Continued investments in fossil fuel infrastructure in Southeast Asia

Understanding climate risks faced by the power sector means thinking about two issues: physical risks and transition risks. By physical risks, we mean how power sector infrastructure might be directly affected by climate change impacts, such as sea-level rise,  and increasing frequency and severity of tropical storms and floods. By transition risks, we mean how power sector infrastructure might become devalued and potentially “stranded” due to policies, regulations, consumption patterns, and market responses that prioritize reducing emissions.

Many power-sector investors within the region are not in the habit of considering physical climate risks and transition risks in their decisions. Even if they change their habits, their typical risk assessment tools are not designed to take these climate risks into account.

Moreover, regional investors tend to feel protected through a key tool: the power purchase agreement, or PPA, between the power producer and the “offtaker” – typically the state-owned electricity distribution company. In Southeast Asia, the power market is not very liberalized, and PPAs are often written strongly in favour of the power producer.

All over the world, investors seek strong guarantees to protect return on investments – particularly when they are putting money into what they consider to be politically risky markets. In the power sector, this typically means that the PPA will include guaranteed payment as long as the power plant is available, regardless of whether it is used. This set-up works in regions such as Southeast Asia because it is well established, and because governments desperately want to attract investment in power production to meet the growing demand for electricity.

Southeast Asia is one of the regions most vulnerable to the physical risks of climate change.

And I do think transition pressures are going to mount as these countries grow economically and contribute more to global emissions. But by the time this pressure is strong enough to make a difference, countries may already be locked into fossil fuel-based energy-system infrastructures.

That is the key question. We know that global investors are beginning to rethink. For instance, the Norwegian state pension fund divested from fossil fuels, and that this had an impact on companies’ investment in the Philippines. Some seeds of change have started to appear in the Southeast Asian region, too, with a number of Asian banks recently announcing they will shift away from financing coal. But without more action, more significant change at the regional and local levels in Southeast Asia will be slow in coming.

One way to pick up the pace may be to liberalize the market to enable more competition amongst power producers and more choice for offtakers. This shifts the burden of risk from the offtakers and their consumers to the power producers and their investors. For example, India’s more liberalized power market – along with the banks that fund it – is currently exposed to a very high financial risk from investment in fossil fuels due to strong competition from solar power.

But liberalizing the power sector is no easy task and brings its own challenges, as the history of power sector reform across the world shows. At the very least, governments need to give clear signals that they are not going to sign any more PPAs for fossil fuel-based investments. Doing this would encourage investors and power companies to start reorienting the businesses. That said, governments still must deal with the commitments that already exist. Legacy is already an issue.

Another element that could change the landscape is pressure from the public.  One such case emerged in southern Thailand where plans for a coal power plant were scrapped after strong public opposition.

Energy demand in Southeast Asia has risen in the last decade or so with the region’s economic growth. Demand is likely to continue to rise. There is an assumption that renewable energies cannot match that demand. There is also the argument that coal is cheap so, “Why shouldn’t we use it?”  In addition, state-business relations in Southeast Asia are fraught with vested interests, strong family ties and political opacity, which make any change to the status quo very difficult to achieve.

Furthermore, not all decision-making is confined to the country that contemplates building a power plant. In a global world, international financiers and international suppliers can carry sway – for good or ill.

What really strikes me is this lack of concern amongst regional investors over the potential of stranded assets. On the global level, people such as the Governor of the Bank of England, Mark Carney, are very clear in their calls to investors to start factoring climate risks into their assessments. But there is a strong dissonance between this global rhetoric and the regional picture in Southeast Asia where investors are either unaware of the risk of stranded assets, or they think that it is a manageable risk.