Accelerating the coal-to-clean transition
Over the past year, Jacobson Solutions has been working with our collaborators to identify whether it is viable to transition coal power plants to renewables, before 2030, without significant financial subsidies or grants.
We have identified 5 power plants in 5 different countries (Botswana, Colombia, Morocco, Romania, and Thailand) where one could structure transactions that make the transition feasible and profitable, while drawing in billions of USD in investment. The costs of the transaction include site rehabilitation, some new transmission infrastructure, and subsidization of the retraining and reemployment of impacted workers in the wider economy. The economics of the transaction can carry these costs in the cases we identified, while still generating returns in excess of typical cost of capital.
A key requirement is a willingness by existing utilities, Independent Power Producers, and regulators to restructure existing Power Purchase Agreements (PPAs). The new PPAs would extend the contracted term for energy sales, provided the coal facility is ramped-down, decommissioned, and replaced by renewables and energy storage before 2030.
Based on the characteristics of those 5, there may be as many as 800 more units in 54 countries where such transition transactions could be viable by 2030.
More financial institutions, development banks, utilities, developers, and governments need to think about transitioning their asset base by 2030. Jacobson Solutions hopes to continue to support the activity and implementation of some of these transactions in future.
Thanks go to the sponsors of the work, our collaborators at IEEFA, and the many individuals who tested and supported our efforts in understanding this complex topic.
We won’t republish the article here, but instead follow the link to the IEEFA website
https://ieefa.org/resources/accelerating-coal-clean-transition
Renewable Natural Gas
Background
We have been asked in the past whether Renewable Natural Gas (RNG) should be considered as a target for investors seeking to deploy development capital into cleaner energy alternatives to Natural Gas. The below assessment is our take on the market for RNG. Note that this research is not intended as investment advice or to provide the basis for making an investment in this sector, as each opportunity’s economics differ and requires individual economic assessment not performed here.
Overall RNG investment thesis: Help address climate change while carbon reduction credits provide profitability utilizing proven technology
Natural gas (methane) is a known contributor to climate change, whether emitted itself or through the generation of carbon dioxide through combustion to generate power. Natural gas is typically produced by oil and gas majors who produce the gas either as a direct product of drilling operations or as a byproduct in oil production. However, natural gas is also a natural byproduct of naturally occurring systems. Think of sewage, solid waste landfills, or cattle farming.
The investment thesis is to build facilities that recover this methane from those systems and then sell it into existing natural gas pipelines (offsetting the production of natural gas from the oil and gas sector). The economics of this process vary significantly depending on the source of methane generation (and the associated cost of methane recovery), but what makes the projects economically attractive are US federal and state government carbon reduction credits that can be sold or traded.
There are public benefits that arise through utilizing a waste stream to produce a beneficial, necessary product. This is especially relevant in waste treatment (sewage, landfills) where the sectors are facing challenges.
Overall assessment:
Sector: Waste management, renewable/sustainable energy, carbon abatement, industrial process technology,
Typical investment required (debt plus equity): small- to mid-scale projects of $50-150 million,
Attractive economic returns, with known cases where investment has been profitable but two considerations in particular impact profitability,
The source of methane, as the cost structure of recovering RNG varies significant between them,
The proximity of the facility to an off-taker, which is typically a natural gas utilities pipeline,
There is an environmental benefit,
Capturing RNG from existing emissions and utilizing reduces natural gas drilling and is beneficial to addressing climate change,
However, the volumes addressed are relatively small versus the scale of the climate change problem (look elsewhere if you want transformative change),
Risks are tied to regulations and typical developer risks
The technology and operation of these facilities is proven, with a wide range of available suppliers and contractors (1),
An investment of this nature requires an adoption of development, regulatory and construction risk, which requires the right kind of development team,
Economics depend on credits and e.g., eRINs and LCFS may change over time as carbon emissions targets get stricter,
Our hypothesis is that this type of investment is comparable to other Core Plus infrastructure services, like waste collection,
While demand for gas would mirror typical energy demand cycles, market demand risk is likely lower because “cleaner” gas would be preferred by the market and the share of RNG production is relatively small compared to traditional natural gas production, limiting the potential for overproduction and leading to relatively stable revenues,
Growth is tied to additional capital investment through aggressive development of new facilities or acquisition of existing facilities, as volumes from individual RNG facilities are relatively steady, as is typical for mature infrastructure - this is not a high-growth consumer tech or software investment,
Government incentives support reliable economic returns, as is common in infrastructure development,
Other observations
Research indicates that economic returns are in line with PE fund and energy company return expectations,
RNG assets are suitable for wide range of portfolios, and it should prove simple to to sell assets once developed and operational; large energy firms (e.g., Chevron) are already acquiring small-mid cap players,
Most projects are greenfield or brownfield developments, likely with a partnerships between a DevCo, an Opco, and the emitter.
Suitability of RNG
There are typically three types of facility where RNG has proven attractive in the US: landfills, sewage treatment facilities, and dairy farms. In each case, the developer invests in onsite facilities to capture and treat methane emissions (at e.g., wastewater treatment facilities or at solid waste landfills) and sells the recovered gas to a local utilities pipeline. When it comes to waste treatment, there is potential to combine this business into a larger business of solid organic waste recycling, management and operation of treatment sites, and organic compost sales. In the waste business more broadly, there are problems with increasingly limited landfill capacity (particularly in the US northeast), changing political attitudes to waste disposal (with an emphasis on reuse), and government-set targets to reduce methane emissions from this waste. This is spurring investment and incentives to capture and utilize methane and process the solids for use as organic fertilizer. These investments enhance the traditional value of sewage management as the sales price of the products is higher than the input costs, however, government incentives are critical to ensure profitability and offset the production costs. It is possible that eventually every waste site in the US will require this investment.
Economics of RNG
The production costs of RNG range from 7-33 $/MMBTU while typical revenues plus govt. credits come to 8-45 $/MMBTU (2). Note that these production costs (including the cost of capital) are higher than the production costs of traditional gas exploration and drilling. and hence govt. credits are essential to economic viability, seen by e.g., the Henry Hub natural gas spot price of 2.52 $/MMBTU in December 2023; well below the production costs of RNG (3).
The high range of these production costs depends on the RNG source as dairy, landfills and wastewater provide feedstock at different production costs. Anecdotally, dairy farms are the most expensive source of RNG.
Market maturity
While the market is well established, there is room for continued growth. In 2021 the number of production facilities rose 46% and volumes rose 24% yoy (2). There are established off-taker markets for the energy, typically gas utilities, and organic fertilizer and readily available sources of feedstock. These off-takers are credible contractual counterparties for the purposes of raising project finance for building the RNG facility.
There are already established players investing in RNG. This includes majors like Kinder-Morgan ($1.1b announced investment) and Chevron, and smaller players such as Clean Energy Fuels, Aemetis, Montrose, Vanguard Renewables, Anaergia, and GFL Renewables, amongst others.
Despite the maturity of the market, there is significant continued room for growth. This is because of the long tail of methane emitters amongst water treatment facilities, landfills and dairy farmers across the US. Identifying, educating, and developing commercial contracts with these emitter entities is a time-consuming, relationship and local-personnel intensive process. In many cases the supplier counterparty would be a municipalities; many of these do not yet utilize any tech to recover the natural gas and may be completely unaware of the viability and financial benefits of doing so.
Regulatory incentive structure
The regulatory incentives for RNG take the form carbon reduction credits that can be sold or traded. These include RINs, ERINs, and LCFS:
LCFS: Low Carbon Fuel Standards is a credit generated per metric ton (MT) of carbon equivalent reduced,
RIN: Renewable Identification Number is a credit generated per volume of renewable fuel produced,
E-RIN is a credit generated through the electricity used in electric vehicles (EVs), provided it originates from renewable sources.
Additional government subsidies are potentially available through programs in the Inflation Reducation Act (2022) and the Bipartisan Infrastructure Deal (2021) where capital for water or clean energy projects can be tapped by municipal partners. This can sweeten deal economics and in many cases municipalities are unaware of these.
Risks to consider
The technology and operation of these facilities is proven, with a wide range of available suppliers and contractors (1). The biggest risks like in what we call developer risks. Here the sourcing of opportunities can be a time consuming and costly, requiring an on-the-ground, heavily localized presence,
Emitters may not be aware of the opportunity and will require education before deciding to move forward, slowing down the development cycle,
Publicly-owned waste facilities likely will require a public-private partnership and a competitive bidding process, which requires the developer to invest personnel time and at-risk development capital that cannot be recovered if a bid fails,
Permits dealing with water use can be slow to secure,
Finally, the economics depend on credits and e.g., eRINs and LCFS may change over time as carbon emissions targets get stricter, requiring certainty in political priorities and the resulting regulatory regime.
What is required to benefit from this opportunity
The opportunity here lies in successfully developing new projects as opportunities are in markets that have not yet made these investments. A developer would need to take on the responsibilities of securing municipal contracts, off-taker agreements, and permits, invest in the design of the system, identify and manage contractors, and establish an operator or partner with one.
There are two pathways to enter the RNG business:
Take a stake in or aquire an existing developer – this avoids investment in development phase of the asset, particularly applicable if one believes the development cycle is long and risky,
Develop your own assets – no barriers to entry here, if one is prepared to invest in development in US locales where RNG facilities are not yet prevalent.
For the latter approach, the key components of a viable deal are the utility off-taker agreements for gas, contracts to secure feedstock from water treatment facilities/landfills/dairy farms, permits, tech/engineering vendors, and connection to an existing local distribution network (pipeline, potentially trucking). The activities that must be undertaken include:
Source viable opportunities where municipal interest can be piqued,
Develop commercial terms with gas utility off-taker and methane emitter (potentially also solids waste customers where relevant),
Develop site selection capabilities:
RNG facilities located onsite with emitter but requires proximate gas pipeline
If collecting solid organic waste for treatment and sale/disposal, then suitable landfill/treatment site required
Hire in a strong regulatory team to secure permits including environmental consultants, lawyers, and local influencers for stakeholder management
Select the technology and issue an RFP from design contractors
Identify a strategic operating partner to run the portfolio of assets (either local players or a national player depending on the scale of investment planned)
If one wants to go further and enter the organic business, in the case of landfill or wastewater emitters, this requires a close network of sources of organic waste within trucking distance of a centralized landfill/processing site for the waste. Permitted land availability can be a problem for waste handling, but if such a permitted site can be sourced it provides substantial competitive advantage, particularly in northeast US.
Identified gaps in this analysis and room for future updates
More detailed information required on unit economics, pricing, recent transactions in this space, will help to confirm viability of opportunities,
More information on where project opportunities have been depleted and where they still remain was not available,
The market data is from 2021, 2022.
Sources
(1) https://www.rngcoalition.com/coalitionmembers
(2) https://seekingalpha.com/article/4544525-renewable-natural-gas-attracting-significant-capital
(3) https://www.eia.gov/dnav/ng/hist/rngwhhdm.htm