Insights and Commentaries

Insights and Commentaries

Investing in CCS: What do financiers need?

12th June 2019

Topic(s): Policy, Project financing

In 2018 the International Panel on Climate Change (IPCC) determined that to avoid the worst effects of climate change, we must limit global warming to 1.5 degrees. To achieve this, carbon dioxide emissions must reduce by approximately 45 per cent from 2010 levels by 2030, and reach net-zero by 2050. Every available low emission technology will be required to achieve these deep cuts in greenhouse gas emissions.

Of the many mitigation technologies available, carbon capture and storage (CCS) is widely recognised as critical to achieving global climate targets, not least in the most ambitious emissions reductions scenarios. However, for CCS to fulfill its potential, rates of deployment must significantly increase. Enabling this will require a significant increase of private sector investment in CCS.

Currently, there are 43 large-scale CCS facilities in operation, development or construction. Experts estimate that approximately 2000 large-scale facilities are required to meet global emissions reduction targets by 2040. This equates to hundreds of billions of dollars in investments. Public funding for CCS, the most common funding mechanism to date, cannot sustain this level of investment on its own.

To date, investment in CCS projects have typically been supplemented by capital grants from public funds, with returns relying heavily on revenues from enhanced oil recovery (EOR). Although this arrangement has significantly contributed towards learning rates, an essential driver of cost reductions, it cannot be sustained at scale. The large-scale deployment of CCS will, therefore, require significant investments from the private sector i.e. banks.

However, as outlined in our recent report, a range of barriers and risks are limiting private sector investment in CCS. In the absence of EOR, there is an insufficient value on carbon dioxide to generate the revenues required for a sufficient return on investment. In addition, hard to reduce risks, namely cross chain and liability related risks, drive up the cost of capital. Since CCS facilities are capital intensive, this represents a significant material cost to projects, further reducing their economic viability.

Under these conditions, banks cannot qualify CCS projects for debt financing. As such, government has an important role to play in de-risking CCS investments.

Firstly, a material value must be placed on carbon dioxide, which can be in the form of a carbon price or a financial reward for CO2 storage. This value must be sufficient to incentivise investment in CCS.

Secondly, the cross chain (or counter party) risk must be addressed. This risk emerges from single source, single sink CCS projects, whereby only one capture facility sells carbon dioxide to a storage operator across a pipeline. The possibility of either the capture plant or the storage facility becoming unavailable presents itself as a significant risk to the overall project.

Moving towards a hub and cluster model reduces the risk of either counter party being unable to deliver or accept carbon dioxide. It utilises a transport and storage (T&S) network, connecting clusters of capture facilities together. In addition, this arrangement also reduces the unit cost of CO2 transportation through economies of scale.

Investing in T&S networks is, however, challenging for the private sector. The initial investment will be exposed to all the costs and risks of a single source, single sink model until other facilities join the network. This presents a significant barrier unless guarantees are provided for revenue during the early stages of deployment. This can be achieved through the Regulated Asset Base (RAB) model, which recovers costs from consumers — by way of long-term tariffs — under regulation. In this way, the consumers cover the risks, making it possible for the private sector to invest.

Where the balance of risk and return is insufficient to initiate private sector investment in the T&S network, government can take on the role of first investor. It could make the initial investment, establishing a T&S network for an anchor customer. Over time, more customers are able to join the network until such time that the business becomes an attractive investment. At this point, government can then choose to sell this mature business to the private sector for a profit.

Finally, addressing the liability risk, specifically long-term storage liability, is the last piece of the puzzle to ensure sufficient de-risking of CCS to attract private investments. If there are no limitations on liability, the storage operator will be liable for any leakage that occurs at any time in the future. To mitigate this risk, it is critical for governments to implement a well-characterised legal and regulatory framework that clarifies storage operators’ potential liabilities. Therein, it may be that the storage operator bears the risk of short-term liability during the operational period, as has been implemented by the Australian Government, which then goes on to accept the long-term risk. Each government will choose the path that best suits its circumstances.

De-risking will attract debt financing to projects, which can initially be blended with grant funding to reduce the cost of capital. With each successive project, costs are reduced through knowledge spillovers and economies of scale. Further, the perception of risks also decreases as investors can rely on more empirical evidence.

Over time, as the market develops and there is more experience from successfully implementing more and more CCS projects, costs will plateau. Risks will be well understood, reduce or disappear, and grant funding will no longer be needed to incentivise and support investments. The CCS market will attract significant debt funding at pricing comparable to other infrastructure projects, allowing deployment to reach the numbers required. Projects will eventually come to rely exclusively on equity and debt for funding, and acceptable returns will be achieved through diminished costs and the increased value of CO2.

Only then will CCS truly advance and deployment of this vital technology accelerate at the rate required to deliver substantial emissions reductions. Only then can we guarantee we are on the right path to achieving a net-zero emissions future, limiting global warming to 1.5 degrees and avoiding the very worst effects of climate change.

Author: Dominic Rassool, Senior Consultant - Policy & Finance

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