the middle of a deep, long-running liquidity crisis. Faced with a triple whammy of increasing load shedding, rising bad debts and increasing grid defection, Eskom is unable to generate enough cash to meet its debt repayments without ad hoc government support. It needs a major long-term solution.

One of the most promising potential solutions is a ‘debt for climate’ restructuring, which could involve international DFIs replacing Eskom’s existing expensive debt with cheaper funds, in return for contractual promises on an accelerated phase-out of coal power plants. A deal to refinance Eskom will be complex. But if successful, the deal could become a model for how international climate finance can help accelerate the transition in coal exporters.


 

Matthew Huxham is principal at Climate Policy Initiative Energy Finance and leads the sovereign transition risk programme.