Our analysts Matt Gray and Laurence Watson respond to PPL’s recent Climate Assessment Report.
Summary
- Following a shareholder resolution in May last year, PPL Corporation, a US electricity utility, published a report assessing the impact of climate policies on their business. Carbon Tracker welcomes climate disclosures from electricity utilities. PPL’s report, however, has several shortcomings.
- The report’s main shortcomings include:
- A misguided interpretation of a 2°C pathway. By using an economy-wide emissions pathway – rather than a region and fuel specific pathway – PPL is ignoring the structural changes required to make their power generation activities consistent with the temperature goal in the Paris Agreement. In the IEA’s sustainable development scenario (SDS) – which replaced the 450 scenario in 2017 – coal power generation in the US declines over 90% from 2016 to 2040. Moreover, under the IEA’s beyond 2°C Scenario (B2DS), which transparently distinguishes coal generation with and without carbon capture and storage (CCS), coal generation without CCS is phased-out by 2035. PPL has around 6 GW of operating coal capacity, with only 272 MW scheduled to be retired by 2035. Based on our report, no country for coal gen, PPL potentially has $4.5b of “stranded value” from closing its coal capacity in a manner consistent with the temperature goal in the Paris Agreement. $4.5b is around 10% of PPL’s enterprise value. Investors might ask what PPL would invest in to replace those cash flows in such a scenario.
- A failure to compare asset competitiveness with the least-cost principle. PPL owns regulated coal units and therefore must adhere to the least-cost principle. By detailing the cash costs of their coal capacity – rather than the operating costs – PPL is not disclosing how uncompetitive their coal generation is relative to lower cost alternatives. When operating costs are included, the running cost of PPL’s coal capacity could already be higher than building new gas. New onshore wind and solar PV could be cheaper than operating its coal capacity by 2021 and 2023, respectively. On this basis, capital expenditures to keep coal units online is highly questionable. Indeed, in no country for coal gen, we compared the value of all regulated coal plants with their market value and found, absent climate considerations, the increasingly unfavourable cost profile of PPL’s coal units could represent a regulatory risk of $10b under the least cost principle. $10b is over 20% of PPL’s enterprise value. Again, investors might ask how PPL would replace those cash flows when regulators demand lower cost alternatives.
- A failure to deepen a dialogue on climate policy risk with investors. With regards to electricity utilities, investors require scenario analysis to understand (i) when fossil-fuel generation assets need to be phased-out to meet the temperature goal in the Paris Agreement; and (ii) how the company will replace the revenues lost from the premature retirement of those assets. PPL’s scenario analysis fails to grapple with the early retirement risk, and is unlikely deepen engagement with investors.
- The report’s failure to conduct robust and defensible climate scenario analysis and compare PPL’s assets in the context of the least cost principle is a missed opportunity to communicate the risks and opportunities to its shareholders.
PPL corporation, a US electricity utility headquartered in Pennsylvania, released a report in November last year aimed at assessing the long-term impact of climate policies on its business. This report was produced in response to a shareholder resolution in May last year.
Carbon Tracker welcomes disclosures from electricity utilities who, due to the nature of their activities, face greater complexity when assessing their preparedness for the energy transition and compliance with the temperature goal of “well below” 2°C outlined in the Paris Agreement.
The report includes many positives, such as reducing the company’s carbon emissions by 50% from 2010 to 2016, mainly due to a restructuring. Unfortunately, PPL’s report falls well short of the standards proposed by the Task Force on Climate-related Financial Disclosure (TCFD). Below are the report’s main shortcomings.
1. A misguided interpretation of a 2°C pathway
Aligning the demand target with that of the Paris Agreement serves as a useful proxy for the long-term impact of climate policies on business activities. PPL uses a global economy-wide emissions pathway drawing on a UNFCCC global target as a metric, in lieu of the IEA scenario’s country-specific coal generation numbers, or applying what was included in the US NDC submitted to the UNFCCC, (80% or more below 2005 levels by 2050). PPL states:
“Under this scenario, PPL assumed Kentucky segment would be required to achieve 50 percent reduction in CO2 emissions from 2005 levels by 2050 and that reductions prior to 2050 would be consistent with current policies.”
A credible demand projection would look at the emissions pathway of fossil fuels used within the region the company is operating in. Over two thirds of PPL’s total generation capacity is coal. In the IEA’s SDS – which replaced the 450 scenario in 2017 – coal power generation in the US declines over 90% from 2016 to 2040. Moreover, under the IEA’s B2DS, which transparently distinguishes coal generation with and without CCS, coal generation without CCS is phased-out by 2035. Currently, PPL has around 6 GW of operating coal capacity, with only 272 MW scheduled to retired by 2035. PPL appears to use an overriding assumption that coal plants will run for at least 55 years in all of the scenarios it considers, which results in a much more limited retirement program than if no minimum period of operation is assumed.
Figure 1. Retirement of PPL’s coal units under a pathway consistent with the temperature goal in the Paris Agreement compared to announced retirements
Source: Carbon Tracker (2017)
Notes: See below for an overview of our modelling methodology. In November 2017, after the publication of no country for coal gen, LG&E and KU announced plans to retire E.W. Brown Units 1 and 2 totalling 272 MW. These pending retirements are reflected in Figure 1.
The TCFD identified that climate change-related issues will penetrate the core financial considerations of a company. Our cost-curve approach, which allows investors to understand the relative competitiveness of coal capacity, can provide this insight. As detailed in no country for coal gen, our modelling approach to understand climate policy risk involves three steps:
– Identify the amount of capacity required to fill the generation requirement in the IEA’s B2DS. As detailed above, under the B2DS, coal power in the US is phased-out by 2035. To keep coal generation consistent with a below 2˚C pathway, units are retired over time when generation exceeds the B2DS generation.
– Rank the coal units to establish a retirement schedule. We rank units based on operating cost per balancing authority, due to the regulated nature of US power markets. Within each balancing authority, the units with the highest operating costs are retired first.
– Value every operating unit in both the B2DS and business as usual (BAU) outcomes to understand “stranded value”. Stranded value under the B2DS is defined as the difference between the NPV of cashflow in the B2DS (which phases-out all coal power by 2035) and the NPV of cashflow in the BAU scenario (which is based on retirements announced by PPL).
Based on analysis in no country for coal gen, PPL has $4.5b of stranded value from its coal capacity – around 10% of PPL’s enterprise value. Figure 2 below details PPL’s stranded value from its coal capacity relative to other listed US coal power owners.
Figure 2. PPL’s stranded value from coal capacity relative to peers
Source: Carbon Tracker (2017)
2. A failure to compare asset competitiveness with the least-cost principle
PPL holds regulated coal units and therefore must adhere to the least-cost principle to ensure their consumers receive the lowest-cost power possible.[i] The report fails to comprehensively disclose asset competitiveness relative to other power generation technologies, and in doing so, fails to satisfy the least-cost principle. The report leaves the reader with the impression that PPL’s coal capacity is the most competitive form of generation for the foreseeable future, which is highly questionable. When reporting the running cost of coal capacity an important distinction needs to be made between cash and operating costs.
Cash costs include fuel and variable operating costs, while operating costs include cash costs, as well as fixed operating costs and annual capital additions. Moreover, fitting control technologies to meet forthcoming regulations will create significant new costs in the future. By only including the cash cost (see pg. 7 of the report), PPL is giving the impression that the operating cost of its coal capacity is going to be lower than onshore wind and solar PV until the 2030s and 2040s, respectively.[ii] As detailed in Figure 3 below, when operating costs are included new onshore wind and solar PV could be cheaper than running PPL’s coal capacity by 2021 and 2023, respectively. The report also omits a comparison to combined cycle natural gas turbines (CCGTs), one of the key technologies that has driven coal generation from service in the US. As shown in Figure 3, the running cost of its coal capacity could already be higher than building new gas.
Indeed, according to the report, LG&E and KU, a subsidiaries of PPL, invested $2.8b to add environmental controls to four coal power plants. Based on PPL’s operating capacity, this represents a capital investment of $500/kW, highlighting the significant capital costs associated with keeping coal generation operating. In no country for coal gen, we compared the value of all regulated coal plants with their market value and found, absent climate considerations, the increasingly unfavourable cost profile of PPL’s coal units could represent a regulatory risk of $10b under the least cost principle. $10b is over 20% of PPL’s enterprise value. Figure 3 supports analysis in no country for coal gen, which found phasing-out coal could save the US consumer $10 billion per year by 2021, with Kentucky households saving on average 10%.
Figure 3. The operating cost of PPL’s coal units relative to the levelised cost of onshore wind, solar PV and natural gas
Source: Carbon Tracker (2017)
Notes: The cash and operating costs of coal are capacity-weighted and based on modelling in no country for coal gen. It should be noted the operating cost is based on average capacity factors from 2013 to 2015. E W Brown units 1 and 3 have capacity factors of 32% and 35%, respectively, which could inflate their operating costs as fixed costs are spread over a smaller number of hours. Onshore wind and solar PV estimates are based on a US average from no country for coal gen. Learning rate of 20% for solar and 12% for wind. Capacity additions based on the IEA’s B2DS. The gas LCOE estimate is based on modelling from no country for coal gen.
3. A failure to deepen a dialogue on climate policy risk with investors
To deepen engagement with investors, companies need to provide robust and defensible scenario analysis of climate policy outcomes. With regards to electricity utilities, investors require scenario analysis to understand (i) when fossil-fuel generation assets need to be phased-out to meet the temperature goal in the Paris Agreement; and (ii) how the company will replace the revenues lost from the premature retirement of those assets. To appeal to mainstream investors, scenario analysis needs to replicate real-world economic and investment decisions by developing a retirement schedule that reflects market conditions. The scenario analysis in PPL’s report isn’t robust and defensible. Rather than transparently disclosing its significant exposure to coal generation and the cost profile of its coal units, much of the report is dedicated to discounting the energy transition.
Conclusion
The PPL report failed to meaningfully characterize how a climate scenario would likely impact fossil fuel generation, and further failed to provide a fair assessment of the cost pressures facing coal power. Any credible climate scenario disclosure from electricity generators should seek to inform investors on the financial implications of retiring fossil-fuel capacity prematurely. To be robust and defensible, this disclosure should be conducted at asset-level and replicate real-world economic and investment decisions.
Moreover, any such analysis should consider how the company can replace lost revenues from premature closures and, in the context of the US, whether current generation can be justified under the least-cost principle. Rather than advocate increasingly expensive retrofits for its existing coal plants, PPL should consider a strategy that deploys cheaper technologies to minimize the risk of being caught flat-footed by regulators, should regulation catch up with prevailing economics. As PPL notes, as a regulated utility it may be able to build and operate lower-carbon power generation and thereby benefit from the low-carbon transition. Our analysis clearly shows that coal generation has all but lost its competitive advantage, and therefore its licence to operate will increasingly be questioned by regulators.
The report’s failure to conduct robust and defensible climate scenario analysis and compare PPL’s assets in the context of the least cost principle is a missed opportunity to communicate the risks and opportunities to its shareholders.
Matt Gray – Analyst (Power & Utilities)
Laurence Watson – Data Scientist
Notes:
[i] For more information on the least-cost principle: http://www.raponline.org/wp-content/uploads/2016/07/rap-lazar-electricity-regulation-US-june-2016.pdf
[ii] The figure on pg. 7 of the report uses the term “marginal cost” which, in the absence of further information, we interpret as cash cost. The cash cost includes the costs incurred from fuel and variable operations and maintenance.
