The U.S. Environmental Protection Agency’s (EPA) recently proposed guidance for limiting greenhouse gas emissions from coal and gas-fired power plants could result in material compliance costs and erode operating margins for power generators reliant on fossil fuels, according to Fitch Ratings. In May, the EPA proposed new carbon emissions restrictions that would require phased-in implementation of carbon capture and sequestration, the use of low greenhouse gas hydrogen (green hydrogen), or emission control systems for existing coal and new and existing gas fuel-fired power plants. Requirements are based on fuel type, dispatch profile, and whether the project is new or existing. Base load and mid-merit natural gas-fired plants that operate more frequently and are expected to be in operation for a longer period of time generally have more stringent requirements.
If implemented, the stricter compliance standards could have a significant impact on coal plants and natural gas generators with at least 300MW capacity and may lead to unplanned capital or operating cost increases. Coal projects would be most affected due to the higher costs of compliance and the greater risk of becoming unprofitable. Plants could continue to operate if returns and incentives to promote grid reliability are sufficient to fund capital costs. Plant closures and early retirements are possible in cases where lower asset utilization and costs cannot be supported by continued operations. Natural gas-fired plants face uncertain capital costs to transition to hydrogen fuel or employ carbon sequestration or other emission control systems as the technology is nascent.
Fitch’s portfolio of rated thermal projects is mostly composed of natural gas-fired facilities with long-tenor debt with maturities ranging from 2026 to 2041 supported by power purchase agreements (PPA). Projects with long-term, fixed margin PPAs are more susceptible to cost fluctuations. The effect on a project’s financial and operating profile will depend on the final form of the rule/ultimate compliance requirements; costs incurred to comply; and ability to pass on costs to offtakers or absorb costs with existing liquidity, additional equity, or new debt.
Project ratings range from ‘A-’ to ‘B+’, and erosion of cash flows due to higher costs, a greater debt burden inconsistent with current ratings, or changes to long term financial performance expectations could result in negative rating action on affected projects. Production tax credits under 45Q of the Inflation Reduction Act (IRA) can help partially alleviate the financial impact if power plants pursue carbon capture and sequestration additions, but potential compliance costs over time are likely to be much greater than current tax subsidies. Construction of new projects will likely be delayed until the rule is finalized and impacts on cost of new builds is more certain.
The comment period for the proposal will end on Aug. 8, 2023. Fitch expects greater clarity on any credit impacts when the rule is finalized and projects provide plans to address the new requirements.
