Renewables become cheaper than coal for utilities—but near-term decarbonization prospects remain dim
Utility firms can now theoretically make a profit by switching from coal to renewables, leapfrogging natural gas as a transition fuel, but this does not necessarily paint a bright outlook for decarbonization in the near term.
In reality, industry participants suggest that insufficient renewable energy supply as well as below-average economics for coal-to-renewables switching in major emitting countries are likely to pose challenges in kickstarting a rapid emissions reduction.
According to the Coal-to-Clean Carbon Price Index (C3PI) launched by nonprofit TransitionZero earlier this week, the global weighted average carbon price required to incentivize a shift from coal to renewables fell below zero for the first time last July before continuing to dip to negative $43.55 per metric ton (mt) of CO2 in April.
The carbon price effectively refers to the differential in generation costs between an existing coal-fired power plant and a new onshore wind or solar photovoltaic farm plus battery storage in the analytics outfit's methodology.
Matt Gray, co-founder and co-CEO of TransitionZero, said in an introductory report that the global average price has shown an extraordinary decline since January 2010 when it stood at $548.59/mt CO2, and this can be attributed mostly to falling costs for renewable energy and power storage.
Historically, the analysis of fuel switching costs in the power sector has focused on the shift from coal to gas, with gas having a lower carbon intensity than coal. Power generators would find it more economical to burn gas than coal if the carbon price is high enough.
The global carbon price needed for coal-to-gas switching exceeded that for coal-to-renewables switching for the first time last July. Since then, thanks to gas prices more than doubling, the switching price spiked to $499.01/mt CO2 last month.
Gas and coal prices were already high last winter due to a post-pandemic economic rebound and supply issues. This year, they have hit all-time peaks amid supply disruption from Russia, one of the world's largest fossil fuel suppliers, pushing up generation costs for power firms that burn the two fuels.
Gas prices have enjoyed larger gains than coal as Russia plays a bigger role in the fuel's supply picture, contributing to the increase in the coal-to-gas carbon price.
"We found it is now cheaper to switch from coal to clean [energy] than from coal to gas … Russia's unprovoked attack on Ukraine has caused energy markets to become increasingly chaotic," said Gray, adding that Western sanctions on Russia in response to the invasion had led to "extreme price volatility."
"Zero-carbon technologies are not immune to supply chain gyrations, but they are unlikely to suffer from the same volatility as fossil fuels due to the fact they have near-zero marginal costs. For this reason, these technologies need to be at the heart of supply-side strategies to reduce the impact of the energy crisis," Gray added.
While the coal-to-gas approach represents a modest transition, it "ignores the transformation required for electricity generation to be consistent with the temperature goal in the Paris Agreement," Gray said. To cap global warming at 1.5 degrees Celsius, the International Energy Agency said unabated coal use must be phased out and gas use reduced significantly in the power sector by 2040.
"We have taken fuel switch analysis a step further, by calculating the fuel switch cost required to leapfrog fossil gas and transition directly to dispatchable renewables," Gray said.
However, even if coal-to-renewables switching costs are negative, that does not always mean utilities can shift to the low-carbon generation immediately. In many instances, renewable supplies are simply not yet available.
"Even if the signal is there that you should start to use renewables and shut off coal, it doesn't happen until the renewables are built," Mercurian Energy Trading's Head of Origination for Environmental Products in Europe James Cooper said. "You will still run coal."
Cooper suggested businesses will determine their renewable investments based on forecast generation costs. The C3PI's current forward curves show the global carbon price for coal-to-renewables will be negative $3.58/mt CO2 in April 2024, versus $50.66/mt CO2 for coal-to-gas switching. The gap of $54.24/mt CO2 is less than a tenth of this April's $592.14/mt CO2.
"When you're a company looking at capital allocation in the midterm … the idea of internal carbon pricing exists," Cooper said at the C3PI's launch event.
The C3PI project is based on TransitionZero's analysis of data from multiple sources, including from Global Energy Monitor and S&P Global, for 25 countries that represent around 85% of the world's coal-fired generation capacity.
A case in point is what has happened in the EU, where utilities in the last six months have switched from gas to coal rather than from coal to renewables. Despite having have some of the lowest carbon prices required for coal-to-renewables switching based on the C3PI, they could not get enough low-carbon supplies and need to burn more coal to stay financially feasible.
Carbon prices under the EU Emissions Trading System had triggered coal-to-gas fuel switching in the electricity market since 2005 before the recent market turmoil. But the reverse is happening—the EU weighted carbon cost for coal-to-gas switching reached a record high of $838.81/mt CO2 last month while the emissions allowance price hovered below €90/mt CO2 ($94.80/mt).
"In the near term, the EU is expected to see an increase in absolute emissions in the bloc" due to a spike in "coal-related emissions," TransitionZero Energy Analyst Jacqueline Tao said.
Big emitters' switch
Moreover, the C3PI shows the coal-to-renewables carbon cost stood at $10.32/mt CO2 in China, $47.47/mt CO2 in the US, and $36.73/mt CO2 in India last month—all higher than the global average in negative territory.
This implies that utilities in the world's three largest emitters lack financial incentives to switch from coal to renewables. India and the US do not have a national carbon tax or trading system, while China Emissions Allowances have traded below CNY 60/mt CO2 ($8.92/mt).
"There is considerable regional variation in the carbon price needed to replace existing coal with renewable energy and battery storage," Gray said. "China and the US are world leaders in renewable energy, but lower domestic coal prices partially offset these cost advantages."
Cooper said: "It's interesting to see the nuance, once you move away from the global weighted number into what happens in individual countries … There's still a lot that needs to be done [at the national level]."
Many analysts believe that a carbon pricing mechanism is essential in promoting renewables. According to the World Bank, 65 pricing initiatives—like a tax or an emissions trading system—were operating in 45 countries responsible for 21.5% of global GHG emissions last year.
But the initiatives were mostly ineffective. Carbon prices were above $40/mt CO2—the threshold that the bank said was required to trigger a low-carbon transition—in countries accounting for just 4% of global emissions.
"Countries' climate plans continue to fall short, and carbon pricing instruments are no exception," Marissa Santikarn, a climate change specialist at the bank, said at the launch event
With fuel switching costs moving in line with the often volatile energy markets, Cooper suggested that a carbon tax—which would fix the emissions cost for a certain period—might not work as well as carbon trading in prompting a switch to renewables.
"A carbon tax, with a pre-ordained level trying to engender change, maybe isn't the optimal solution," he said. "The optimal solution is a market-based mechanism that is able to follow the way that the market moves but also allows a hedgeble price instrument, which is key to the investment community."
Such mechanisms can develop from national trading systems. In the absence of them, Cooper said international voluntary carbon offsets could play an important role.
Some offset registries have rejected most renewable projects due to falling costs of wind and solar energy, but Cooper described this approach as "silly."
"You need to support renewables where you can … An offset price is perfect, because what you enable is international [pricing] with forward curves; curves that allow people to factor that into the power price," he added.
TransitionZero's Gray also suggested that by itself, a negative carbon price for coal-to-renewables switching in the C3PI index is not sufficient in triggering a low-carbon transition. Countries have to design their electricity markets in ways that can reflect generation costs without subsidizing coal and gas consumption, he said.
Cutting the red tape is also important. "Both regulated and deregulated markets need to urgently reform permitting processes. While the political will to deploy more capacity is clear, permitting is a key bottleneck slowing deployment and increasing the cost of zero-carbon sources of electricity generation," Gray said.
Adam Bruce, global head of corporate affairs at Ireland-based Mainstream Renewable Power, said the policy focus should be on eliminating non-price barriers for renewables development.
"The biggest [barrier] in most markets is simply that electricity systems were designed with coal and hydro as the backbone … built to link generation to centers of demand," Bruce said in the event. "Wind and solar generation tend to be in different areas."
This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.
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