Buy coal-fired power plants, shut them down and reap cost-plus profits

What is the way for serious money to bet on the Biden administration’s climate initiatives? Invest in a solar panel assembler? Patiently extend microcredit to struggling organic farmers?

No. Too much trouble for chancy returns.

Counter-intuitively you want to buy outright, or do a block investment in, local utilities with ageing coal-fired power plants. Do that as quickly as possible. There are already teams of M&A bankers roaming the country, trying to fit in as best they can with the pick-up driving locals in flyover country, on the hunt for such properties.

The point of handing over your nine and 10-figure sums for shabby, inefficient, not to mention regulated coal plants bought at a premium price, is that you want to be ordered to shut them down. The Biden administration’s regulators in the Environmental Protection Agency and Federal Energy Regulatory Commission will make that happens as fast as possible.

When strict coal-directed regulations are published by the Biden team, you and your lawyers go to the state-level public utility commission to explain that you need to tear down the old, largely depreciated coal plant before the end of its useful life. Electricity customers will be charged for the cost.

At the same time, regulators need to approve building expensive new transmission and distribution systems, along with battery storage and low carbon generation, to replace the old coal plant. Customers of your monopoly will be required to pay down the capital charges or “rate base” over two or three decades, including a fixed return on equity of, say, 9 per cent.

A few years ago, and with a different federal administration in power, the state public utility commissions might have fought the added expense of an early coal plant shutdown. Now, they will be more compliant.

Nine per cent fixed sounds good to an equity investor in Europe, or in low-interest-rate places such as Singapore. More rate base is better and best of all is the prospect of rate base growth driven by decarbonisation requirements.

Twice weekly newsletter

Energy is the world’s indispensable business and Energy Source is its newsletter. Every Tuesday and Thursday, direct to your inbox, Energy Source brings you essential news, forward-thinking analysis and insider intelligence. Sign up here.

That is exactly what GIC just bought in to. The Singaporean sovereign wealth fund acquired a 19.9 per cent position in Duke’s Indiana operating company for $2.07bn. GIC is paying a 27.7 historic price/earnings multiple for its piece of Duke Indiana, but the high multiple is worth it for the rapid rate base growth from the retirement of a coal plant.

NextEra Energy has probably been the most aggressive bidder for regulated coal-fired utilities, and might be able to buy Duke itself at some point. Avangrid’s purchase of New Mexico’s PNM Resources at the end of 2020, was subject to PNM’S getting out of coal contracts seven years earlier than planned.

The unattractive end of coal plant ownership would be merchant plants. Then the EPA, or FERC, could shut you down and you would have no revenues and no monopoly-supplied customers on the hook to support cost-plus pricing of a new plant. 

Andy DeVries of CreditSights said: “There would be other targets (of rate based coal-fired power) to bid for in Wisconsin or Kentucky. You talk to the ESG crowd about coal plants and they don’t seem to get it. The goal is spend, spend, spend. Buy coal to retire it and reset the rate base higher.”

As one experienced coal company lawyer said: “There are a number of ways the Biden people can regulate coal plants out of business, from tighter rules on nitrous oxide, treating coal ash as a toxic material, changing their interpretation of the water rules . . . but at a minimum it will take 18 months. They cannot really do it directly as a carbon rule, but they can use other things that come with carbon to have the same effect.” 

The most important Biden official on carbon policy is not the high profile “climate envoy” John Kerry, but the tough, quietly effective Gina McCarthy, who will oversee everything from a small office in the White House.

A pro-coal Republican said: “She’ll have to get everything done before 60 days from the next inauguration. Otherwise, we’ll reverse it all through the Congressional Review Act.”

Local monopolies are the future for energy.