AEGIS Hedging
Carbon Capture and Inflation Reduction Act Primer
Carbon capture and storage (CCS) is a range of emissions reduction technologies that captures carbon dioxide (CO2) from large emitters, such as power plants or industrial facilities, and stores it underground so that it is not released into the atmosphere.
CCS can be Broken Down into Three Main Components:
- Capture: Technologies such as absorption, adsorption and membrane separation are used to capture CO2 from flue gas, or the exhaust gas emitted from power plants and large industrial facilities. Flue gas may contain more than just CO2, including sulfur oxide, mercury dioxide and nitrogen oxides.
- Transport: The captured CO2 is transported via pipeline, ship or truck to a storage site.
- Storage: The CO2 is injected underground into geological formations, depleted oil reservoirs or aquifers.
The Capture Technologies can be Expounded on Further:
- Pre-combustion: fossil fuels are converted into a mixture of hydrogen and carbon monoxide, known as synthesis gas or syngas. The carbon monoxide is then reacted with steam to produce CO2 and hydrogen. The CO2 is captured and separated from the hydrogen, which can be used as a clean fuel.
Post-Combustion Methods:
- Absorption: Uses a liquid solvent to absorb CO2 from the flue gas. The CO2-rich solvent is then heated to release the CO2, which is then compressed and stored.
- Adsorption: Uses activated carbon to adsorb CO2 from the flue gas. The CO2-adsorbed material is then heated to release the CO2.
- Membrane separation: Uses a membrane to separate CO2 from the flue gas. The CO2-rich stream is then compressed and stored.
Common Storage Methods:
- Geological storage: Injects CO2 deep underground into rock formations such as depleted oil and gas reservoirs, saline aquifers, or abandoned coal seams. The CO2 is stored in the porous spaces of the rock and is trapped by various physical and chemical mechanisms.
- Ocean storage: Injects CO2 directly into the deep ocean, where it dissolves in the water and forms stable compounds. This approach is environmentally contentious.
- Mineral carbonation: CO2 reacts with minerals, such as olivine and serpentine, to form stable carbonate minerals. This method can provide long-term, stable storage but is currently less developed than geological storage.
Carbon Sequestration in Natural Landscapes
Natural carbon sequestration involves removing CO2 from the atmosphere for storage in terrestrial ecosystems, such as forests, wetlands, grasslands, and soils. This process relies on the ability of plants to photosynthesize and convert atmospheric CO2 into organic matter, which can then be stored as biomass or in the soil.
Forests: Forests are among the most effective natural carbon sinks, as they can store large amounts of carbon in both their aboveground biomass (e.g., trees, branches, and leaves) and belowground biomass (e.g., roots and soil organic matter).
Forests can store up to 200 tons of carbon per hectare, making forests the top natural carbon repository available to emitters.
Reforestation, afforestation, and sustainable forest management practices increase the carbon sequestration potential of forests and reduce CO2 emissions from deforestation and forest degradation.
Wetlands: Wetlands, such as marshes, swamps, and peatlands, are highly effective at sequestering carbon due to their unique hydrological conditions and high productivity. The waterlogged soils of wetlands slow down the decomposition process, allowing for the accumulation of organic matter and the storage of significant amounts of carbon over time.
Wetlands can store up to 100 tons of carbon per hectare.
The restoration and conservation of wetlands can help enhance their carbon sequestration potential and provide additional benefits, such as improved water quality and enhanced biodiversity.
Grasslands: Grasslands sequester carbon in their extensive root systems and soil organic matter.
Grasslands—like wetlands—can store up to 100 tons of carbon per hectare.
Proper management practices, such as rotational grazing, reduced tillage, and the use of cover crops, can help maintain or increase the carbon sequestration potential of grasslands.
Soils: Storing carbon in soil organic matter is a fourth component of terrestrial carbon sinks. Agricultural practices, such as no-till or conservation tillage, cover cropping, and organic amendments (e.g., compost, biochar), can help increase the carbon content of soils and contribute to climate change mitigation.
The Federal and State Credit Landscape
There are several federal and state incentives available for CCS projects ranging from Department of Energy (DOE) funding and the 45Q Tax Credit carved out in the Inflation Reduction Act to a patchwork of state incentive programs.
- 45Q Tax Credit: This federal tax credit was established under the Bipartisan Budget Act of 2018 to incentivize CCS projects. It provides a credit of $50 per metric ton of CO2 stored geologically and $35 per metric ton of CO2 used for enhanced oil recovery or other approved purposes.
- DOE Grants: The DOE provides funding for research, development, and deployment of CCS technologies through various programs, including the Carbon Storage Program and the Carbon Capture Program.
- State Incentives: Various states offer incentives for CCS projects, such as tax credits, grants, and low-interest loans. California’s Low Carbon Fuel Standard (LCFS) provides credits for projects that reduce the carbon intensity of transportation fuels.
Methodology for Calculating 45Q Credits
Most methodologies involve quantifying the amount of CO2 captured, stored, or utilized, and determining the corresponding reduction in emissions. Here, we will discuss the general steps for calculating credits under the 45Q Tax Credit, as it is the prominent federal incentive program.
- Establish a baseline: Before a project can earn credits, it is essential to establish a baseline for CO2 emissions, representing the emissions level without the CCS project in place. It is determined by measuring the emissions from the source (e.g., a power plant or industrial facility) over a specified period, and then calculating the average emission rate.
- Measure and monitor CO2 capture: The project must continuously measure and monitor the amount of CO2 captured, stored, or utilized throughout its operational life. This involves installing and maintaining accurate monitoring equipment, such as flow meters and gas analyzers, to track CO2 flows from the capture process to storage or utilization.
- Quantify CO2 storage or utilization: For geological storage, the project must demonstrate that the CO2 is securely stored and does not leak back into the atmosphere. This requires monitoring and verifying the injected CO2 through techniques like pressure monitoring, tracer tests, and seismic surveys. For enhanced oil recovery (EOR) or other approved uses, the project must demonstrate that the CO2 is utilized and results in a net reduction of emissions.
- Calculate emission reductions: The project calculates its emission reductions by comparing the captured, stored, or utilized CO2 to the baseline emissions. The reduction is expressed in metric tons of CO2 equivalent (MtCO2e). For example, if a project captures and stores 100,000 metric tons of CO2 annually and the baseline emissions are 500,000 metric tons per year, the project has reduced emissions by 20% (100,000 / 500,000).
- Apply the credit rate: The calculated emission reductions are then multiplied by the applicable credit rate to determine the total credits earned. Under the 45Q Tax Credit, the credit rate is $50 per metric ton for geological storage and $35 per metric ton for EOR or other approved uses. In the above example, if the project stores the CO2 geologically, it would earn $5 million in tax credits annually (100,000 metric tons * $50 per metric ton).
- Verification and reporting: To claim the credits, the project must undergo independent third-party verification to ensure that the CO2 capture, storage, or utilization, and the resulting emission reductions are accurately quantified and comply with the program's requirements. Additionally, the project must report its performance to the relevant regulatory authorities on a regular basis.
IRC Section 45Q Carbon Oxide Sequestration Credits (Bill Section 13104)
Eligible carbon oxide sequestration credit projects must begin construction prior to January 1, 2026. The bill would extend that beginning-of-construction-deadline to January 1, 2033. Further, the bill would require the following for qualified facilities:
- For direct air capture (DAC) facilities, annual capture requirements would be lowered to at least 1,000 metric tons of qualified carbon oxide
- For an electricity generating facility, (1) annual capture requirements would be lowered to at least 18,750 metric tons of qualified carbon oxide, and (2) with respect to any carbon capture equipment for the applicable electric generating unit at such facility, has a capture design capacity of at least 75% of the baseline carbon oxide production of such unit (the bill contains detailed definitions of the applicable electric generating unit, the baseline carbon oxide production, the capacity factor and others); or
- For all other facilities, annual capture requirement would be lowered to at least 12,500 metric tons of qualified carbon oxide
The IRC Section 45Q carbon oxide sequestration tax credit would be subject to the two-tiered credit regime, with a lower base rate and a higher bonus rate (if the prevailing wage and apprenticeship requirements are met Under the bill, the applicable credit rates would be as follows:
- Permanent sequestration ($17/metric ton base rate / $85/metric ton top, bonus rate): For qualified carbon oxide that is captured and disposed of by the taxpayer in secure geological storage and not used, the base credit amount would be $17 per metric ton of qualified carbon oxide, and the top, bonus rate would be $85 per metric ton of qualified carbon oxide.
- Utilization or enhanced oil or natural gas recovery (EOR) ($12/metric ton base rate / $60/metric ton top, bonus rate): For qualified carbon oxides that are captured and either (1) utilized in an approved manner, or (2) used as a tertiary injectant in a qualified EOR project and disposed of by the taxpayer, the base rate would be $12 per metric ton of qualified carbon oxide, and the top, bonus rate would be $60 per metric ton of qualified carbon oxide.
- DAC: With respect to DAC facilities, for taxpayers that dispose of the qualified carbon oxides in secure geological storage and do not use them, the base rate would be $36 per metric ton of qualified carbon oxide, and the top, bonus rate would be $180 per metric ton. For taxpayers that either "utilize" the carbon oxides in an approved manner or use the carbon oxides in an approved EOR project and dispose of them properly, the base rate is $26 per metric ton of qualified carbon oxides, and the top, bonus rate would be $130 per metric ton of qualified carbon oxides.
The bill includes a provision that would allow certain taxpayers to elect to have the 12-year credit term period begin on the first day of the first tax year in which an IRC Section 45Q tax credit is claimed if certain conditions are met. This would apply with respect to carbon capture equipment that is originally placed in service at a qualified facility on or after the date the Bipartisan Budget Act of 2018 was enacted if (1) no taxpayer has claimed a credit under IRC Section 45Q for the equipment for any prior year, (2) the facility where the equipment is placed in service is located in an area affected by a federally-declared disaster after the capture equipment was originally placed in service and (3) the disaster resulted in the facility or equipment ceasing to operate after it was originally placed in service.
The revised IRC Section 45Q would have similar rules on reducing the credit when tax-exempt bonds are used in financing the facility. The amendments would generally apply to facilities or equipment placed in service after December 31, 2022.
The bill does not allow a double benefit by noting that the term "qualified facility" does not include any facility for which a credit under IRC Sections 45, 45J, 45Q, 45U, 48, 48A, or 48D is allowed for the tax year or any prior tax year.
Latest developments: Debt ceiling negotiations have seen a hefty portion of the emissions reduction component of the IRA within the Republican’s sights for spending cuts. The current bill put forth would drastically limit the clean fuel tax credits available for renewable fuels yet left the CCUS component untouched. The bill it no expected to be taken up by the senate as President Joe Biden has signaled he would veto the Save and Grow Act.
State CCS Incentives
A number of states also offer incentives for CCS projects including:
- California
- Illinois
- Iowa
- Kansas
- Louisiana
- Michigan
- New Mexico
- North Dakota
- Ohio
- Oklahoma
- Texas
Emissions obligations are notoriously complex and quick to change. This requires constant monitoring of pending updates or future regulations.
AEGIS has a dedicated emissions team that can help
