In many cases, refinancing a coal unit's debt and/or equity at a lower cost of capital may not be enough to expedite retirement at a pace compliant with carbon budgets. For this reason, we model the cost needed to pay refinancers so that they meet their minimum return on investment in the case of early retirement.
The donor or subsidy provider's role is to compensate the refinancer for any shortfall in the event that retiring the coal plant early results in profits below the return expected at the point of refinancing. Essentially, the donor supplements the amount of money needed to ensure that the refinancer does not lose profits by retiring early. Potential sources of subsidy payments could be provided by philanthropies or carbon revenue, like carbon taxes or transition credits.
The data below shows the present value of the total annuities that a donor or subsidy provider would have to pay the refinancer each year between refinancing and early retirement to make retirement and business as usual equivalent financial options. We also present these subsidies below on US$/tCO2-avoided terms. In scenarios where subsidy funding or additional revenue is needed to encourage early retirement, we discount these payments at 4%, the global risk-free rate at the time of modelling.
There are two approaches to determine the costs needed to compensate the refinancer for foregone profits in the event of early retirement:
- Internal Rate of Return (IRR) method: In the event that the refinancer fails to reach its hurdle rate before early retirement, subsidy payments are calculated so that they are sufficient in giving the refinancer an IRR equivalent to the refinanced cost of equity.
- Net Present Value (NPV) method: Subsidy payments are calculated so that they offset all the refinancer's shortfalls in the NPV of cashflows to equity in each post-retirement year.