Climate “bad banks”: the key to sustainable energy transformation?

– The world is increasingly moving away from coal production

– The cost of financing coal projects has increased sharply

– Climate “bad banks” are seen as a solution to take over and wind down such assets

– Plans are under way to establish a transition vehicle

Amid an increased focus on environmental sustainability, the idea of fossil fuel “bad banks” is gaining traction globally. The concept refers to special companies specifically dedicated to acquiring and winding down fossil fuel assets.

As renewable energy becomes cheaper, more investors around the world are turning their backs on fossil fuels, and coal in particular, which is increasingly seen as high-risk relative to other energy projects.

Citibank, for example, recently announced that it will stop financing thermal coal mining, with a view to eliminating its credit exposure entirely by 2030; elsewhere, Deutsche Bank has pledged to cut ties with companies that make more than half their revenue from coal mining by 2025.

A report published this year by the University of Oxford found that coal mining loan volumes were down 90% in Europe and 57% in ASEAN over the past decade, although they decreased by just 11% and 23%, respectively, in North America and Australia, and remained stable in China.

In this sense, with the global energy sector rapidly decarbonising, coal could be the canary in the mine. “If these observed trends continue and we see the cost of capital for oil and gas go the way of coal, this could have very significant implications for the economics of oil and gas projects around the world. This could result in stranded assets and introduce substantial re-financing risks,” the report stated.

For now, companies are primarily seeking to offload their coal projects. This has given rise to calls to guarantee that such assets be handled appropriately, and not simply moved off balance sheet.

Bad banks to the rescue?

The term bad bank first emerged in the aftermath of the 2008 financial crisis, when big banks created smaller, separate entities to absorb their toxic, subprime assets, sanitising their balance sheets and winding down these assets.

Earlier this year BlackRock's CEO, Larry Fink, proposed that a similar model could be used to help companies divest from fossil fuel assets.

Fink rehearsed his ideas at the G20 meetings in July, at which Mark Carney, the UN’s special envoy for climate, announced that Fink was working with Jane Fraser, CEO of Citibank, and Oliver Bäte, CEO of Allianz, on the issue.

For Fink, the wholesale divestiture of dirty assets could lead to “greenwashing”, as there is no guarantee that the private entity that buys them would manage them correctly.

Indeed, energy consultancy Wood Mackenzie estimates that since 2018 oil majors such as ExxonMobil and Total have sold almost $30bn of such assets to private companies, with a further $140bn currently for sale.

While such transactions help companies meet their climate change targets, there is no guarantee that they help reduce emissions. There are widely held concerns that purchasing entities aim to extract as much value as possible from the assets, with little concern for environmental consequences, and face much less scrutiny than prominent multinationals.

By contrast, a climate bad bank would hive off the fossil fuel-related aspects of a given company’s portfolio, freeing it to concentrate on other, cleaner lines of business, while at the same time being assured that the asset would be dismantled responsibly.

For now, the idea has gained the most traction in relation to coal. But if oil and gas does indeed go the way of coal, then this model could be expanded to cover all fossil fuels, as Fink proposed.

Another function of bad banks is to shoulder the costs of clean-up once the asset has been closed.

Such clean-ups often involve significant outlays. For example, Australia-headquartered mining company South32 is in the process of transferring its South Africa Energy Coal unit to mining group Seriti Resources. As part of the deal, South32 will pay $200m over a decade to help finance environmental clean-up, and a further $50m to restructure some loss-making sites.

Notably, when the deal was first floated in 2019 Seriti Resources was slated to pay $6.7m, in addition to deferred payments based on future cash flow, capped at $101.5m per year. Since then, however, the deferred payment plan has been dropped, and South32 has agreed to accept a nominal fee for the sites.

First steps

A major step towards a new era of coal-related bad banks came in May, when Citigroup and Trafigura, a commodity trading company, proposed the creation of a fund that would operate on the model of a bad bank.

The vehicle – called Coal to Zero – will buy up mines and run them for a profit until 2045; the project is being pitched as an “energy transition vehicle focused on global decarbonisation by acquiring, responsibly operating and retiring coal assets significantly before the end of their mineable life”.

According to Citigroup, Coal to Zero “aims to deploy private capital to support an orderly exit from coal in a way that is fair to the people and communities impacted. In doing so, it intends to generate a positive, measurable environmental and social impact alongside a financial return for investors”.

While such proposals are seen as a step in the right direction, some doubts have also been voiced. Foremost among these is that the completion year of 2045 is beyond the date by which emissions have to be considerably reduced in order to avoid substantial climate change.

Although the concept of a safe and timely phasing out of coal mining is front and centre, there are a number of steps still to be taken before such a vision can become a reality – and crucially, one which is not vulnerable to accusations of greenwashing.