On 10 February 2021 the UK government published a consultation paper seeking views on an approach to sequencing the deployment of carbon capture, usage, and storage (CCUS) clusters. The consultation closes on 10 March 2021 and follows a previous update dated 21 December 2020 in which the government set out its proposals on potential business models and revenue mechanisms for CCUS projects.
CCUS Cluster Sequencing Consultation
A “cluster” is a reference to an industrial cluster and is defined as comprising both of the following:
- a “first phase” of carbon capture projects. A “first phase” of carbon capture projects can be any combination of at least two projects of the following: power, industrial carbon capture and hydrogen; and
- a transmission and storage network, incorporating the onshore and offshore network/pipelines, and the storage capability.
The government intends to assess carbon capture projects at a cluster level given the interdependency between different parts of the CCUS chain. Projects which involve shipping may be considered as an alternative to pipelines.
This consultation follows on from Prime Minister Boris Johnson’s Ten Point Plan for a Green Industrial Revolution announced on 18 November 2020, in which a commitment was announced to deploy two carbon capture clusters by the mid-2020s (“Track-1”) and a further two clusters by 2030 (“Track-2”).
Track-1 is further divided into two phases: “Phase-1” (Provisional Cluster Sequencing) and “Phase 2” (Final Project Selection). The consultation paper provides a tentative timetable for Phase 1 and 2 as follows:
Phase-1 cluster sequencing launched and call for cluster plans to be submitted.
Deadline for cluster plans to be submitted. To be eligible a cluster must credibly demonstrate that it can be operational by 2030.
Phase-1 eligible clusters announced.
Phase-2 call for capture projects to be included in eligible clusters. This allows projects not affiliated with clusters an opportunity to enter the process.
Announcement of result of Phase-1 cluster sequencing.
Phase-2 - deadline for capture project applications.
Phase-2 - project assessment, negotiation, and due diligence.
H1 2022 Onwards
Final investment decisions of Track-1 clusters.
The paper further outlines the government funding available for carbon capture and hydrogen projects, including the £1bn CCS Infrastructure Fund (CIF), and the £240m Net Zero Hydrogen Production Fund.
The Proposed Funding and Business Models for CCUS Projects
The 21 December 2021 update gives details of the proposed business models for CCUS, which are summarised as follows:
- CO2 Transportation and Storage Model Regulatory Investment Model (“TRI Model”) – CO2 transportation and storage network projects will receive an economic licence allowing the project as licensee to receive a regulated fee from network users from the completion of construction. The regulatory framework is derived from precedents, including utility regulation and is intended to support a stable, predictable, indexed linked business model, with government intervention to ensure that transportation and storage networks are “right sized” to accommodate future growth in CO2 volumes. The government intervention may include the following, which is a non-exhaustive list: (i) upfront capital contribution through the CIF (ii) shaping the revenue structure to match expected utilisation - deferring revenue to later operational phases (iii) incentives for the project to connect more users and (iv) consumer or taxpayer funding. The update goes on to identify the risk of timing mismatches between completion of “anchor” projects, under-utilisation risks, and solvency risks, and explains support options the government is considering for such risks, including: (i) “rolling up” of lost revenue (ii) payments of opex by consumers or tax payers (iii) incentive regimes and (iv) payments of losses by consumers or tax payers. A Government Support Package is also discussed for high impact low probability risks such as CO2 leakage, asset stranding and uninsurable risks. A risk matrix for the various project risks is also provided.
- Dispatchable Power Agreement (“DPA”) for Power CCUS – The update states that Power CCUS plants will have to be operated in dispatchable mode mid merit order to complement renewable energy generation. The DPA would be established between the power CCUS project company and the Low Carbon Contracts Company (“LCCC”), an existing government company which participates in renewable energy projects with subsidies from energy consumers. The first power CCUS projects will likely have a bilaterally negotiated DPA, rather than a DPA awarded through a competitive process. The DPA has similarities to the Contract for Difference (CfD) used for renewable energy projects, although a key difference is that the payment terms will comprise a capacity based availability payment and a variable payment designed to incentivise the plant to generate ahead of unabated equivalent plant when demand cannot be met by renewables and nuclear. A draft Heads of Terms for the DPC Contract is provided with the update, together with a risk matrix.
- Industrial Carbon Capture (ICC) – Industrial carbon capture projects are expected to be supported with funding for capex through from the CIF and an industrial carbon capture contract (“ICC Contract”) anticipated to be with LCCC. The ICC Contract is envisaged to be a CFD based contract with a 15 year term, with a strike price for CO2 to cover operational and capital costs. The strike price will be negotiated bilaterally for initial projects, moving to a competitive allocation process as the technology matures and more CCUS clusters are operational. Projects will be expected to give up their free allowances under the emissions trading system (ETS) in return for entering into the ICC Contract. Work on the LCC Contract is described as ongoing, and an indicative outline HoT that the ICC Contract could follow is provided in the update together with a risk matrix.
- Hydrogen Business Model – A consultation on the government’s preferred hydrogen business revenue models is expected in Q2 2021. It is also expected that support will be provided from the Net Zero Hydrogen Production Fund.
Cluster Business Models
Whilst the government has provided detail on the business models for individual carbon capture projects, no model has been provided or required for the clusters themselves. This topic may arise in the consultation and in the evaluation of the deliverability of clusters. The following may be considerations as to how clusters are structured:
- Integrated or Non-Integrated Clusters – An integrated structure involving common ownership of all facilities in the CCUS cluster will likely be more bankable as such a structure will mitigate project on project risk that might otherwise arise for investors and financiers to individual projects in the cluster. However, an integrated ownership structure is more difficult to achieve if the project sponsors interests are not completely aligned. As a cluster will comprise different CCUS projects in different industrial sectors, possibly with different technologies, development timelines, costings and revenues, alignment may be difficult. The cluster sponsors may prefer to finance or invest in individual CCUS projects in the cluster separately, particularly if any facility in the cluster is integrated into an existing power or industrial plant that only one sponsor owns. Transportation and storage infrastructure will likely need to be utilised by others, requiring a different ownership structure, meaning that in a cluster only the carbon capture projects are integrated and developed as one business. Non-integrated structures in the cluster are, however, likely to be more challenging to finance.
- Merchant and Tolling Type Structures – In a merchant structure, the owner(s) of the infrastructure along the CO2 supply chain from capture to storage would take CO2 commodity risk and risk of leakage. This would involve the owners of the individual facilities owning the CO2 and acquiring and supplying it/disposing of it/receiving it for a fee along the value chain under CO2 Supply Agreements. Under a tolling structure the owners of the infrastructure along the value chain do not own the CO2 but charge fees for transporting and processing the CO2. The merchant structure includes the risk of supply and disposal of CO2 and involves more risk taking by the asset owners in chain (and their funders). This is no requirement for either model, although it is notable that the ICC Contract envisages a contract for difference for sale and purchase of CO2, and therefore a merchant structure.
Assessment of the Government’s Approach
The government’s proposals all have the common aim of eliminating the uncertainty for the private sector of the future pricing, costs, demand, and availability of CCUS power and CO2 disposal. The government is also identifying and trying to solve risks such as (i) technology risks (ii) risks of unfixed or unknown costs (iii) liabilities (such as CO2 leakage liability) (iv) force majeure risks and (v) uninsurable risks. In addressing the uncertainty and risks, the government is seeking to obtain private sector investment and expertise for CCUS projects.
Initial projects will be negotiated projects, not awarded by competitive tender. Future projects involving sponsors taking any element of pricing, cost or availability risk in relation to CO2 disposal, as is currently done in the power sector, may require: (i) a market for CO2 to have matured and sponsors having the ability to fix or hedge the future price of CO2 with an external hedge provider and (ii) an allocation of and pricing of risks and operational flexibility along the CO2 value chain, and into other value chains (for instance from CO2 into power, emissions and hydrogen prices).
The government’s plans for CCUS clusters will rely on proven project development and finance techniques and models. Given the interplay within clusters, and with others not in the cluster, CCUS projects will be complicated to negotiate, but doable based on the government’s plans. The government’s timetable is ambitious, and the success of its plans depends on its ability to negotiate agreements with the private sector which provide for a politically acceptable level of risk taking by and cost for energy consumers and or the taxpayer.