While coal remains essential for U.S. electricity generation in the foreseeable future, any climate change regulatory scenario will mandate coal-fired power plants to make meaningful carbon emissions reductions. To properly protect their business interests, electric power generators and the banking community must analyze and evaluate the environmental and economic risk profile of existing generation portfolios and new construction projects, including during pre-financing diligence.

Toward that end, Citi, JPMorgan Chase, and Morgan Stanley announced yesterday the formation of “Carbon Principles,” climate change guidelines for advisers and lenders to power companies in the United States to strengthen environmental and economic risk management in the financing and construction of electricity generation facilities. The banks developed the Principles in conjunction with several power companies, many of which are heavily dependent on coal as a fuel, and two environmental organizations, Environmental Defense and Natural Resources Defense Council.

The Carbon Principles outline an approach to evaluating and managing carbon risks in the financing of electric power projects. As part of this effort, the banks developed an Enhanced Diligence framework to help lenders understand and evaluate the potential carbon risks associated with coal plant investments. Among the tenets of the Enhanced Diligence Process are consideration of: (i) demand reduction caused by increased energy efficiency; (ii) production increases from renewable and low carbon generation; and (iii) uncertain financial, regulatory and environmental liability risks for fossil fuel generation.

The Carbon Principles are:

Energy efficiency. The banks will encourage their clients to invest in cost-effective demand reduction, taking into consideration the value of avoided CO₂ emissions. They intend to encourage regulatory and legislative changes to advance increased efficiency in electricity consumption.

Renewable and low carbon distributed energy technologies. The banks will encourage clients to invest in cost-effective renewable energy and distributed technologies, taking into consideration the value of avoided CO₂ emissions, and will seek legislative and regulatory changes that remove barriers and promote such investments.

Conventional and advanced generation. The banks recognize the need for investment in conventional or advanced generating facilities (including power from natural gas, coal and nuclear technologies) to supply reliable electric power to the US market. The banks intend to encourage regulatory and legislative changes that facilitate carbon capture and storage to further reduce CO₂ emissions from the electric sector.

Perhaps not surprising, groups seeking a moratorium on financing new coal development are not satisfied with the scope of the Principles and the lack of binding commitments to not finance high carbon emitting energy sources, such as coal-fired power plants. For example, Rainforest Action Network, while praising the Principles as “an important step toward recognizing the climate risks associated with financing coal plants,” indicated its displeasure over “lack of any binding commitments” and the “failure” to address the environmental impact of coal extraction methods.

By the same token, groups interested in promoting continued reliance on coal for power generation expressed concerns over whether the Enhanced Diligence program could use a limited formula and produce perverse financing and investment decisions. For example, in comparing greenhouse gas emissions by coal versus natural gas fired units, there are assertions that if emissions were tracked from the wellhead-mine mouth to the point of electricity generation, the emission gap between coal and natural gas narrows. Some emissions tracking systems find that more GHGs are emitted to the atmosphere in the natural gas production and processing parts of the supply chain than in coal production and processing.

In the final analysis, the Carbon Principles represent an important development toward evaluating the costs, risks, and opportunities presented by a carbon-constrained regulatory system. The processes for undertaking these analyses are by no means simple or static. Especially in the near-term, as legislation is enacted, regulations are promulgated, and court decisions are issued, the ability to anticipate the changes and to be prepared to capitalize on that information will be critical in separating profitable projects and transaction from those that are less likely to succeed.

For further information about this topic, please contact Akin Gump.