The challenging costs of CCS

Most climate models acknowledge the need for the permanent removal and storage of atmospheric carbon dioxide. But it’s difficult to find organisations willing to fund the development of such technologies. Jennifer Johnson looks at how a combination of innovative finance and policy backing could turn the tide for CCS.

Cost has long been a barrier to the successful deployment of carbon capture and storage (CCS) technologies. There’s no hiding the fact that it’s expensive to develop any new industrial process, but low carbon prices mean there’s presently little incentive for private companies to lead the way with CCS. From a financial perspective, retrofitting a gas-fired power station or a steel plant with carbon trapping equipment is nothing more than a capital outlay. This is why the fledgling CCS sector is searching for viable business and investment models to help get its technologies off the ground.

The International Energy Agency (IEA)’s Sustainable Development Scenario stipulates that almost 15% of all emissions abatements needed to keep global temperature rise below 2°C must come from CCS. The Global CCS Institute (GCCSI), a think tank that aims to accelerate the deployment of carbon capture technologies, has calculated that this will require a nearly 100-fold increase in CCS capacity by 2050.

‘Most existing CCS facilities have been funded primarily on the books of large corporations or state-owned enterprises,’ says Dominic Rassool, Senior Consultant – Policy and Finance at the Global CCS Institute. ‘The magnitude of investment required, and the fact that many companies are constrained by their balance sheets means this model will not support rapid growth in CCS capacity. There are trillions of dollars available in the private sector for investing in CCS but allocating it requires policy incentives which facilitate viable business models for CCS.’

Project finance

It’s incumbent on the private sector – rather than governments – to provide this capital because the requisite amount ‘far outstrips what governments are willing to pay in the timeframe required’, the report reads. This means CCS must be funded by capital markets, debt and additional sources, such as sovereign wealth funds, none of which currently support carbon capture at any significant scale. The GCCSI believes that a model known as project finance could encourage potential investors to come forward, as could the use of green bonds applied to CCS projects.

Many of the CCS projects that have been funded to date have utilised a traditional corporate financing structure, in which a single entity foots the bill for the full development of a scheme. If the project exceeds (or merely meets) financial expectations, there will be no trouble. But if the project fails to generate the expected returns, lenders could have recourse to seizing assets from the developer firm. Many corporations, especially smaller ones, understandably consider this too big a risk to bear, meaning some may steer clear of CCS altogether.

However, under a project financing structure, a company’s existing assets are protected, as any debt is typically provided on a ‘non-recourse’ basis. This also means that interest is charged at a higher rate than corporate debt. Multiple equity investors tend to participate in a single project, with each of them having an equity stake through what’s known as a special purpose vehicle (SPV) – see Figure 1.

Figure 1: Example of a project finance structure used to enable a CCS investment

Source: Global CCS Institute

This arrangement is increasingly common for large renewable projects, especially those in developing or emerging markets. For instance, the first utility-scale offshore wind project in the US, Vineyard Wind, recently lined up $2.3bn in project financing courtesy of nine major banks, including JPMorgan Chase and Bank of America.

In the case of CCS, commercial lenders will not initially be the sole providers of finance, as they tend to be more risk averse than entities with government ties – and demand higher returns. If banks believe project risks are inadequately managed, lending rates will go up and a project will not be able to take on the amount of debt that it requires. This inevitably creates what the GCCSI calls a ‘funding gap’, which it believes can be filled by a trio of specialist financiers: national export credit agencies (ECAs), multilateral agencies (MLAs) and development financial institutions (DFIs).

ECAs, such as UK Export Finance (UKEF), provide loans, guarantees and insurance to domestic corporations looking to do business overseas, often in emerging markets. In 2019/2020, for instance, UKEF handed out £4.4bn in support for UK exports, including more than £300mn for wind farm projects in Taiwan. German and Italian ECAs also came together last year to offer a total of $743mn in loan financing to National Grid for its €2bn subsea interconnector between the UK and Denmark. The 1,400 Viking Link cable will supply renewable energy to some 1.4mn households. Meanwhile, MLAs (including the World Bank and the European Investment Bank) and DFIs (such as the UK Infrastructure Bank and the USA’s OPIC) fund projects solely in emerging markets or industries in line with economic development goals. The European Investment Bank (EIB) is renowned for playing an important role in kickstarting the region’s offshore wind industry. Since 2003, the EIB has provided about €10bn to support the construction of 9 GW of offshore capacity – or about one third of existing capacity.

In shouldering risks that commercial lenders were unwilling to bear, the EIB helped to shore up the sector until other lenders felt it could offer them comfortable returns. Today, the bank seldom gets involved with wind power at all, except in Europe’s less developed economies. However, it contributed to the funding of a new floating wind park in Belgium this summer, indicating that it also intends to support the development of this promising renewable technology.

Green bonds

To develop and commercialise carbon capture, the Global CCS Institute believes in using many of the same financial instruments that helped renewables rise to prominence – green bonds among them. These fixed-income instruments are a kind of loan made by an investor to a borrower to finance the operation and development of a green asset or project. Climate change mitigation technologies usually fall under this purview, though there are exceptions for CCS facilities at coal power stations, for example.

Investor interest in green bonds has skyrocketed in recent years as fund managers face scrutiny over the environmental impact of their practices. At the same time, many of these investors have also found that green assets deliver comfortable returns.

Assuming that successful CCS deployments – backed by specialist financiers – begin to grow in the coming years, the GCCSI predicts that private sector funding will increase. Green bonds, which can be issued by banks, governments or corporations, are likely to be part of this picture, even if some evidence points to their negligible impact on the emissions intensity of their issuers. For green bonds to make a difference, the GCCSI recommends that they are applied to ‘hard to abate’ sectors.

Under the EU’s new sustainable finance taxonomy, CCS is considered a ‘green’ investment – opening the door to increasing bond issuances from the industry. This year, the UK government is planning to issue £15bn in green savings bonds of its own, which will allow investors to fund renewable energy projects, as well as CCS and ‘blue’ hydrogen ventures. However, some ethical investors have indicated they will forego the sale because of the limited existing evidence of carbon capture’s efficacy.

William de Vries, Director of Impact Equities and Bonds at Netherlands-based Triodos Investment Management, recently told Bloomberg that his firm would not purchase any of the UK’s green bonds. ‘We have a serious problem with these types of projects because we don’t think carbon capture projects will add to carbon reduction in the end,’ he told the news outlet.

Future trajectory

Ultimately, the policy actions of governments will determine the future trajectory of CCS – and the energy transition more broadly. If policymakers and government-linked financiers throw their weight decisively behind CCS, it’s likely that private capital will follow. Naturally, advocates of carbon capture say that now is the time for key decisions to be made and policies to be announced.

‘What happens in the next decade will be crucial in enabling CCS to reach necessary scale in time to limit the impacts of global warming,’ says a statement by Brad Page, CEO of the GCCSI. ‘The necessary investment far exceeds what governments are willing to provide, particularly within a short timeframe. Governments have a key role to play in creating an enabling environment for very large-scale private sector capital allocation through climate policies which place a value on CO2 emissions reductions.’

There’s no way of knowing whether CCS – which still raises eyebrows in some environmental circles – will go the way of offshore wind and become a global industrial superpower. But one thing is certain: it took a patchwork of funding methods and a wide variety of investors to scale the sector to its present size. Carbon capture will be no different in theory or in practice.