Latest progress towards UK carbon capture and storage and hydrogen industries

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Latest progress towards UK carbon capture and storage and hydrogen industries

Latest progress towards UK carbon capture and storage and hydrogen industries

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September 1, 2020

Introduction

On 17 August 2020, the UK's Department for Business, Energy and Industrial Strategy (BEIS) published five new policy documents on carbon capture, usage and storage (CCUS) and hydrogen. This article discusses how these long-awaited follow-ups to BEIS’s July 2019 consultations on the same subjects signal some progress towards establishing new UK industries.

The key thing implicit in these BEIS publications is that the government’s CCUS and hydrogen policy, and funding ambitions are very much alive and undiminished as a result of the Covid-19 pandemic, albeit that they are perhaps moving more slowly towards fruition than anticipated.

Our team has forensically analysed the current state of CCUS and hydrogen law and policy and previously advised HM government on CCS – please contact the authors for an in-depth discussion.

A government response on potential business models for CCUS

This document sets out new policy, following the July 2019 consultation on this subject.¹ This policy, on which business models the government plans to adopt, was originally scheduled for publication by the end of 2019. Instead of definitive decisions on many of the key questions that must be taken, it seems that most key policy is yet to be developed, much of it in “Expert Working Groups” involving BEIS and its advisers and potential investors. The next key policy announcements are scheduled for Q4 2020 onwards. The document broadly confirms the basic types of preferred business model but does not expand on the detail of them or how initial projects will be taken forward to meet the 2020 Budget deliverables.

We briefly note below, key elements of policy set out in the document.

The policy deliverables set out in the Chancellor's March 2020 Budget remain unchanged: two CCUS clusters in operation by 2030 supported by a new CCS Infrastructure Fund of at least £800 million and a consumer-funded, gas-fired CCS power station (also by 2030).
Some limited (and largely predictable) insight is provided as to how BEIS will make design and funding decisions, i.e. they will be based on timely deployment, delivering value-for-money by maximising CO₂ capture/£ invested by the government, unlocking private sector investment, maximising future learning for clusters and reducing the impact on (i.e. cost to) consumers and taxpayers over time. These seem to inform some parameters (the relationship between them is confusing) which it says it will apply to the policy and funding approach:

decarbonisation – aim to decarbonise, not incentivise CO₂ production;
sustainable financing, giving investors confidence and leading to subsidy-free investment;
economy – value to the UK economy and high-value jobs;
cost reductions, including by competition, over time;
market and flexibility in policy, to develop and minimise market distortions and respond to market development;
value for money – for those providing public support and “risk-adjusted fair return” for investors; and
cost-reflective but not undermining UK industrial competitiveness.

These items are likely to form the basis of selection for the first clusters to be supported and the individual elements within each. While the emphasis throughout the document is on discussion with industry – at least for the rest of 2020 – in reality, there will be at least an element of competition between clusters and, potentially, between emissions sources within clusters, if there are more candidate projects for support than can meet the more detailed version of these criteria that BEIS will develop.
The disaggregation of physical CCUS chain links (CO₂ capture from power, CO₂ capture from industrial processes, CO₂ capture from hydrogen production and CO₂ transport and storage) envisaged in the 2019 consultation is maintained; there will be separate business and funding models – described below – for each, though with a willingness to support exceptions for a “whole chain” approach.
Recognition that allocation of and support for cross-chain risks – described as integration – will be critical.
A nod to CO₂ usage, which is to be “further explored”.
There is greater prominence given to CO₂ storage as an export opportunity.
A “detailed delivery plan” envisages design work towards enduring legal/commercial regimes, continued engagement with projects, finalised business models and project/funding deployment selection processes and criteria taking place to support final investment decisions “within the next two years”, with the next major policy milestone being a series of updates at the end of 2020. In this, hydrogen policy development seems to be running slower than CCUS, as it is hinted that the CCUS business models may have been determined, whereas hydrogen ones will only be “potential” by the time of the next policy update.²

Also, although the focus remains on developing business models for each chain link, there are hints at some deeper thinking going on about cluster and project coordination issues. The paper recognises the need for cooperation and coordination with local and regional authorities, and for coordination and transparency about how emitters will interface with the CO₂ network. It also speaks of the need to engender confidence for investors, at the point of first FIDs, about the future pipeline of projects.

Transport & Storage (T&S) business model

Policy will be based on an assumption that there will be regional T&S systems operating as local monopolies, so that there is apparently no intention, at least at the outset, to:

establish an integrated offshore network; or
separate transport from storage.

Government ownership and development of T&S systems is not ruled out, but does not appear to be the favoured approach.
Each network will be regulated by an independent regulator, based on a Regulated Asset Base model. The discussion of risk allocation makes it clear that there is likely to be a blend of “fixed price” risk allocation – where the regulated network operator takes specified development and operation cost risks – and “pass-through” risk allocation – where the operator and its customers share the risk that certain defined risks/costs fluctuate, with the regulator determining the extent of costs/risk pass-through.
Precedent funding models suggest this will be a complex and potentially contentious area. It should not be assumed that a RAB model allows pass-through of all categories of cost increases. What seems clear is that the existing, light touch offshore regime will not be the model.
The policy note makes a very odd distinction between an economic regulator (regulating system costs) and a market regulator (regulating capture plant system connections). It is suggested that there could be separate regulators for each of these functions or a single one discharging both functions. Given the exceptional complexity implied by the disintegrated business model approach, this would seem a confusing and unnecessary separation which seems unlikely to endure; Ofgem, ORR and Ofwat all perform both functions in the electricity, onshore gas transportation, rail and water network industries, respectively.
There is discussion of the work to be done over the next period but no other detail of policy or the anticipated business model.
The emphasis on T&S as an export opportunity (a.k.a. keeping up with the Norwegians³) results in:

the need to develop approaches to cross-border CO₂ shipping in parallel to domestic pipelines; and
a need to deal with remaining London Protocol issues.

HMG is conscious of the need:

for models to accommodate emitters from different industries operating under different models;
to address demand risk for investors;
to deal with possible needs for early emitters to be loaded with initial costs;
for proper risk sharing between industry and the public sector.

BEIS plans to continue a detailed cost discovery and risk allocation exercise over the remainder of 2020.
Going beyond current core T&S policy, it is interesting to see that alongside the consultation response, BEIS has published a report looking at some of the practical questions facing the deployment of CCUS at industrial sites that are not located in one of what are perceived as being the main "clusters" of emitters.⁴ This emphasises that the policy is to facilitate decarbonisation of all British industry.

Power CCUS business model

The model preferred in the previous consultation was the so-called “dispatchable CfD”, i.e. one that would allow CCS power plants to be dispatched ahead of unabated plant but behind cleaner, renewable technologies. Although the policy does not explicitly say as much, this seems to be the approach to be adopted – the policy document proposes a classic split model with fixed CfD payments for available capacity and variable payments when the plant is dispatched.
There is some development of the principles of the "dispatchable CfD" model:

reference is made to the potential for reductions in availability payments for underperformance against an expected capture rate and unscheduled outages; and
the paper refers to the variable payments to the generator being capped to ensure a fair return to investors based on the risk allocation. The cap and the generator's variable payments would need to be regularly reviewed using benchmarking against a reference plant.⁵

Further work is to be done to develop the model, with particular focus on:

defining the requirements for each type of payment, what the reference plant mechanism should be, how T&S fees should be defined and how outages should be dealt with; and
a call for evidence later in 2020 on negative emissions technologies and carbon pricing, to build on the evidence supplied in response to the HM Treasury consultation on a carbon emissions tax.⁶

BEIS states the power business model will be applicable to all forms of power CCUS (pre and post combustion, and oxy-fuelled). It also states that hydrogen fired power, where hydrogen production is standalone, could be considered under the model, but also says this will depend on development of a hydrogen business model.
The paper is less certain than last year's consultation⁷ that the transport and storage fee should be incorporated into the generator's cost base. BEIS now says it is considering options for this, including the potential for it to be administered separately.
Interestingly, the document states the aim that the model should have “the capacity to be competitively allocated”. Presumably, the implication is that the first CCS power plant CfD may not be awarded by competition.

Industrial CO₂ capture business model

Here, BEIS now favours an industrial contract for difference (by reference to a carbon price) coupled with government co-funding of capital costs.
Again, there is the suggestion that, while industrial CfDs are likely to be competitively awarded, this may not be the case for initial projects. BEIS envisages a phased approach:

Phase 1: emitters would be a awarded a negotiated industrial CfD with upfront payment of capital costs (albeit that BEIS is considering the balance between HMG support and private finance);
Phase 2: emitters would be allocated an industrial CfD competitively; and
Phase 3: market based approach would apply relying on cost of carbon to incentivise emitters.

BEIS is considering the appropriate counterparty for the industrial CfD, and no mention is made of whether it would be an existing body (for example LCCC) or a newly created body.

Hydrogen production business model

It is clear that thinking about a hydrogen business model remains behind the stage reached for other models. For the time being, the paper speaks of focusing on support of hydrogen production costs rather than consumption costs. Having said that, it also says that BEIS recognises the need to encourage demand for hydrogen, and that it will explore policies and instruments to incentivise this.
BEIS is now giving equal prominence to "green" (electrolytic) as well as "blue" (CCUS enabled) production of low carbon hydrogen.
Attention is being paid to the work being done in Netherlands and Germany,⁸ although no mention is made of policy developments elsewhere, such as in Portugal.
BEIS speaks about focusing on key markets – industry and heavy transport. There is no mention of continuing work on blending hydrogen into heat networks, but that is perhaps consistent with the supply rather than demand-side focus.⁹

A government response on re-use of oil and gas assets for CCUS

This document¹⁰ needs to be read in conjunction with the Oil and Gas Authority’s (OGA) recent consultation on its strategy and final report on "energy integration" in the UKCS, in which CCUS features prominently.¹¹

Some reservations were expressed about the two types of oil and gas infrastructure identified in the consultation paper as most likely to be appropriate for reuse. Respondents emphasised the importance of considering the number and condition of existing wells when assessing the use of a depleted reservoir and of the expected cessation-of-operations date when assessing the use of a trunk pipeline. Although not a focus of the consultation paper, a large enough number of responses referred to the potential of reusing onshore infrastructure for the government's response to include a section noting this, along with the value of data and technical records as an asset class not previously identified. BEIS has committed to a number of actions to further study these issues with both the British Geological Survey and the OGA.
The major policy change proposed by the consultation paper was to make Change of Use Relief available to remove the liability on previous owners to decommission oil and gas assets that are reused as part of a CCUS project. The responses appear to have been broadly supportive of this proposal, while highlighting the need for further clarity around eligibility, timing, tax and administration. Interestingly, the government's response refers to market developments since the consultation paper that have prompted it to review its original policy proposal. Although Change of Use Relief may still be available in some cases, the government appears to contemplate a greater role for commercial agreements between asset owners (past and present) to manage the risks associated with decommissioning costs and points to a further policy statement in this key area later in the year.