UK CCUS – Ready, Set, Capture?

On the 17th August 2020 the UK government published its long-awaited response (the “Response”) to the consultation “Carbon capture, usage and storage (CCUS): business models”, published on the 22nd July 2019 (the “Consultation”). The Ministerial Forward of the Response calls it a ‘significant milestone’, marking the progress made on developing business models to incentivise CCUS projects in the UK, as well as the new CCS Infrastructure Fund.

The CCS Infrastructure Fund (the “Fund”) of at least £800 million was announced at the Spring Budget 2020 (the “Budget”). The Fund is intended to help facilitate the delivery of CCUS in at least two clusters, one by the mid-2020s and a second by 2030. Alongside the required business models for CCUS, the Fund aims to provide a pathway for the deployment of low carbon technologies which will support the UK reaching net zero emissions by 2050.

As analysed in our August 2019 publication outlining and analysing the details of the Consultation: “UK CCUS policy – is the UK ready to capture the opportunity?”, there are a number of issues that the government needed to work through with industry. We focus here on how the position has been updated in the Response and the implications for investors and financiers involved in the CCUS and ‘blue’ hydrogen sectors.

Summary of key findings

Parameters, Integration and Usage

The government has set out the parameters that will guide its approach to the ongoing development of CCUS and hydrogen business models. In light of consultation responses and further engagement with industry, the government proposes a number of key principles to guide their decision-making in the design of the CCUS business models and the CCS Infrastructure Fund (see diagram below).

Recognising that CCUS is made up of a number of interlinked yet distinct aspects, the Response breaks down the policy approach for the following key elements of a CCUS project:

1. CO₂ Transport and Storage infrastructure for one or more CCUS capture projects
2. Power CCUS – a Contract for Difference (“CfD”) for the thermal power with CO₂ capture facility
3. Industrial CCUS – phased approach to supporting industrial emitters over the next decade supported by the Fund
4. Low Carbon Hydrogen Production – ways to stimulate private sector investment in low carbon hydrogen production, including with support from the Fund.

What’s changed since the Consultation?

Whilst over a year has passed since the publication of the Consultation, the government has been engaging with the CCUS industry through a number of industry expert groups to gather information and test its policy ideas. Much of what has been published in the Response is therefore not surprising to those closely involved in UK CCUS and aligns closely with the government’s position in the Consultation. For example, the Response confirms the government’s intention to have a separate support model for CO₂ transport and storage (“T&S”) versus the CO₂ capture elements of CCUS projects.

Transport and Storage (“T&S”) regulatory model

The Consultation proposed (among others) a Regulated Asset Base (“RAB”) model for T&S network assets. The RAB model has historically been used in privatised regulated industries (for example, the utilities networks and the rail sector). While the option of regulating through a RAB model is confirmed, the ownership structure for the RAB or the level of government support which might be required is still unclear.

The RAB model referred to in the Response is a generic economic regulation model. The model would consist of a regulated revenue stream determined by a building block approach, paid to the T&S company (“T&SCo”) during operation by users of the T&S network, determined by an economic regulator. This is to mimic the incentives that would be faced by the market if it were competitive. Notably, the cost and risks of the T&S infrastructure in construction would be for the T&SCo to bear as T&S fee payments would only start once the infrastructure becomes operational.

The Response is also silent on details such as the frequency of the periodic price control reviews or how the T&S fee would be paid to T&SCo particularly if the T&S infrastructure is built to service a number of emitters.

Re-using existing oil and gas assets for CCUS

This was subject to a separate consultation and the government response was published alongside the Response which we are analysing and will comment on separately.

CfD for dispatchable power

While the Consultation mentioned a variety of potential models (including a RAB model) for supporting carbon capture in the power sector, the focus remains on CfDs, which formed the basis of the previous support model for CCUS. The Consultation considered two types of CfD in depth, the Standard CfD and the Dispatchable CfD.

Subject to further work through the expert groups over the course of this year on the structure of a revenue mechanism for Power CCUS, it is expected that the Dispatchable CfD payment mechanism will comprise a payment for availability of low carbon generation capacity, and a variable payment. A combination of these payments is on the basis of the government seeking to enable a plant to operate flexibly, providing value to a low carbon electricity system with growing renewable capacity, and still provide sufficient certainty to investors.

Hydrogen business models

The Consultation scope was limited in its proposals on hydrogen, particularly with regard to the absence of any proposed hydrogen business models. The Responses acknowledges that the business model should incentivise a range of low carbon production methods.

The Response also identifies the following challenges that still need to be addressed for the purpose of effective hydrogen deployment:

• Need for CO₂ T&S infrastructure to be deployed;
• Technical and safety challenges across the hydrogen value chain, particularly in novel use cases; and
• Regulatory barriers such as current hydrogen limits in the Gas Safety Management Regulations (“GSMR”).

The Response effectively restates the view outlined in the Consultation: further research is needed to create an effective evaluation of potential business models. The model may include principles such as the need to prioritise flexibility in the design of the model in order to adapt to changing costs and technological and future market developments. Some of the potential models the government is still considering include:

• CfD model;
• Hybrid grant-CfD model;
• Obligations based approach;
• Expansion of the Renewable Transport Fuel Obligation (“RFTO”)
• RAB model for hydrogen production; and
• RAB model for specific end uses (such as power and transport).

The Response restates the government’s commitment to progressing the development of a low carbon hydrogen production business model(s) and agrees that focussing on production costs is likely to be the most effective approach to unlocking investment. The Response also notes the need to consider other potential sources of support for end users, such as the RFTO, and the need to evaluate the interactions between a low carbon hydrogen production business models and the wider value chain.

Encouraging CCUS in energy intensive industry

The Consultation had left open the options for supporting energy intensive industry where CCUS can play a key role for decarbonising many of the existing processes. The Response does not provide much more detail but recognises that support for industry may need to be phased and that any model adopted will need to incentivise deployment of early projects across different industrial sectors, whilst having the flexibility to evolve for later phases of deployment. As the costs of CCUS come down and the carbon price increases, government expects to reduce its level of support to new projects to achieve its long term vision of “subsidy-free decarbonisation”.

Will there be a CCUS regulator?

The Consultation noted some criticisms about the lack of a coordinated government body responsible for CCUS policy and regulations. To that end, the Response anticipates having possibly two regulators (though the role may be combined in one entity) to oversee the development of the network and support deployment in line with government policy. One would be the economic regulator (such as Ofgem) and the second would be a market regulator (such as the Oil and Gas authority). The economic regulator would be responsible for overseeing the economic regulatory regime for the T&S network, whilst the market regulator would oversee the connection of capture plants to the T&S network. While the Response contemplates separate entities for the market and economic regulator roles, there may be benefits of having one regulator especially where the role involves setting the revenues in a RAB model.

Next Steps

The Response brings CCUS one step closer to deployment in the UK. The Government’s support for breaking the full-chain model, the proposals around a dispatchable CfD, the potential use of the RAB model as well as forming one (or two) entity to oversee all CCUS activity may all help unlock UK CCUS and achieve the government’s ambitious goals. There are also efforts to reuse existing oil and gas infrastructure (as noted above, the consultation response on this was published the same day) and BEIS is also considering how to deploy CCUS in sites that are not currently tied to an identified cluster. On the same day that the Response was published, BEIS also released an independent report by Element Energy, “CCS deployment at dispersed industrial sites”, which identifies high-level deployment options for CCUS technology at dispersed industrial sites in the UK.

These are all positive steps in the direction of building a CCUS industry in the UK but, as always, the devil is in the detail, and some of the key pieces (such as business models for low carbon hydrogen production, encouraging CCUS in energy intensive industry and details of the T&S fee payments) are yet to be developed. The government has tabled for a suite of developments and updates to be published by the end of the year (see table of key dates the government is aiming for below) which to be meaningful will require sustained and in depth engagement with the industry over the coming months as well as testing of the proposals with the wider investment and financing community.

As the Committee on Climate Change stated in their 2019 Report, “Net Zero: The UK’s contribution to stopping global warming”, “CCUS is a necessity, not an option”. If the UK is to achieve its net zero aims, the time to wait for the construction of the first CCUS projects is becoming critical.