Business models for CCUS – what’s new?

United Kingdom

Further to its consultation response, published in August 2020, the Department for Business, Energy and Industry (“BEIS”) provided an update in December 2020 on potential business models for carbon capture, usage and storage (“CCUS”) projects (the “Update”). The Update considers the proposed commercial frameworks for each key element of a CCUS project: CO2 transport and storage (“T&S”), power and industrial carbon capture (“ICC”), as well as a brief update on the progress of proposed hydrogen business models.

The Update delivers on the UK government’s promise to provide further details on the commercial frameworks for industry, CO2 T&S networks and power by the end of 2020, as part of its “CCUS delivery action plan” (see the consultation response). As such, it could be understood that the UK is on track for achieving its desired goals for CCUS projects as set out in the Ten Point Plan and the Energy White Paper: to capture 10Mt of CO2 by 2030 and establishing two “SuperPlaces” by the mid-2020s. However, when it comes to CCUS, the UK has so far been slow to mobilise in comparison to its EU counterparts.

This bulletin looks at new details that have emerged from the Update and reflects on the progress made since the CCUS business model consultation opened to industry in July 2019. You can read our take on the earlier consultation here, as well as comments on the government’s response here.

T&S Regulatory Investment (“TRI”) business model

Inspired by BEIS’s previous Regulated Asset Base (“RAB”) model – the TRI model aims to attract private sector investment in respect of the T&S aspect of the CCUS supply chain. It shouldn’t be forgotten that the T&S model was proposed in order to isolate some of the risks that might arise with a “full-chain” CCUS model, for example risk of stranded assets or long-term leakage, and allocate these to those best placed to deal with them, the T&S companies (“T&SCo”).

Published alongside the Update were draft commercial principles for a T&SCo licence within which several indications were given that the model will follow existing electricity licences: namely, the use of cap and floor mechanism to incentivise availability, as well as the introduction of a “T&S Code” setting out procedures for users to connect to the T&S network, amongst other things (much like the existing Grid Code).

Overall, the Update addresses these risks while building upon previous proposals, looking specifically at three areas: the revenue model, economic regulatory regime (“ERR”) and government support package (“GSP”).

Revenue model

As stated within the consultation response, this will be a User Pays model; those who use the T&S network to transport/store their captured CO2 would pay fees structured in a similar way to the gas network charges. In adopting the User Pays model, this allows risk to be priced into the network fee without solely falling to the T&SCo to absorb, but rather to be shared with network users.

The below diagram, provided in the Update, is of the User Pays revenue model in the steady state operational phase, i.e. a mature network. The Update notes that the proposed revenue model would be most suitable for a mature network and so suggests alternate revenue models which may be more appropriate for earlier phases of a T&S network. To note, the LCCC is being considered as a potential counterparty.

Graphic energy article

ERR

The ERR does not appear to be dissimilar to the generic RAB model and so is framed around (i) a statutory regulator with the ability to grant licences to a T&SCo, (ii) periodic price controls, (iii) allowed revenue, and (iv) adjustments to allowed revenues. What is not yet known is key question around who will take on the role of statutory regulator; whether this will be Ofgem, as for other RAB models, or another body such as the Oil and Gas Authority.

GSP

Where BEIS deems it necessary, a GSP may be offered for the protection of investors and users against specific, high impact / low probability T&S risks: the risk of stranded assets and defined CO2 leakage from storage facilities (the “Defined Risks”). Draft commercial principles of the GSP were published alongside the Update in which the Defined Risks were outlined and the trigger events for compensation under the GSP were identified. A word of caution: compensation will only be paid out in very limited circumstances (such as commercial insurance being unavailable) and, even then, only where the T&SCo has acted to mitigate the risk. Where insurance is unavailable, the government could step in as an insurer of last resort compensating the T&SCo for any remaining operating expenditure or up to the remaining regulated asset value, in the case of stranded assets but, in the case of CO2 leakage, only where T&SCo has taken steps to mitigate. Levels of compensation paid out under the GSP are not defined in the draft commercial principles.

However, at least a GSP is being proposed for the TRI model whereas no such similar support has been proposed in relation to the Dispatchable Power Agreement (“DPA”) for power CCUS projects (see more, below).

Dispatchable Power Agreement for power CCUS

The DPA model will be contractual and based on the allocation round three (“AR3”) renewables contracts for difference (“CfD”) model. Indicative heads of terms have been provided alongside the Update. Similarities between AR3 CfD and DPA heads of terms include the term (BEIS suggest 15 years) and the DPA being subject to conditions familiar to CfD projects, such as needing to satisfy Milestone Requirements and commission within specified Target Commissioning Windows. A comprehensive narrative of the main changes between AR3 CfD and DPA heads of terms is also provided at Annex C to the Update. It should be noted that the CfD terms are being updated in 2021 for the next allocation round, AR4, so it is likely that once these are finalised, the DPA terms may too reflect any updates (you can read more about the updates to CfD AR4 here).

While the heads of terms largely follow the AR3 CfD (or, at least, say the approach will be based on the AR3 CfD), there are a number of key differences. Namely, the payment structure shall be made up of an availability payment and a variable payment. The availability payment - based on an availability payment rate that will be set through negotiation or competitive tender process - will depend on the available low-carbon generation capacity of the individual facility (CCUS plant) and is aimed to provide a regular monthly income for investors. The variable payment aims to ensure the facility in question dispatches power ahead of an equivalent, unabated plant by comparing the CCUS facility (taking its gas cost differential, carbon cost differential, T&S volumetric fee and other extra variable costs) to a theoretical “reference” plant and providing a payment to reflect this such that the CCUS facility is put in an economic position to dispatch electricity ahead of an unabated plant. The formula, and accompanying detailed rationale, are laid out in Annex C for further understanding.

Other changes to note include the right of the DPA Counterparty to terminate where the T&S asset is unavailable (i.e. stranding of the Generator)  for a prolonged period or for prolonged force majeure preventing completion, the proposal for a gain share mechanism, as well as more onerous reporting requirements for T&SCo during construction through to commissioning phases of the project. BEIS is also considering whether T&SCo should pay compensation for defaulting and whether penalties should be imposed where the T&SCo’s performance is poor over a prolonged period. While this may be common on contracts negotiated for mature technologies and non-low-carbon renewable projects, some of the changes would depart from the subsidy-type arrangement mentality that applies to current CfD projects, let alone the nuclear CfD terms which were offered to Hinkley C in 2016. The impact of this risk transfer would need to be carefully considered by those looking to develop projects on the basis of the DPA.

ICC contract

Aimed at first of a kind and early-stage ICC projects, the Update proposes a commercial framework for the ICC contract and provides ICC indicative heads of terms.

Again, the ICC Contract will be based on the CfD mechanism and the heads of terms do not appear to deviate much, though there is much less detail than provided in the DPA heads of terms. The ICC heads of terms indicate reference and strike prices will be key components of the ICC contract and, in a similar vein to the DPA, there will be Milestone Requirements to satisfy and a Target Commissioning Window for the facility (yet to be determined). However, perhaps most notably, the ICC contract term is likely to differ from the power CfD’s precedent 15 year term with the aim of providing some flexibility for an emerging market; the Update states this could be an initial term of 10 years with either a five year option to extend or a reopening of the strike price.

The ICC contract continues to be developed by the LCCC, ICC expert group and other advisers within BEIS. It is clear that it is still in very early stages of development as details of the reference price trajectory, determination of strike price and revenue mechanism are all yet to be decided; these are due to be released in 2021.

What’s next?

The Update touches on the progress towards a hydrogen business model but lacks any new detail for industry; instead, this section is repetition from the proposals within the Ten Point Plan and Energy White Paper. More detail is expected in spring 2021.

Much like the consultation response, the Update concludes with a timeline of when industry can expect further engagement from BEIS with regard to CCUS and associated business models. As can be seen from the table, below, plenty of additional clarification is still needed ahead of BEIS finalising a CCUS business model in 2022.

CCUS Policy

Indicative Date

Cluster consultation

Q1/Q2 2021

Hydrogen business model consultation

Q2 2021

TRI model update (incl. revenue model, ERR and GSP)

Q2 2021

DPA model update

Q2 2021

ICC business model update

Q2 2021

Supply chain update

Q2 2021

T&S decommissioning regime

Q3 2021

Biomass strategy position paper

Q3 2021

CCUS regulatory framework update

Q3 2021

T&S connection arrangements

Q3 2021

While BEIS have not invited any formal feedback on the Update, it is stated that they will continue to engage with industry, in particular, prospective developers and potential investors of CCUS projects. If the UK is to become a “global leader in carbon storage services”, much more action – in addition to engagement – is going to be needed to achieve this goal.