THE Monetary Authority of Singapore (MAS) has proposed the creation of a new asset class of carbon credits, known as transition credits, which can be generated when coal-fired power plants are retired early and replaced with cleaner energy sources.

This working concept, laid out in a report by MAS and McKinsey and released on Tuesday (Sep 26), could provide an additional revenue stream to compensate coal plant owners for income lost from the early closure of their plants.

If there is enough market confidence by capital market participants in this new asset class, it could increase the economic viability and scalability of the early phase-out of coal. Concerns over viability and scalability have long stood in the way of such projects taking off.

The report estimated that the income lost from retiring a coal plant with a 1 GW capacity five years before its intended lifespan would be about US$70 million. This translates to between US$11 and US$12 per tonne of carbon dioxide equivalent.

The ultimate goal is to generate enough demand for these credits among companies and governments that are seeking to offset their emissions, through the voluntary carbon market and compliance market.

Assuming that the level of emissions reduced after a coal plant is retired early and replaced by renewable energy sources can be measured accurately and transparently, the transition credits generated can be the product of an irreversible action to reduce emissions at their source.

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The MAS-McKinsey report follows several initiatives to facilitate more early coal phase-out transactions in South-east Asia, a region with many young coal plants.

Both the MAS and Asia-Pacific chapter of the Glasgow Financial Alliance for Net Zero have launched consultations on early coal phase-out. These came after the Asean Taxonomy added coal phase-out to its list in March this year. (The Asean Taxonomy is the regional bloc’s classification system spelling out the activities that qualify for sustainable financing.)

These efforts have been aimed at providing regulatory endorsement and guidance to financiers wary of entering such projects. However, the issue of the economic viability of such projects remains unresolved.

While the proposal by MAS and McKinsey tries to tackle this challenge by setting out ways transition credits can be a financing instrument for early coal phase-out, the report also recognises several challenges standing in the way of market acceptance, chief of which are integrity concerns over such credits.

To begin with, the voluntary carbon market is not mature. Several reports have questioned whether carbon credits that have been sold represent genuine reductions in emissions.

On top of that, there is no universally accepted methodology at the moment on the conditions under which high-quality and credible carbon credits can be generated from early coal retirement. Methodologies are now being developed by bodies such as Gold Standard, which sets standards for carbon credits.

To ensure that there is genuine demand for transition credits, it needs to be aligned with the core carbon principles set out by the Integrity Council for the Voluntary Carbon Market, an independent governance body for the voluntary carbon market. These include principles of additionality, under which the early retirement of coal plants would not have occurred without the incorporation of transition credits. Another core carbon principle is that of permanence, which requires sufficient safeguards to ensure that the projected reduction in carbon emissions is not reversed.

The report also recommends the creation of insurance products to reduce the risks associated with transition credits.

This is because these credits are likely to be issued years later, given that a coal plant will still run for a few years before it is decommissioned. The actual reduction in emissions must also be verified, so buyers need to be covered for the risk they bear that there might be political or policy changes where these plants are based.

A gradual phase-out of these plants, which will show the year-to-year reduction in emissions, could also help to bring forward the issuance of these credits.

The MAS-McKinsey report noted that a credible early coal phase-out transaction would have to take into account “just-transition” principles, to ensure that people affected by the plant’s closure suffer the least disruption and are duly compensated.

While the intention behind the creation of transition credits is to scale early coal phase-out projects beyond a transaction-by-transaction approach, MAS chief sustainability officer Gillian Tan said that the inclusion of just-transition principles, while important, complicates matters because geography would dictate the local circumstances.

“Some of the pricing mechanisms, we can probably standardise fairly quickly. But this (just-transition) piece, it will be interesting to see whether we can actually extract some standardised principles (from some of the pilot projects) that we can apply across the board, at least as a starting point,” said Tan, who spoke at a panel at the launch of the report.