One step closer to piping away the carbon dioxide: UK Government updates the Business Model for CCUS transport and storage

On 23 June 2023, the Department for Energy Security & Net Zero (“DESNZ”) published an update (the “TRI Update”) on the proposals for the CO₂ transport and storage (“T&S”) Regulatory Investment (“TRI”) business model. The TRI model consists of an economic regulatory regime built around a Regulated Asset Base (“RAB”), coupled with a user-pays revenue model and Government Support Package (“GSP”), with the aim of attracting private sector investment in respect of the T&S aspect of the carbon, capture, usage and storage (“CCUS”) ecosystem. In parallel, DESNZ also published an update on its January 2022 response to its August 2021 consultation on the offshore T&S decommissioning regime (the “Decommissioning Update”). In this article, we consider some of the key aspects of these updates.

TRI Update

The TRI Update builds on the previous iteration of the TRI heads of terms published in January 2022, and covers three specific areas within the TRI model:

1. the licence (the “Licence”) to be granted to each T&S network operator (“T&SCo”);
2. the GSP; and
3. the Revenue Support Agreement (“RSA”).

While the Licence will provide for the recovery of regulated “Allowed Revenue” from connecting emitters in the ordinary course, it is envisaged that:

• the RSA will enable T&SCos to recover certain shortfalls in their Allowed Revenue from an industry “RSA Counterparty” (although not yet formally appointed, it is currently envisaged that LCCC will take on this role), funded by either taxpayers or energy consumers; and
• DESNZ will, via the GSP, provide further assurance to T&SCos on certain high impact / low probability T&S risks, including the risk of stranded assets and defined CO₂ leakage from storage facilities.

While the TRI Update represents a step towards the establishment of the TRI model, DESNZ notes that there is still some way to go in developing the TRI regime.

TRI Update – the T&SCo Licence

How the Licence will be granted

Energy legislation that is (at the time of writing) at the Report Stage in the House of Commons (the “Energy Bill”) seeks to govern the basis on which Licences will be granted. The Energy Bill (in clauses 7-12 and 16 and Schedule 1) proposes to give powers to DESNZ to grant Licences to T&SCos during an initial interim period, the duration of which will be determined by DESNZ. Responsibility for granting Licences will thereafter be taken over by the economic regulator for T&S (although not yet formally appointed, this is expected to be Ofgem), which will also have general responsibility for administering Licences.

It is envisaged that, upon T&SCo’s Final Investment Decision (“FID”), T&SCo will be granted the Licence and will also enter into:

1. the GSP, including the Supplementary Compensation Agreement (“SCA”) and Discontinuation Agreement (“Discontinuation Agreement”), with DESNZ;
2. the RSA with the RSA Counterparty; and
3. any funding arrangements agreed under the CCS Infrastructure Fund.

Early Works Support will be available from DESNZ for critical path activities should a T&SCo be FID-ready before its Licence can be granted.

Structure of the Licence

The Licence will be granted to T&SCos to design, build, own and operate the T&S Network. It will be made up of three sections in line with the structure for other regulated networks: the Standard Conditions, Special Conditions and Schedules of the Licence. While some aspects have been borrowed from licences for other regulated utilities, the context of the T&SCo Licence is quite different from precedent in some respects, notably in that the period of the Licence is intended to cover the initial construction of T&S networks as well as their operation.

Working with each T&SCo, DESNZ will determine an “initial settlement” on which the T&SCo’s licence conditions will be based for the “First Regulatory Period”, defined as the period from the Licence being awarded until three years after the Commercial Operations Date.

Standard Conditions

In the Licence heads of terms included in the TRI Update, the Standard Conditions are further subdivided into “General”, “Onshore” and “Offshore” subsections.

With respect to the “General” subsection, it is envisaged that some of the ringfencing and other standard provisions typically found in gas and electricity network licences will be adapted for inclusion, governing matters such as how T&SCo should conduct its business, regulatory accounts and reporting and provision of information to the regulator. The TRI Update envisages that the Standard Conditions will also provide for matters including the provision of access to the T&S Networks and the administration of the CCS Network Code (the industry code to be administered by T&SCos providing for commercial and technical rules and arrangements between T&SCos and Users) The detail of these provisions remains to be developed.

The Onshore and Offshore Standard Conditions have (building on the previous iteration of the Licence heads of terms published in January 2022) been developed to provide for further details on matters including:

• Compliance with the UK Emissions Trading Scheme (“ETS”) – DESNZ has confirmed that T&SCos will be required to comply with all obligations under the UK ETS relating to all carbon dioxide that is delivered by Users into the Onshore Transportation System;
• Metering – T&SCos will be responsible for ensuring that appropriate metering equipment is installed, operated and maintained to accurately measure the rate of flow and composition of carbon dioxide being delivered by Users into the T&S Network.; and
• Decommissioning – The heads of terms in the Update now make clear that the Licence will contain substantive provisions on decommissioning, including an obligation to comply with all legal requirements applying to the decommissioning of onshore facilities. For further details on DESNZ’s proposals on decommissioning, see the “Decommissioning Update” section below.

Special Conditions

The Special Conditions of the Licence, relating to T&SCos’ network development and operation responsibilities and the determination of T&SCos’ Allowed Revenue, continue to develop. In the Licence heads of terms included in the TRI Update, the Special Conditions have been separated into three distinct stages: Construction Phase, Commissioning Phase and Operational Phase.

Schedules

DESNZ have also added three schedules to the Licence heads of terms: Schedule 2 Revocation, which sets out the general licence revocation events; Schedule 3 Financial Settlement Schedule, which sets out the framework for incorporation of details of the financial settlement reached with T&SCo in respect of the First Regulatory Period; and Schedule 4 Technical Details Schedule, which sets out the framework for incorporation of project specific technical and programming details for each T&SCo, such as the project details, key dates and other variables relevant to the construction, commissioning, operation and decommissioning of the Approved T&S Network.

TRI Update – Government Support Package

DESNZ had indicated from the start that there would be limited risks which it has agreed to shoulder. The details of how this will be set up are contained in the documents making up the GSP.

SCA

The SCA is a contract under which DESNZ will make payments to T&SCo with respect to certain losses arising in particular CO₂ leakage scenarios in circumstances where commercial insurance is unavailable or insufficient. The objective of the SCA is to ensure T&SCos are able to return their assets to a reasonable and sustainable level of operational readiness. While the SCA will be available to manage the risk of leakage of CO₂, it is not designed to assist with stranded asset risk.

DESNZ proposes to insert an insurance schedule with a specification for insured risks and insured losses within the SCA heads of terms. DESNZ has also clarified T&SCo’s obligation to procure the insurances set out in the insurance schedule prior to being awarded the Licence; T&SCo's obligation to undertake regular market testing of the commercial insurance market in respect of the insured risks, insured losses and any unavailability of commercial insurances; the process T&SCo should follow around renewals of the commercial insurance; and a right for DESNZ to vary or amend the insurance schedule.

Discontinuation Agreement

The Discontinuation Agreement allows for DESNZ to discontinue the GSP, and entitles T&SCo to be compensated for its equity and debt investments where:

1. the T&S Network becomes a stranded asset; or
2. the level of calls under the SCA have reached a specified threshold (which will continue to increase in stages where DESNZ elects not to Discontinue) and DESNZ takes the view that ongoing SCA support is not sustainable.

The Discontinuation Agreement heads of terms have been updated to clarify how these triggers for Discontinuation will operate.

Liaison Agreement

The Liaison Agreement sets out the relationship between DESNZ and T&SCo, including in relation to proposed changes to the project documents or variations to the T&S Network, the TRI Update clarifies that the Liaison Agreement will form part of the GSP.

TRI Update – RSA

There have been key updates to the difference payment mechanics within the RSA heads of terms. For example, it has been made clear that interim difference payments will be based on the shortfall in any forecast market revenue as against Allowed Revenue in each April-March year during the Licence term (“Charging Year”). This will be calculated 2 months prior to the commencement of the relevant Charging Year and settled within a specified period following the end of the relevant month. Further detail has also been provided on reconciliation of difference payments on both a quarterly and an annual basis. 

Decommissioning Update

T&SCos will have various obligations with respect to the decommissioning of their assets, including under their consenting arrangements with respect to onshore assets and under carbon storage legislation and the Petroleum Act 1998 with respect to offshore assets. The Energy Bill (in clause 88) provides a power for DESNZ to enact secondary legislation to require T&SCos (and others who may have liability with respect to the decommissioning of carbon storage installations under the Petroleum Act 1998) to provide security for their decommissioning obligations, and now expressly envisages that this security may take the form of (a) decommissioning fund(s).

The Decommissioning Update provides further details on DESNZ’s proposed approach to the development of T&SCo decommissioning obligations, focussing on areas including estimation of decommissioning liability, investment and holding arrangements for decommissioning funds, the allocation of the shortfall and windfall risks and the application of the decommissioning regime to repurposed assets.

Holding arrangements for decommissioning funds

Given that the extent to which any particular fund holding arrangement may be effective in safeguarding any decommissioning fund will vary between different T&SCos, DESNZ has decided not to dictate one mechanism that should be used for the decommissioning funds. Instead, DESNZ proposes enabling T&SCos to choose for themselves which mechanism they would prefer to utilise for their networks, so long as they can demonstrate to the regulator that a set list of criteria have been met, and the regulator approves the holding arrangements. Further detail on potential fund mechanisms and criteria to be met will be set out in regulations or guidance, but are likely to include:

• Appropriate ringfencing and restricted access
• Facilitation of investment of the decommissioning funds
• Sufficient regulatory oversight and withdrawal approval mechanism
• Adequate protection against insolvency
• Cost efficiency

Allocation of risks

The Decommissioning Update develops DESNZ’s thinking on managing shortfall and windfall risks. It remains DESNZ’s position that T&SCos will continue to manage the shortfall risk under the majority of potential scenarios. The scenarios where the risk will sit directly with the T&SCo  include (i) where the change to the decommissioning liability is calculated after the final review period of the network; (ii) where the approved investment strategy has not been undertaken as agreed; (iii) where unexpected volatile market conditions (i.e high inflation) create a negative impact on the value accruing in the fund after the final review period; (iv) inefficient decommissioning activity; and (v) early closure prior to full accrual due to a transportation or storage issue. On the other hand, DESNZ has decided that it is prepared to bear the specific risk of a decommissioning fund shortfall caused by a lack of demand from users of the T&S network. This will be managed via any Discontinuation Agreement arrangements in place to support the deployment of the CCUS T&S infrastructure as part of the proposed GSP. Considering this decision, DESNZ has also decided that it will now retain any amounts remaining in any decommissioning funds once all decommissioning and post-closure obligations have been met, (based on an expectation that any such windfall is likely to be marginal).

Repurposing of assets

The Decommissioning Update sets out DESNZ’s vision for how re-purposed assets will be transferred into the CCUS regulated regime. For all re-purposed assets, DESNZ will expect an upfront top-up into the CCUS decommissioning funds which reflects the full decommissioning liability of that asset. As such, the financial negotiation relating to the transfer of the asset into the CCUS regulated regime would only focus on the asset value of the asset.

Next Steps

In parallel with the progress of the Energy Bill through Parliament, DESNZ continues to develop the TRI regime in consultation with industry stakeholders. The TRI Update and Decommissioning Update represent steps towards establishing the T&S aspects of the CCUS value chain with a view to achieving the Government’s ambition to capture and store 20-30Mt of carbon emissions per year by 2030.

The focus is currently on Track 1 CCUS projects who will be most interested in the development of the Licence terms and GSP and making sure they align with the ongoing development of all other components of the CCUS programme, in particular the CCS Network Code.

What’s more, the terms of the TRI model will be closely watched by the Track 2 CCUS projects seeking to add to the CCUS projects in the UK and build further pipelines and stores in the coming years.