UK CCUS policy – is the UK ready to capture the opportunity?

On 22 July 2019, the UK Government’s Department for Business, Energy & Industrial Strategy (BEIS) published, among others, its proposals for business models for Carbon Capture Usage and Storage (CCUS) (the “Consultation”). The Consultation forms part of BEIS’ package of proposed measures to support the decarbonisation of the UK economy, which also includes consultations on reusing oil and gas assets in CCUS projects, on the Capacity Market carbon dioxide emissions limits, on the RAB model for nuclear and on facilitating energy efficiency in the electricity system.

In summary, the Consultation largely deals with uncoupling the business models for different parts of a CCUS project to address cross-chain risks across the project chain. Cross-chain risks were previously identified as a key barrier to success of earlier CCUS efforts in the UK (namely in the 2012-2015 CCS competition process). The level of detail set out in the Consultation varies. The more developed proposal is the RAB model for CO₂ transport and storage projects. However, questions regarding fee structures and regulatory oversight for this model remain. The Consultation is less settled on the direction for supporting CCUS in the energy-intensive industry and power sectors (although the focus for the latter appears to be on Contracts for Difference, either in conventional form or with modifications to optimise the role of abated CCGT plant in balancing intermittency – as further described below). Least developed in the Consultation is the proposal for supporting the role of CCUS in the hydrogen economy, which currently lacks any business models and is confined to hydrogen production facility costs only (apparently ignoring the costs of hydrogen distribution and retrofitting end-user plant).

Overall, this is a further step in the direction of providing policies that encourage the development of UK CCUS projects, but details of exactly what’s on offer are not yet fully developed. Whether this is enough to attract the private sector investment that is critical to achieving UK’s net-zero aims with CCUS projects remains to be seen.

Why now?

The UK Government has been steadily developing its policy thinking around CCUS over the last two years: it features in both the Clean Growth Strategy and the Industrial Strategy, and fits the wider statutory commitment to reduce greenhouse gas emissions to net-zero by 2050, which passed into law on 27 June 2019. The Consultation reiterates the Committee on Climate Change’s May 2019 report, stating that CCUS is a ‘necessity, not an option’ for meeting net-zero targets. This is due to CCUS’ ability to de-carbonise otherwise-hard-to-reach emissions producers, especially energy-intensive industry, transport, heat and dispatchable power.

However, the UK does not have any commercially operating CCUS plant (owing in part to the decision in 2015 to cancel a £1bn CCUS technology competition). The Government recognises that to ensure the delivery of CCUS, a supportive policy environment is vital, and the Consultation seeks views on how best to achieve this.

What is proposed?

Breaking the CCUS full project chain

The Consultation identifies three CCUS-specific risks which need addressing for CCUS projects to attract the necessary investment and be delivered:

1. Cross-chain risks: those that relate to failures of one part of the CCUS project chain affecting another part. For example, capture plant unavailability, which would have ramifications down the chain for (available) carbon dioxide transport and storage elements of the same CCUS project.

1. Stranded asset risks: those that relate to permanent unavailability of one part of the CCUS project chain, leaving other parts ‘stranded’ without access to revenue. In our view, this is an example of cross-chain risk.

1. Long-term CO2 storage and leakage risks: those that relate to liability for future escape of stored CO2. The Consultation states that the risk is very low. However, the long-term nature of the risk, and the current difficulty in obtaining affordable insurance cover, means the risk presents a significant challenge to CCUS delivery, and may need to be mitigated through government support.

The Consultation acknowledges deficiencies in the previous “full-chain” approach to CCUS policy support, which was predicated on Contracts for Difference (CfDs) being awarded in respect of projects that captured, transported and stored carbon emissions (as opposed to in respect of one or two of these strands only). As mentioned above, the risk profiles for the different parts of the chain vary considerably, leading to problems of risk sharing between the different parts of the chain when separate entities operate these different parts (which they often do due to the inherent differences and risks between the parts). A single CfD strike price (and therefore subsidy) for the full project chain means operators are exposed to enhanced cross-chain risk. Ultimately this drives up the cost of CCUS projects and increases the chances of project failure.

In a move to be welcomed, the Consultation proposes breaking the “full-chain” and having a separate support model for CO₂ transport and storage (“T&S”) versus the carbon capture element. If implemented, this would isolate some of the cross-chain risks present in CCUS project chains. Nevertheless, long-term CO₂ storage and leakage risks would still need to be addressed to avoid cross-chain risk issues arising in the T&S part of a project. Arguably the cross-chain risks that steered the policy direction towards splitting T&S from the carbon capture part of the CCUS project chain apply equally to the separate transportation and storage stages of T&S. If extraction and transportation in the oil and gas industry is used as a precedent, the transportation and storage operations are unlikely to be performed by the same entity, and therefore a support model that bundles these operations together seemingly ignores the risk asymmetry and corresponding cross-chain risk between transportation and storage.

RAB model for T&S network

The Consultation proposes (among others) a RAB (Regulated Asset Base) model for T&S network assets. The RAB model has historically been used in privatised regulated industries (for example, the utilities networks and the rail sector).

A RAB model in the T&S context would involve a regulator granting operators licences to provide T&S services, allowing them to charge a regulated price (a T&S Fee) to CO₂ capturers for their use of the T&S network. The regulated price would be set by the regulator periodically, and would be based on a function of the approved costs of developing the T&S infrastructure (the RAB), which may increase or decrease against estimates as construction progresses, and a weighted average cost of capital (the WACC, i.e. the investor returns required in order to attract the necessary investment), which may be determined by a competitive process.

The key advantage of a RAB model is that the income risks which would otherwise be priced into the cost of building the T&S assets can be borne by or shared with consumers. Lessons from other RAB projects suggest that this would reduce project costs and enable developers to secure a lower cost of capital, the savings on which would ultimately pass to the consumer.

Re-using existing oil & gas assets for CCUS

A number of government initiatives have been considering the ability to re-use and/or re-purpose existing oil and gas infrastructure. The potential re-use of North and East Irish Sea oil and gas infrastructure for T&S is the subject of a contemporaneous separate consultation by BEIS (the “O&G Consultation”). The O&G Consultation proposes legislative changes to give the Secretary of State the discretionary power to relieve oil and gas owners and operators from decommissioning liabilities in respect of oil and gas assets that are transferred to a CCUS project.

The O&G Consultation expects only a small number of existing assets to be suitable for re-use in CCUS projects, and that most of these will be pipeline assets. However, where this is achieved, the cost-savings could afford such CCUS projects a competitive advantage over purpose-built T&S infrastructure.

New ways for encouraging CCUS in energy intensive industry

In previous competition rounds, CCUS was primarily seen as a way of decarbonising electricity specifically. As such, the potential CCUS has for decarbonising industry has only recently come to the fore. Three support models for CCUS in industry are considered by the Consultation:

1. CfD: as with other CfDs, this model would involve a strike price (based on capital and operational expenditure of carbon capture assets) and an underlying income value, in this case by reference to a CO2-certificate-based market in respect of carbon emissions/avoided carbon emissions. During periods when the strike price exceeded the market value of the relevant CO2 Certificates, the Government would (for each tonne of CO₂ abated) pay the industrial carbon capturer the difference; where the market value of the relevant CO2 Certificates exceeded the strike price, the capturer would pay the Government. Like with CfDs generally, this would be designed to provide the industrial carbon capturer with a guaranteed aggregate income level.

1. CCS certificates + obligation: similarly to other certificate schemes such as Renewables Obligation Certificates, this model would involve the issuance of a freely tradeable certificate for each tonne of CO2 captured, and a corresponding obligation on industrial green-house gas emitters to either capture a certain amount of their emissions themselves, or purchase certificates in lieu.

1. Cost + open book: this model would involve direct compensation by the Government for all capital and operational expenditure properly incurred in capturing emissions, plus an agreed rate of return on capital.

Ultimately the Government seems open to views of the industry on what may be a suitable model for incentivising industry to use CCUS.

CfD for dispatchable power

While the Consultation namechecks a variety of models (including a RAB model) for supporting carbon capture in the power sector, the focus remains on CfDs, which formed the basis of the previous support model for CCUS. The Consultation considers two types of CfD in depth:

1. Standard CfD: this would use a fixed strike price for each MWh of low-carbon (i.e. carbon abated) electricity generated, with some adjustment to protect the generator and consumers (respectively) against upwards and downwards fuel price fluctuation. The static nature of this model lends itself to baseload generation but risks being uncompetitive in its CfD strike price compared to other low-carbon technologies.

1. Dispatchable CfD: this would use a dynamic strike price to incentivise a generator to dispatch low-carbon electricity ahead of comparable (but unabated) generators, but behind renewables. To ensure the plant merit order is maintained as wholesale prices fluctuate, a reference plant (likely a comparable but unabated load-following CCGT plant) would be needed to establish price levels. (Further detail on this proposal can be found at page 61 of the Cornwall Insight and WSP report published alongside the Consultation.) A fixed availability-based payment is mooted as one aspect of the income stream. This CfD may be more attractive to consider in light of increasing amounts of intermittent generation on the electricity system but would be more challenging to implement than a standard CfD, given its departure from existing CfD principles.

What else is needed? What’s left to the future?

T&S fee

The Consultation considers that correctly establishing the fee structure for using T&S networks will be central to their development. The Parliamentary Advisory Group as well as industry groups proposed a fee structure based on £/tCO₂ for use of a regional T&S network. However, BEIS is not settled on how the £/tCO₂ should be set, or indeed whether this basis is the right one. In particular, the Consultation seeks views on whether:

1. All of the costs of the T&S network should initially fall on the first user of a T&S network;

1. T&S fees should accord with a user’s utilisation of the T&S network; or

1. A fee structure that is not based on £/tCO2 is more appropriate.

While the Consultation only provides an outline of each of these fee structures, it seems likely that the impact on CO₂ capturers, especially first users of T&S networks, will vary dramatically between the structures. Without greater clarity on the likely trajectory, it is difficult for industry stakeholders to evaluate the interface between the RAB model and T&S fee while major uncertainties remain in one or both. More detail is therefore urgently needed with regard to T&S fees.

Hydrogen business models

While the potential for a hydrogen economy, driven by CCUS, is significant, the Consultation scope is limited, in its proposals on hydrogen, to the capital and operation costs of hydrogen production facilities. This scope appears to lack the necessary ambition, considering the costs of new hydrogen pipelines and converting or retrofitting end-users’ plant are likely to be substantial. Another gap in this part of the Consultation is the absence of any proposed hydrogen business models. From this, one can but conclude that policy thinking on CCUS for hydrogen is at an earlier stage than other areas of the Consultation.

Who should have policy oversight for CCUS?

A criticism about the CCUS policy has at times been levelled at the lack of a coordinated government body responsible for CCUS. The Consultation considers whether one should be established, partly because a RAB model for T&S requires a regulator responsible for granting licences and overseeing the price control mechanism. While the scope of a regulator’s role would need careful consideration to inspire investor and consumer confidence, having one entity to oversee all CCUS activity in the UK may be the key that unlocks UK CCUS.

Next steps

CCUS is now internationally regarded as being essential to reducing green-house gas emissions in line with international and domestic targets. Removing some of the hurdles that previously proved insurmountable for UK CCUS projects is critical if the UK is to achieve its CCUS aims. The Consultation’s support for breaking the “full-chain” is one part of the potential solution. The RAB model may also interest investors not previously seen in the CCUS sector.

In a wider change to the energy landscape, the proposals around a dispatchable CfD and recognition of the role that CCGT plant with post-combustion carbon capture will likely provide are notable. The dispatchable CfD appears to be capable of responding to the evolving role of CCGT + carbon capture, but careful checks and balances are required with regard to the reference plant to ensure merit order is not distorted. What’s more, further details are needed for how CCUS will work with the hydrogen economy and in decarbonising heavy industry.

Yet, more than anything else, if the UK is serious about achieving net-zero, what’s needed next is the first CCUS cluster to be built.

The Consultation is open until Monday 16 September 2019.