A critical aspect of President Biden’s $2 trillion American Job Plan focuses on mobilizing private capital to invest in clean energy production and deployment in order to achieve 100 percent carbon-free electricity production by 2035. These investments are crucial to his strategy to meet the ambitious new national commitments to the Paris agreement and keep global average temperature to a 1.5 degree C limit. The plan earmarks $15 billion to fund clean energy demonstration projects, including carbon capture and storage, and $46 billion in federal buying power, including of recycled CO2. To spur the expansive deployment of carbon capture, utilization, and storage (CCUS), the plan aims to reform and expand the bipartisan Section 45Q tax credit.
One important provision being considered by lawmakers and the administration is direct pay. On March 25, a group of senators led by Tina Smith (D-MN) and Shelley Moore Capito (R-WV) introduced the 45Q Carbon Capture, Utilization, and Storage Tax Credit Amendments Act of 2021, a crucial bipartisan piece of legislation that provides amendments to the 45Q tax credit. This amendment seeks to boost project financing and scaling of CCUS projects in the United States. This is important considering that growing consensus across governments, researchers and businesses points to CCUS as a critical strategy to achieving deep decarbonization of power and industrial facilities, and moving the world closer to a net-zero emissions scenario.
Crucial components of the legislation include:
- Extending by an additional five years the date for projects to qualify for the 45Q tax credit — projects that begin construction by the end of 2030 would qualify;
- Creating a direct pay option for the 45Q and 48A tax credits; the direct pay option allows developers to treat the credits as an overpayment of taxes, so that the credit is delivered in the company’s tax returns;
- Increasing the value of the 45Q tax credit for direct air capture of CO2 — from $50 to $120 per metric ton for facilities that capture and store captured CO2 in saline formations, and from $35 to $75 per ton for such facilities that store CO2 via enhanced oil recovery; and,
- Allowing existing power and industrial carbon capture facilities to combine 48A investment tax credit with the 45Q tax credit to finance CCUS retrofits.
These provisions may not necessarily achieve the level of support required to finance the volume of CCUS projects needed to contribute to decarbonizing the hard-to-abate sectors (sectors such as heavy industry that are currently carbon-intensive but have limited alternatives), but they will still have a big impact. Broadly, the amendments will improve direct revenues to developers and investors in CCUS projects. They can use this revenue for debt repayments, reducing the risk of project financing, and improving the attractiveness of CCUS projects to debt financing, while reducing the added cost of tax equity transactions.
Without the direct pay capability, the nature of the 45Q tax credit requires that the CO2 injectors or users must have predictably large annual tax payments due in order to make full use of the credits, which adds some complexity to the project financing arrangements and excludes some prospective projects. Direct pay helps eliminate the need to seek tax equity investors, who would usually charge higher rates of return to support projects, increasing the capital cost of CCUS projects. With direct pay, CCUS projects’ capital costs become relatively cheaper, lower-cost debt financing can be more easily accessed, more companies can take part, and the cost of CO2 reduction and removal becomes lower. This is important because a lower capital cost can encourage more investors, and more projects can be financed.
But for U.S. power plants, what is the value of making the 45Q tax credit direct pay? Will direct pay make 45Q adequate to finance substantial deployment of CCUS projects in power plants in the United States?
Columbia University’s Center on Global Energy Policy has published work examining what policy configurations would incentivize the widespread deployment of CCUS in the U.S. power sector. These configurations included designed sets of policy support, in addition to the 45Q tax credit — such as capital incentives (private activity bonds, investment tax credit, etc.) and revenue treatments (production tax credits, contracts for differences, etc.) — needed to finance retrofits in U.S. power plants to capture, utilize and store carbon emissions. Detailed analysis from the report showed that the additional capital cost of retrofitting a typical combined cycle natural gas power plant and a pulverized coal power plant in the United States creates a financing gap, which makes investment in CCUS unattractive without an incentive. The work found that neither a 45Q tax credit of $35 per metric ton of CO2 captured and injected in enhanced oil recovery, nor $50 per metric ton of CO2 captured and stored safely in geological formations, is sufficient to clear this financing gap for all types of power plant ownerships — largely investor-owned utilities and independent power producers. Consequently, to reduce investment risks and attract private capital to finance CCUS projects, the 45Q credit value would need to be further enhanced to between $60 to $110 per metric ton, or combined with revenue treatments such as production tax credits or contracts for differences.
To understand the potential effect of the direct pay options on financing CCUS power projects in the U.S., we modified the existing peer-reviewed model that we used for this report and incorporated the impact of the direct pay option. In addition, we assumed that the rates of return demanded by equity investors would reduce with direct pay, and adjusted the hurdle rate from 10% to 8% for investor-owned utilities and from 15% to 10% for independent power producers. This reduced the capital cost of the CCUS project.
These initial analyses indicate that direct pay matters. The initial observable impact of the reduction in equity rates of return on CCUS project capital cost is significant. Additionally, the extra benefit of including debt financing in the project financing mix further enhances the benefit of direct pay. A summary of the initial findings shows the value of direct pay 45Q in closing the financing gap created by including the capital cost of CCUS equipment on existing or new coal and natural gas power plants. More specifically, we found that:
- For investors for typical U.S. natural gas power plants, a 45Q credit of $50 per metric ton for CO2 capture into saline formations is not quite enough to clear the hurdle rate, but it’s close. The direct pay option, if passed, is expected to improve the viability of combined cycle natural gas CCUS projects by reducing the value of incentive required. This would close the financing gap from $8.41 per megawatt to $2.17 per megawatt. This means that the value of the direct pay in this scenario is about $6.24/MW. And if direct pay is combined with a production tax credit of $24 per megawatt-hour, the value is about $5.6/MW, completely closing the $2.17/MW financing gap.
- In the case of the investor-owned utilities using pulverized coal with CCUS, the direct pay option, worth $2.94/MW, completely clears the hurdle rate and closes the $0.16/MW financing gap. Thus, the direct pay option makes 45Q adequate to incentivize investor-owned utilities coal with CCUS projects in the United States.
We plan to publish a more detailed piece reflecting our findings in the coming weeks.
The other provisions of the 45Q CCUS Tax Credit Amendments Act of 2021 are also important. The five-year extension could provide opportunities to complete ongoing CCUS projects and open up additional opportunities for more developers and investors to make project decisions and start construction to take advantage of the 45Q tax credit. This financial certainty and increased time horizon is expected to help scale CCUS technologies towards meeting mid-century climate goals, which means many more projects could reasonably be expected to achieve lift-off. The direct air capture provisions could provide certainty to help finance the first-of-a-kind large-scale plants—megabucks for megatons of abatement. Together, these provisions and other proposed legislation (like the SCALE Act) will help get more carbon capture and storage projects deployed more quickly, reducing our local and national greenhouse gas emissions and creating new jobs and a new industry through U.S. leadership.