India power sector should prepare for climate transition risks

Domestic thermal power sector should prepare itself for the impact of the country’s climate transition scenario of 450GW of renewable energy capacity by 2030, a new report by IEEFA has said.

With higher renewable generation displacing coal-based power in India, the thermal power producers will get negatively impacted by drop in potential revenues and costs from the sale of coal-based power as assumed in the business-as-usual scenario, said a report authored by Gireesh Shrimali, scholar from Precourt Institute for Energy at Stanford University.

“This would impact equipment suppliers, generation asset owners and consumers paying the bills, as well as the financial institutions supporting these now stranded or underutilized assets,” Gireesh said.

The financial impact can be captured in reduced operating income, also known as earnings before interest, taxes, depreciation, and amortisation (EBITDA). Reduced EBITDA then means reduced cash flows, reduced operating life and hence reduced valuations.

Climate change risks

Climate change has created financial risks for business. These can be broadly categorised as physical and transition risks.

Physical risk is essentially the impact of a changing climate on revenues as well as costs.

A simple example is higher real estate operating costs due to increasing damages from floods due to rise in average global temperature. For a real estate portfolio, this could result in lower valuations due to anticipated higher costs.

Transition risk, on the other hand, is the financial risk due to changing policies, technologies, and markets.

For example, a business may be planning to operate under a scenario by a particular year, whereas future policy changes may result in a different scenario by that time, which may impact the planned revenues and costs. This is true for power producers reliant on coal power generation, as we discuss below.