Rethinking Debt-Equity Ratios and Securitized Bonds Could Help Finance a Green New Deal

Political firebrand and HouseRepresentative Alexandria Ocasio-Cortez and Senator Ed Markey released the GreenNew Deal (“GND”) in early February 2019. Spurred by recent findings fromthe Intergovernmental Panel on Climate Change (IPCC) that suggest humans haveless than a decade to reverse course on climate change before it will be toolate to prevent catastrophic events, the GND is somewhat of a roadmap ofpolicies intended to address climate change. In very broad terms, it describesa series of investments into both renewable infrastructure and clean energyjobs. Even from those that agree in principle with the overall themes of theGND, a reoccurring criticism is simply how these massive investments can befunded.

Though not a solution that could solelyfund the GND, economistsand regulators have recently been examining how debt refinancing could betterbe used to help transition aging fossil fuel generation to renewablegeneration. While closing down a dirty coal plant is a commendable goal ofenvironmentalists, plant closure is quite an expensive prospect. Whenconsidering that energy infrastructure projects often run into the millions orbillions of dollars, the cost of these projects are amortized over a fixed andlengthy duration of usually no less than thirty years. If a coal plant is thenforced to shut down before its thirty-year mark, it risks becoming a strandedasset.

Investorsare primarily the group most opposed to an asset being shut down before itsend-of-life as it represents their unrecovered investment. These large capitalprojects are usually funded by a combination of equity where investorspurchase shares of ownership, and debt where investors loan utilities money bypurchasing bonds. In the event of bankruptcy, creditors are paid beforeshareholders which means equity investors usually have higher rates of returnto compensate them for their additional risk. While the market determines autility’s stock price, financial institutions issue credit ratings that determinethe cost of debt financing, similarly to how Equifax or Experian issue creditscores for individuals to indicate their ability to repay a loan.

Actualizing the GND would likely require an enormous federal initiative, but it would be foolhardy to disregard the potential financing tools already available at the local and state levels that could ameliorate some of the financial sting. Though a high debt to equity ratio is sometimes a sign of a utility that is at a high risk of bankruptcy, there is another key reason why utility executives push for equity instead of debt investment—regulators only allow profits on equity investments and not debt. So despite the very real risks that a higher debt to equity ratio might have for a utility, the potential impacts and industry best practices surrounding this ratio are obfuscated by a utility’s blatant incentive to use equity instead of debt. Given its lower risk to investors—debt is actually cheaper for utilities to obtain.

Therefore, refinancing unrecovered equity investments in aging fossil fuel generation plants with debt or securitized utility bonds, could allow a quicker transition to renewable generation by lowering the cost burden on ratepayers and shareholders when closing down still useful assets. In addition to examining how this refinancing tool could apply to coal plants, other potential applications might include refinancing for nuclear plants that never were fully constructed like that in South Carolina or refinancing in the wake of environmental accidents that require swift closure of the offending source. Achieving the GND will require creativity, dedication, and a willingness to forge ahead in a piecemeal approach with already available tools instead of waiting upon comprehensive legislation. Though not without risk, debt refinancing is one of these available tools.

Abi Christoph, 25 February 2019