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7/31/2019 Policy Strategy for Ccs
1/562012
A POLICY STRATEGY FOR
CARBON CAPTURE AND STORAGE
January
INFORMATION PAPER
7/31/2019 Policy Strategy for Ccs
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7/31/2019 Policy Strategy for Ccs
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This paper is published under the authority of the Sustainable Energy Policy and
Technology Directorate and may not reflect the views of individual IEA member countries.For further information, please contact Wolf Heidug at: wolf.heidug@iea.org
INFORMATION PAPER
A POLICY STRATEGY FOR
CARBON CAPTURE AND STORAGE
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INTERNATIONAL ENERGY AGENCY
The International Energy Agency (IEA), an autonomous agency, was established in November 1974.Its primary mandate was and is two-fold: to promote energy security amongst its membercountries through collective response to physical disruptions in oil supply, and provide authoritative
research and analysis on ways to ensure reliable, affordable and clean energy for its 28 membercountries and beyond. The IEA carries out a comprehensive programme of energy co-operation amongits member countries, each o which is obliged to hold oil stocks equivalent to 90 days o its net imports.The Agencys aims include the following objectives:
n Secure member countries access to reliable and ample supplies o all orms o energy; in particular,through maintaining eective emergency response capabilities in case o oil supply disruptions.
n Promote sustainable energy policies that spur economic growth and environmental protectionin a global context particularly in terms o reducing greenhouse-gas emissions that contributeto climate change.
n Improve transparency of international markets through collection and analysis ofenergy data.
n Support global collaboration on energy technology to secure uture energy supplies
and mitigate their environmental impact, including through improved energyefciency and development and deployment o low-carbon technologies.
n Find solutions to global energy challenges through engagement anddialogue with non-member countries, industry, international
organisations and other stakeholders.IEA member countries:
Australia
Austria
Belgium
Canada
Czech Republic
Denmark
Finland
France
Germany
Greece
Hungary
Ireland
Italy
Japan
Korea (Republic o)
Luxembourg
NetherlandsNew Zealand
Norway
Poland
Portugal
Slovak Republic
Spain
Sweden
Switzerland
Turkey
United Kingdom
United States
The European Commission
also participates in
the work o the IEA.
Please note that this publication
is subject to specifc restrictions
that limit its use and distribution.
The terms and conditions are available
online atwww.iea.org/about/copyright.asp
OECD/IEA, 2012
International Energy Agency9 rue de la Fdration
75739 Paris Cedex 15, France
www.iea.org
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TableofContents
Acknowledgements...........................................................................................................................5
Executivesummary...........................................................................................................................6
Policyarchitecture.............................................................................................................................8
Policylifecycle..............................................................................................................................8
PolicyfocuswillchangeasCCStechnologymatures....................................................................9
Stablebutflexiblepolicyframework..........................................................................................12
Acombinationofpolicies...........................................................................................................13
Policyinstruments...........................................................................................................................17
Controllingcarbon
emissions
......................................................................................................
17
Promotinglearning.....................................................................................................................22
Capitalandfinancialmarkets......................................................................................................27
Transportandstorage.................................................................................................................28
Sectorandcountryassessment......................................................................................................31
Selectingpilotsectors.................................................................................................................31
Locallyappropriatepolicy...........................................................................................................33
CCSincentivesfordevelopingcountries.....................................................................................34
BECCS...............................................................................................................................................40
AnextraincentiveforBECCS......................................................................................................41
ImplementingtheBECCSincentive.............................................................................................42
Conclusions......................................................................................................................................44
References.......................................................................................................................................46
AnnexA:costpassthrough............................................................................................................50
Electricitymarkets......................................................................................................................50
Industrialsettings
........................................................................................................................
51
Carbonleakage...........................................................................................................................51
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Listoffigures
Figure1 CurrentcarbonpricesfromtheEUEmissionsTradingSchemeortheCleanDevelopmentMechanism.....................................................................................8
Figure2 DevelopmentofCCSasacompetitiveabatementoption..............................................9Figure3 Progressionofincentivepolicy.....................................................................................10Figure4 PossiblegatewayswithinaCCSpolicyframework.......................................................13Figure5 Evolvingrationaleforpolicyintervention.....................................................................16Figure6 Comparingpower,cement,steel,naturalgasprocessingandrefineriessectorsin
Europe...........................................................................................................................31Figure7 Comparingpower,cement,steel,naturalgasprocessingandrefineriessectorsin
theUnitedStates...........................................................................................................32Figure8 AnalysisidentifyingdevelopedcountriesmostmotivatedtosupportCCSinthe
developingworld...........................................................................................................37Figure9 Analysistoidentifydevelopingcountrieswithgreateststrategicinterestedin
CCSdeployment............................................................................................................38Figure10 BECCSlifecycleemissionscanberecognisedatoneofthreepoints............................42Figure11 Factorsinfluencingcostpassthroughindifferentmarkets.........................................54
Listofboxes
Box1 Anexampleofadversepolicyinteraction.......................................................................15Box2 AcombinationofCCSinitiativesfromrecentUKelectricitymarketreformproposals..16
Box
3
CCS
learning
support
policies
in
the
US
...........................................................................
23
Box4 CO2EnhancedOilRecovery(EOR)asstorageoption......................................................33Box5 IFIscouldsupportCCSindevelopingcountriesinanumberofways.............................39
Listoftables
Table1 Anassessmentofinstrumentstocontrolcarbonemissions........................................21Table2 Policytoolsusedtotackleknowledgemarketfailuresandpromotelearning.............26Table3 Policiesusedtotacklecapitalandfinancialmarketfailures.........................................28Table4 Modelsforinfrastructuredevelopmentandoversight................................................30
Table5
Comparinglifecycle
emissions
of
conventional
CCS
and
BECCS
...................................
41
Table6 AdvantagesanddisadvantagesofBECCSincentiveoptions.........................................43
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Acknowledgements
Thisreport
drew
from
the
expertise
of
many
individuals
both
inside
and
outside
the
IEA.
Special
thanks go to our consultants Robin Smale, John Ward and Max Krahe at Vivid Economics forexpertadviceand for developing the draft text.Dr.AdamBrown,AnselmEisentraut,ChristinaHood, Ellina Levina, Juho Lipponen, and Dr. Matthias Finkenrath from the IEA Secretariatprovidednumeroussuggestionsonvariousversionsoftheentiremanuscript,whilethesectionon BECCS benefited from input from Dr. Sabine Fuss and Dr. Florian Kraxner, InternationalInstitute for Applied Systems Analysis. Lastly, thanks should also go to the following peerreviewers for making time available to read the manuscript and for providing constructivecomments:Dr.OttmarEdenhofer,Dr.ChristianFlachsland,Dr.ChristophvonStechow,MatthiasKalkuhl,PotsdamInstituteforClimateImpactResearch;NataliaKulichenko,theWorldBank;Dr.WarwickMcKibbin,AustralianNationalUniversity;Dr.JoseMoreira,BrazilianReferenceCenter
onBiomass;
and
Dr.
John
Parsons,
Massachusetts
Institute
of
Technology.
Formoreinformationonthisdocument,contact:
Dr.WolfHeidug,IEASecretariat
Tel.+33140576512
Email:Wolf.HEIDUG@iea.org
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Executivesummary
Thisguideforpolicymakersaimstoassistthoseinvolvedindesigningnationalandinternationalpolicy related to carbon capture and storage (CCS). Covering both conventional fossilfuel CCS
and
bioenergy
with
CCS
(BECCS),
it
explores
development
of
CCS
from
its
early
pilot
anddemonstrationproject stages through towidescaledeploymentof the technology.The report
concentrates on the economic and political economy perspective, leaving legal, safety,environmentalandregulatoryissuestobeaddressedbyotheranalysis.
PolicysupportcriticaltotapCCSpotential
The IEAsEnergyTechnologyPerspectives (IEA,2010a) indicatesthatCCS isanessentialpartofthe portfolio of technologies needed to achieve substantial global greenhouse gas (GHG)emissions reduction in themostcosteffectivemanner.The technologycould ifgovernmentscommittospecificpolicies accountfornearlyonefifthoftheemissionsreductionrequiredto
cutGHG
emissions
from
energy
use
in
half
by
2050.
The
scale
of
potential
future
deployment
of
CCS is enormous, spanning manufacturing, power generation and hydrocarbon extractionworldwide.
Despitethishugepotential,thereremainsconsiderabledoubtastothepreciseroleCCSwillplay.Deploying CCS requires policy action; it is not something that the market will do on its own.CCSpolicy willhave toaddress thecreationof newmarkets,market barriersand failures, andpromotionandregulationofinfrastructure.Withsuchhighstakes,thequalityofpolicymattersagreatdealattwolevels:overallpolicyarchitectureandselectionofpolicyinstruments.
Policyarchitecture,policyinstruments
Policy architecture refers to the overall policy framework the vision and main structuralelements and how they fit together. It encompasses a range of policy instruments, with eachchoseninstrumentdesignedtorespondtoaparticularpolicyobjectiveovertime.TogethertheseinstrumentscancomprehensivelyimprovetheconditionsforuptakeofCCStechnologyinawaythatsuitsthemarketenvironment.
The appropriate policy for CCS evolves as the technology matures. The policy moves fromtechnologyspecific support, which explicitly targets the development of CCS as a commercialactivity, to technologyneutral support, which allows deployment of CCS when it is most costeffective among other abatement opportunities. Policy may also adapt from supporting bothCCSinvestmentandoperation toanemphasison CCSoperation; fromanapproach where the
publicand
private
sector
share
in
the
costs
and
risks
of
CCS
development
to
one
where
costs
and
risksaremainlybornebytheprivatesector;andfromanapproachwhereCCSisincentivisedbyprovidingsubsidiestoanapproachwhereitisincentivisedbypricingemissions.
Policytoaddresssectoralandnationalfactors
Many challenges associated with CCS deployment are common to all sectors, includingsiteselection,monitoringandprojectapprovals.Sectorswithlowtradeexposure,lowCCScostsandhighcarbondioxide (CO2)emissions(suchasprocessingofnaturalgasandthepowersector insomeregions)offergoodopportunitiestopilotCCSprojectsandprioritiselearning.
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PotentialbenefitsofCCSaregreaterforcountriesthatarecoalandgasproducers,consumers,orthose that anticipate chronic effects from climate change. Developed countries fulfilling thesecriteriaincludeAustraliaandtheUnitedStates.Intheshortandmediumterm,learningbenefitsare most important. The focus should be on demonstration projects that provide the bestopportunities for learning at the least net cost. This supports the argument in favour of CCS
projectsin
areas
where
there
is
apotential
commercial
market
for
the
captured
CO2 (e.g. for
enhancedoilrecovery)or indevelopingcountriesthatstandtoprofitfromCCS.SuchastrategycouldhelplowersupportcostforthefirstgenerationofCCSplantswhileavoidingduplicationofeffort.
AddedincentiveforBECCS
Among the many applications of CCS, BECCS is of particular interest because it offers thepotentialnotonly to reduceemissions,butalso toactually removeCO2 from theatmosphere,thereby reducingatmospheric GHGconcentrations and directly counteracting oneof themain
drivers
of
climate
change.
An
additional
incentive
targeted
specifically
at
BECCS
may
help
to
realise its potential, but it would only be fully effective in combination with an update ofaccountingpolicyandmethodstoaccountforemissionsfromlandusechange.
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Policyarchitecture
Incentive policies for deployment of CCS initially aim to overcome technical and commercialbarriersand support technology learning. IfCCS technologyprogressesas intended, the policy
focuswill
gradually
move
to
support
mass
deployment
through
incentives
to
reduce
emissions
where it is costeffective to do so. Timing of this change in policy focus is difficult to predict,becauseitwilldependonhowCCSandalternativetechnologiesmature.However,astablepolicyframework with clearly defined break points or gateways can offer flexibility to governmentand some certainty to investors. Effective support for CCS calls for a combination of policies,whereeachpolicyaddressesaseparatedimensionofmarketfailure.
Policylifecycle
CCStechnologywillchangesubstantiallyoverthenext40years
CCSis
ahigh
cost
abatement
option
and
will
remain
so
in
the
short
term.
It
is
technically
immature (at least in termsof integratingcapture, transportand storage in fullscaleprojects)and,unlikerenewableenergyandenergyefficiency,itdoesnotgeneraterevenuesifthereisnocarbon price or a commercial market for the captured CO2 forenhanced oil recovery. CurrentcarbonpricesarewellbelowCCScosts(Figure1).This isbecausecurrentshorttermemissionstargetscanbemetwithouttheuseofCCS.
Figure1CurrentcarbonpricesfromtheEUEmissionsTradingSchemeortheCleanDevelopmentMechanism
- 20.0 40.0 60.0 80.0 100.0 120.0
Gas processing
Iron and steel
Chemicals
Cement
Gas (power)
Coal (power)
Biomass (power)
Cost of abatement (USD/tCO2 avoided)
EU ETS trading price,
primary auction 13.07. 2011
CER trading price,
MidDec 2011 future
Source:IEA(2009),EEX(pricestaken20July2011)andVividEconomics.
The private sector is unlikely to invest in CCS because the cost of abatement is higher thancurrentcarbonprices.Theprivatesectorswillingnessto investmay improveovertime,thoughat different rates in different sectors as CCS becomes a more competitive abatement option(Figure2).Researchanddevelopment,andexperiencegainedfromdemonstrationprojectswilllower costs, while rising carbon prices will boost revenues. The IEA BLUE Map scenario(IEA,2010a)showshowitmightbepossibletoreduceby2050CO2emissionsfromenergyuseto50%oftheir2005level.Thescenarioindicatesthat19%oftotalemissionsreductionscouldcomefromCCS.
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Figure2DevelopmentofCCSasacompetitiveabatementoption
PolicyfocuswillchangeasCCStechnologymatures
Initially,incentivepolicywillfocusontrialsofCCSatacommercialscale,seekinginformationandcostreductionstomakeitpossibletodeployCCSatreasonablescaleandcost.Thepolicygoalatthis point is not to make emissions reductions for their own sake, but rather to advanceCCStechnologyandestablishcommercialarrangementsbetweencapture,networksandstorage.Practicalexamplesofsuchpoliciesarethevariousdemonstrationprogrammes launched intheEuropeanUnion(EU),NorthAmericaandAustralia.
Over time, CCS technology will mature and investors will become more familiar with it. Asemissionreductiontargetsbecomemoredemanding, firmswillcometounderstandwherethebest
opportunities
lie.
Policy
makers
may
either
direct
emissions
savings
where
they
believe
themtobemostcosteffectiveorsimplyletthemarketdecidewheretoinvest.
Thepolicychoices fallunder fourbroadthemes1and thepolicyapproach is likelytoshiftovertime(Figure3):
Funding:incentivesforcapitaldeploymentorforoperations;
Costsandrisks:bornebythepublicsectorortheprivatesector;
Subsidies/penalties:subsidisingabatementorpenalisingemissions;and
Technologysupport:targetingCCSspecificincentivesortechnologyneutralincentives.
1 Public support for research and development of CCS will also be crucial. However, as this report focuses on incentive
mechanismstoencouragewidespreaddeploymentofCCS,itdoesnotexplorepoliciesorincentivesrelatingtoR&D.
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Figure3Progressionofincentivepolicy
3
Supporting capital
deployment and operations
Costs and risks shared by
public and private sector
Subsidising abatement
CCS-specific support
Greater willingness to invest by
capital markets
Polluter pays
Achieving least-cost abatement
Reduced learning spill-overs
and better knowledge of risks
Incentivising operations
Costs and risks mainly
borne by private sector
Penalising emissions
Technology-agnostic policy
Early stage As technology matures Late stage
4
1
2
From
capital
to
operating
incentives
The early stagesofCCSwill require support forbothcapitaldeploymentand theoperationofcapture units, networks and storage. Faced with a combination of technology risk, immatureregulatoryandpolicy frameworksand loworabsentmarketrevenues,capitalproviderswillbereluctanttocommitsubstantialsums.Investmentsupportwillbenecessary,intheformofgrantsand/or provision of debt or equity capital, as will operating support for CCS (i.e. incentivemechanisms to provide additional revenue for each unit of output where a CCS unit isoperational). Plants fitted with CCS will have higher operating costs, but often no additionalrevenue.Withoutfurtherpolicysupportforoperations,theassetwillnotbeused.2
Over time, risks surrounding the technology will diminish and the regulatory and policyframeworkwillbecomebetterestablishedandunderstood.As returnsover the lifetimeof theassetaresubstantiated,investorswillbemorewillingtocommitfundswithoutcapitalsupport.Ifexpectationsarerealised,capitalsupportcandeclineandmakeway foragreateremphasisonoperatingsupport.
Frompublicfundingtoprivateincentives
DuringtheearlyyearsofCCSsupportmechanisms,theburden isbornebythetaxpayerratherthantheprivatesector(eitherfirmsorconsumers).Atthisinitialstage,governmentinvolvementcan facilitate learning opportunities, offering potentially greater benefits to society than byleaving information dissemination to private firms. It can also promote coordination betweenfirms, which will facilitate more efficient infrastructure development. Public support is
particularlyvaluable
where
firms
compete
internationally
and
CCS
is
introduced
asymmetrically,
whichcouldotherwiseleadtoadverseeffectsontradeofgoodsproducedbyplantswhereCCSisfitted.
Public fundingforCCSprojects isalready inplace inanumberofcountries, includingAustralia,Canada,China, Korea, Japan,Norway, theUnitedStates, and in theEUand some EU memberstates. In total, approximately USD23.5billion has been made available to support largescaledemonstrationprojects(GCCSI,2011).
2SuchsupportislesslikelytoberequiredwhereCCSisusedforenhancedoilrecovery(EOR),astheuseofCCSgeneratesa
revenuestreamfromtheadditionaloilextracted.
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Over time, tougher emissions targets will translate into higher compliance costs and make itmore important for policy to stimulate the most costeffective forms of abatement. As thevolumeofabatementgeneratedbyCCSincreases,supportthroughsubsidiesislikelytobecometoocostly;andasmorecountriesdeployCCS,tradeexposedsectorswillwarrantandrequirelessprotection. This situation will favour policies that leave both costs and risks with the private
sectorand
use
market
mechanisms
to
allocate
resources.
Whencostsandrisksarebornebytheprivatesector,marketstructureanddemandconditionsdeterminewhetherfirmscanpassonadditionalcoststoconsumers.Ingeneral,whenasectorislessexposedtotradeandthecost increase ismorecomprehensiveanduniformacrossfirms,agreaterproportionofcostcanbepassedontoconsumers.3
Fromsubsidisingabatementtopenalisingemissions
Intheearlyphasesofdeployment,thekeyaimof incentivepolicies istoexpandknowledgeofhow to deploy CCS technology, in order to identify successful technologies and reduce costs.
Suchearly
projects
generate
information
on
viability
and
cost
reduction
that
is
valuable
to
society
asawhole,butmaynotbecommerciallyusefultothoseundertakingtheinvestment.Subsidiesandquantitymandatesmaybeappropriatetoencouragecommercialfirmstoinvestmorethantheyotherwisewould.
When the technology is immature it isnot credible to force emissions reduction throughhighcarbon prices.4 As learning progresses, the key aim of CCS policy will be directed towardsprovidingincentivesforemissionsreduction.Thenpenaltiesmaysufficetostimulatemorecosteffective CCS. As the volume of CCSgenerated abatement grows, reducing support throughsubsidieswilleasepressureonpublicbudgets. Inaddition, commercialopportunities forusingcapturedCO2arelikelytoexpandinseveralmarkets,furtherreducingtherequirementforpublicsubsidies.
Fromtechnologyspecifictotechnologyneutralpolicies
EarlyobjectivesofCCSincentivepolicyaretopromotethetechnology,todetermineitstechnicalviability, and to demonstrate that it is an affordable option when deeper emission cuts arerequired.TheseobjectivesrequirepolicyinstrumentsexplicitlytargetedatCCS.
Oncethesethreeobjectivesareachieved,theneedfortechnologyspecificinstrumentssubsides.Themainaimthenbecomesabatementat lowestpossiblecost.This isbestachievedthroughatechnologyneutral instrument (applying across all abatement technologies), which leaves themarkettoselectthemostcosteffectiveabatementoptions.
3SeeAnnexAforadetaileddiscussionofcostpassthrough.
4Thisdoesnotmeanthattherearenotgoodreasonsforintroducingcarbonpriceswithinaneconomyinthenearterm,northatsuchcarbonpriceswouldnothelpintheearlydeploymentofCCSincountrieswheretherearecarbonprices.Itsuggests,however,thatsupportforCCSintheshorttermmightnotbebestachievedthroughincentivesthatfocusonlyonpenalisingemissions.
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Stablebutflexiblepolicyframework
Policycredibilityencouragesinvestment
Becauseof
the
uncertainty
of
CCS
costs
and
performance
and
opportunities
offered
by
other
technologies, policy makers value flexibility in incentive policy. However, investors respondstrongly toperceived levelsofpolicycommitment.Theyareparticularly sensitive topolicy riskwhen assets (such as CCS) are longlived and heavily dependent on policy support(Hamilton,2009).
Apotentialsolutionistosetpolicywithinastableframework,sothatthebroadarchitectureandrulesofpolicyevolutionarecertain.Thismayleadtolowercostsoffinance,greaterresearchanddevelopmentexpenditureandmoreeffectiveinfrastructureplanningandcoordination.
Benefitstofirmsandgovernment
Withinastable
framework,
breakpoints
or
policy
gateways
can
provide
the
flexibility
required.
Theycomprisethreecomponents:
thecriteriadefiningwhenorifpolicymovestothenextstage;
thepolicieswithineachstage;and
anoutlineofhowgovernmentwillreactifgatewaysaremissed.
Gateways can be used to link commitment of government and private resources to achievingcertain targets (such as performance thresholds). This allows government to commit fundswithouttheriskofoverstretchingitsresourcesorimposingpoorvalueformoneyobligationsonothers.Inascenarioinwhichlearningbenefitsturnouttobesmall,forinstance,policygateways
wouldallow
for
cost
control
without
reneging
on
earlier
assurances.
For
firms,
this
greater
policy
commitment may reduce policy risk and ease financing costs by reducing the risk of assetstranding.
Howgatewayswork
ManydifferenttypesofgatewayscouldbeputinplacewithinaCCSpolicyframework(Figure4).In a first policy phase, for example, public capital grants and operating subsidies deliver asufficientnumberofprojectstotestefficacyofthetechnology.Structuresaresetuptoensurecollaborationandknowledgesharingbetweenthepartiestomaximiselearningbenefits.Afteraninitial operating period of some years, policy might switch to the next phase, provided that
certain
criteria
have
been
met,
probably
relating
to
technological
efficacy
or
the
development
of
commerciallycompetitiveusesforCO2inthelocalmarket.
Asecondphasecouldbeaperiodoflargerscaledeploymentwherewiderdeploymentistriedinat least one sector,even if CCScostscannot be coveredbya carbonprice alone.Widespreaddeployment,eveninonesector,isunlikelytobefeasiblethroughpublicgrants,sotheemphasiswouldswitchtoprivatefinancingwithimplicitsubsidies.Thesesubsidiescouldtaketheformofsome kind of quantity commitment, either made by government (such as CO2 contracts) orimposed on the private sector (such as portfolio standards). Such quantity commitment couldhelpfuelthedevelopmentofcommercialusesbyguaranteeingalowcostsupplyofCO2.Withoutinternational coordination, such subsidybased policy would be difficult in sectors that aresignificantlytradeexposed,but itwould reducerisk for investorsandprovidethesupplychain
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withconfidenceaboutmagnitudeandtimingofinvestmentsovercomingsomeofthekeyrisksfacedbytheseplayers.PolicywouldevolvebeyondthisphaseonlyifCCScostsfallbelowapredefinedthreshold.
Duringthesecondphase,thepolicymightextendtoinfrastructure,settingoutarrangementsfor
networkdevelopment
and
storage.
It
might
establish
codes
of
practice,
liability
regimes,
rights
of
accessandfranchises,aswellascommercialarrangementsandprotectionsagainstthefailureofthenetworkorstorageoperator.
IfCCStechnologybecomesfullyprovenatcommercialscale,andthesupplychainmatures,thenathirdphasecouldfollowinwhichCCSisstimulatedbyapriceinstrumentwhereveritisacosteffective solution. This might be achieved through a stable economywide carbon price, butnarrower, sectoral approaches might also be used. In this phase, longterm planning ofinfrastructure development might be appropriate, to build greater interconnection andresilience.
Whathappens if thecriteriaarenot satisfied? If the firstgateway ismissed, thengovernment
may
wish
to
reallocate
public
support
to
other
technologies
that
show
more
promise.
If
the
scale
upprovesunsuccessfulandthesecondgatewayismissed,thegovernmentcouldcontinuewithamoderate carbon price, accepting that it may not lead to CCS deployment, if alternativetechnologiesarecoming forward. Intheeventthatothertechnologyoptionsarenotavailable,therewillneed to be acontinued focuson CCSdevelopment even in the face ofhigherthanexpectedcosts.ThismightbepursuedbycontinuingCCSspecificsupportmeasures.
Figure4PossiblegatewayswithinaCCSpolicyframework
Acombinationofpolicies
Fivereasonstointervene
FivefactorsmayjustifypolicyinterventioninmarketswhereCCScouldbedeployed:externality,public good, imperfect competition, information asymmetry and imperfect information, andcomplementarymarkets.
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Externality: When a firms action causes impacts on others which it fails to take intoaccount.AclassicexampleisthereleaseoftoomuchCO2fromfossilfuelcombustionornatural gas extraction. Another example is the benefit members of a network receivewhennewmembersjoin,boostingeconomiesofscale.
Publicgood:
When
the
producer
of
agood
or
service
cannot
prevent
others
from
consumingitandthegoodisnotusedupintheprocessofconsumption.Thecreationofknowledge and innovation relating to CCS has some of these characteristics. Thisknowledge may be created during a period of research and development ordemonstration (where theexplicit intention is tobetterunderstand the technology)orduring a subsequent, early deployment phase. The main focus of this report is onincentives fordeployment,andso the lattercase ismore relevanthere. Ineithercase,without intervention, the knowledge is underproduced. It is helpful to distinguishbetween learning about the efficacy of different sorts of technology across the valuechain(i.e.whichtechnologiesworkbest,ortheextenttowhichthereareproblemswithleakage in different sorts of storage sites), which has been labelled as learning from
diversity(Newbery
et
al.,
2009),
and
the
knowledge
obtained
by
replicating
the
same
productionprocessmany times inaway thatallowscosts tobe reduced (conventionallearningbydoing).GiventhatCCSrequires large,discrete investments, learningfromdiversitymaybemostimportant.
Imperfectcompetition:5Wherethereareasmallnumberoflargefirmsinamarket,theymayhavethepowertoaffectpricesthroughhowmuchoutputtheychoosetosupply.InCO2pipenetworks,forexample,onefirmmaybeunwillingtoofferaccesstoitsnetworktootherfirmsonfairandreasonable(i.e.costreflective)terms.Similarconcernsmightalsoexistinrelationtoaccesstostoragecapacity.Theconsequencecouldbeanetworkthat is built too small in extent and capacity, with restricted access to pipeline andstorageandunreasonablyhighprices.
Information asymmetry and imperfect information: When one person holds moreinformationthananother,orwheninformationisnotknown,themarketwillnotallocateresourcesinanefficientway.Thiscanhappenbothinproductandcapitalmarkets.Itcanlead to managers not behaving in the best interests of shareholders and having theircapitalbudgetsrestricted,ortocustomersreceivingpoorqualityproducts. Informationabout CCS costs and performance is likely to be unequally distributed, making capitalprovidersunwilling toprovide finance iftheyareunable todiscerngoodprojects frombadprojects.Thiscouldholdbackinvestmentingoodprojects.
Complementary markets: When one firm depends upon another to get its goods tomarket,andcoordination inoutputplanning is imperfect, thesystemmayundersupply
capacity.Examples
are
CO2
pipelines,
storage
sites
and
capture
plant,
which
together
formtheCO2captureandstoragesystem. Ifthesepartsoftheverticalchainareunderdifferentownership,investorsinCO2pipelines,forexample,maybeunwillingtocommitfunds as the returns to their investments will depend on potentially unpredictabledecisions made by those investing in capture units and storage space. Investors incaptureandstoragefacetheconversesituation.
Toachievethebestpossibleoutcome,all these factorswouldhavetobeaddressed.However,interventionscancreatetheirowndistortionsormaybedesignedinsuchawaythattheydonot
5 Problems of imperfect competition are not addressed in this report as these are found throughout the economy,
necessitatingagenericresponseintheformofregulationbycompetitionauthorities.
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correct the market failure as anticipated. It is crucial to minimise these policy failures whenchoosingwhetherand/orhowtointervene.
Separatepolicyinstrumentsforeachmarketproblem
Whilemarket
failures
justify
policy
intervention,
it
is
possible
that
solving
one
problem
may
createanother.This isespecially likely ifthepolicy ispoorlydesigned.Oneof theprinciplesofgoodpolicydesignistoappointaseparatepolicyinstrumenttotackleeachmarketproblem.ForCCS,thismeans instrumentstoaddresseachofthefivefactorsidentified.Usingmorethanoneinstrumenttowardsthesameendmayhaveunintendedconsequences(Box1).
FischerandNewell(2008)findthatmultiplepolicieseachaimedataseparatemarketfailurereduce emissions more costeffectively than a single policy in isolation, and Philibert (2011)broadlyconcurs.TheconclusionforpolicymakersisthatitisappropriatetostimulateCCSusingacombination of policy instruments at any one time, and to make a careful exposition and
justificationof
what
market
failure
is
tackled
by
each
instrument
and
why
this
is
not
corrected
by
theotherinterventionsinsupportofCCS.RecentUKelectricitymarketreformproposalsincludesuchacombinationofpolicyinstruments(Box2).
Box1Anexampleofadversepolicyinteraction
Anemissionscapandtradeschemeandafeedintariffbothsupportrenewablepower.Thereductioninemissionsbrought forwardbya feedin tariffdoesnotreduce totalemissions,because thetotalcap on emissions does not adjust. Instead, the reduction in emissions from the expansion ofrenewablepowercausesemissionsallowancepricestofall,causingarise inemissionselsewhereintheeconomy (Fankhauser,HepburnandPark,2011).Seebreghtsetal. (2010)explicitlynote thatasimilarriskmightarisefromthesupportofCCS.Thiscouldbeaccountedfor,inthemediumtolongerterm,byadjustingthecaptotakeaccountoftheemissionreductionsachievedbyotherpolicies.Thecorrectapproachistotakeaccountofinteractionswhendesigningpolicies.
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The relative importance of the five market failures identified above will change over time. Inparticular,intheearlierstages6achievinglearningandovercomingcapitalmarketfailuresmaybethe prime reasons for supporting CCS. As the technology matures, the rationale for policyinterventionwillevolve (Figure5).Theemissionsexternalitywillbecomemore important,andtheassociatedpolicy instrumentscanprovidetheprimarycommercialdriverforCCS.Theneed
to
address
possible
problems
of
market
power
in
emitting
sectors
and
in
downstream
transport
andstoragemarketsispresentatalltimes.
Market failure Example policies Importance over time
Emissions externalitycarbon tax or emissions
trading scheme
Knowledge as a public
good
feed in tariff, portfolio
standards
Information asymmetry
and imperfect information
provision of debt, equity,
insurance, grants, tax credits
Complementary markets regulation
Imperfect competition competition authority
6AftersufficientR&Dhasbeenundertakentodemonstratethatthetechnologycanwork.AsnotedinIPCC(2005),thishas
beenachievedbyCCS.
Box2AcombinationofCCSinitiativesfromrecentUKelectricitymarketreformproposals
TheUKDepartmentforEnergyandClimateChange(DECC)hasrecentlyproposedacombinationofinstrumentstoachievedecarbonisationandheadroom inpowergenerationcapacity.InadditiontoGBP1billionprovidedtothefirstCCSdemonstrationproject,andfurtherfundingforanotheronetothreeCCSprojects,theproposalsincludethefollowing:
(a)anemissionperformancestandard(EPS),setsothatnonewcoalfiredpowerstationsarebuiltwithoutCCS(DECC,2011a);
(b)acarbonpricefloor(CPF),intendedtoreduceinvestmentuncertaintyandstrengthentheincentiveforlowcarbonelectricitygeneration;
(c) a system of feedin tariffs (FITs) combined with contractfordifferences (CfD). This in effectguaranteesthepricereceivedbythegeneratorsifthewholesalepowerpriceisbelowanagreedlevel;
(d)acapacitymechanism,toensureheadroomingenerationcapacity.
As
a
set
of
multiple
instruments
aimed
at
multiple
objectives,
these
proposals
reflect
many
elements
oftheframeworkdescribedinthisreport.Wehaveyettoseetheimpactoftheproposedpolicy,butit is nevertheless worth noting that the UK proposals constitute the first more comprehensiveapproachgloballytosetCCSpolicybeyondthefirstdemonstrationfacilities.
Figure5Evolvingrationaleforpolicyintervention
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Policyinstruments
For each market failure, a number of policy solutions exist. To support policy makers in theselectionofinstruments,thisanalysisexaminestheprosandconsofthemostpopularoptions.It
examinesfour
of
the
five
market
failures
identified
in
the
last
section:
externality,
public
good,
information asymmetry and imperfect information, and complementary markets. Each sectionexplores broad themes and policy instruments relevant to one issue and presents a tableassessingpolicyoptionsagainstappropriatecriteria.
Controllingcarbonemissions
Avarietyofinstruments
There are six main types of instrument to tackle carbon emissions: an economywidecapandtradescheme,aneconomywidecarbontax,aCO2purchasingcontract,abaselineand
creditscheme,
afeebate
scheme
and
an
emissions
performance
standard.
Thefirstfourhavethepotentialtobeappliedacrossanumberofsectorsorthewholeeconomy:
AneconomywidecapandtradeschemecapsthetotalquantityofCO2emissionsfromregulated sectors and creates an equivalent number of emissions allowances. FirmssurrenderanallowanceforeachtonneofCO2emitted.Theymaybuytheseallowancesfromthegovernmentforapriceorbyauction,ormaybegivenaproportionofthemforfree.Thisschemeplacesacostonemissions,which firmscanavoidbytheuseofCCS.TheEUEmissionsTradingScheme(EUETS)istheworldslargestcapandtradescheme.
AneconomywidecarbontaxinwhichthereisataxonCO2emissionsoronfossilfuels.Firms may use CCS to reduce their tax liability. Norway currently has a carbon tax ofbetweenUSD18/tCO2andUSD70/tCO2.
ACO2purchasingcontract isalegallybindingagreementtopurchaseCO2undercertainterms and conditions from eligible sellers. Itcreatesa liability which has to be fundedeitherbytaxpayersorelectricitycustomers,withgovernmentorpowersuppliersactingasthecontractingpartyontheirbehalf.ItcanbeusedtopayforCCS.
Abaselineandcreditschemeestablishesabaselinelevelofemissionsforaninstallation,company or sector. This scheme rewards reductions below that baseline by providingcredits that can be used for compliance purposes by those who have exceeded theirbaseline or face absolute emission limits in a linked capandtrade scheme. Under theClean Development Mechanism (CDM), emissions reduction generates credits that canbe sold to countries that have absolute emissions reduction targets under the KyotoProtocol (aswellas installationswithintheEUETS).CCSprojectsareeligibletoreceivecreditsundertheCDM.
Thelasttwo,bydesign,tendtohavenarrower,sectorspecificapplications:
Afeebateschemeisacarbontaxwithanoffsetbaseline.Thetaxappliestoeveryunitofemissions above a set baseline, and tax credits are issued if emissions are below thebaseline.Itispossibletosetthetaxrateandbaselineatlevelsatwhichtherewouldbelittledifference in thecost to firmsbetweenpaying the taxor investing inaparticularabatementtechnology,suchasCCS.
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An emissions performance standard is a mandate applying either only to newinvestmentortoallemittersinasector,limitingfirmsorinstallationstonomorethanasetamountofemissionsperunitofproduction.Eitherevery installationcomplieswiththe standard, or the obligations are tradable, so that the standard is met on averageacrossthesector.Forexample,thereiscurrentlyanontradableemissionsperformancestandard
of
500g
CO2/kWhonnewelectricitygeneratingplantsinCalifornia.Ifthelimitis
lowenough, itmay requireuseofCCSorotherhighcost technologies.Anontradableemissions performance standard works best where all firms or installations makeidentical products, such as electricity. The United Kingdom is also establishing anemissionsperformancestandard(seeBox2).
Economywidecarbonpricesunderataxorcapandtradeschememaybe
preferable
Economywidecarbonprices,seteitherdirectlythroughataxorindirectlythroughanemissionstrading scheme, are themostefficientway tocontrolcarbonemissions.7They send the same
signalabout
the
value
of
reducing
emissions
to
each
firm
or
person
across
all
their
activities.
This
allowsemissionsreductionatsignificantlylowercostthanifcommandandcontrolregulationoranarrower,sectorspecificapproachisadopted.(Bothoftheseimposeunequalcostsacrosstheeconomy.)Afurtherbenefitofcarbonpricesfromaneconomicperspectiveisthattheyincreasethe prices of emissionsintensive products. This further promotes costeffective emissionsreduction,althoughitcanraiseconcernswherelowerincomehouseholdsspendproportionatelymoreoftheirincomeonemissionsintensiveproducts(i.e.energy).
Thechoicebetweencarbontaxesandemissiontradingschemeshasbeenextensivelydebated.Thedebateturnsonanumberoffactors, includingpoliticaleconomy,uncertaintyofcosts8andinternational scope; and one instrument may be preferred over another in specific cases
(Hepburn,
2006).
A
more
volatile
carbon
price,
associated
with
cap
and
trade
schemes,
makes
the returns on investment more uncertain, which may deter investment in high capitalcostoptions such as CCS (Laing and Grubb, 2010; Abadie and Chamarro, 2008). This effect can bemitigated by the introduction of price floors (and ceilings), although these require additionalsophisticationonbehalfofpolicymakers,andtheybringtheschemecloserinformtoafeebateor tax.Trading schemeshavebeenwidelyadopted,mainly for twopoliticaleconomy reasons:first, firmshavebenefited (at thecostof taxpayers) from freedistributionsofallowances,andsecond,governmentshavebeenattractedtodirectpolicycontroloverthequantityofemissions.
Interventionstocreateacarbonpriceareaparticularlygoodexampleofthepossibilityofpolicyfailure.InordertomakeinvestmentsinlonglivedlowcarbonassetssuchasCCS,investorsneedassurance that the carbon pricing policy underpinning the investment will remain in place.
However,investors
might
question
the
future
credibility
of
the
policy,
especially
ifit
conflicts
with other government objectives (such as keeping energy prices low). Therefore, even in the
7 InnonAnnex1countries, the carbonpricesignal is likely tobeprovided in theshort tomedium termbysome formof
baselineandcreditscheme,ateitherprojectorsectorallevel.Thisisdiscussedmorefullyinthefollowingsection.8AccordingtotheclassicpaperbyWeitzman(1974),underuncertainty,aquantityinstrumenttocontrolapollutantsuchas
CO2ispreferredwhentheadditionaldamagecausedbyanextraunitofpollutionisparticularlyhigh(i.e.whentheslopeofthemarginaldamagecurveisrelativelysteep),andapriceinstrumentispreferredwhenthecostofcontrollinganextraunitofpollutionisparticularlyhigh(i.e.whentheslopeofthemarginalabatementcostcurveisthoughttobesteep).AsCO2isastockpollutant(i.e.theextentofclimatechangewillbedeterminedbyGHGconcentrations intheatmospherethathaveaccumulated since the industrial revolution), this is often interpretedas implying thatprice instrumentsarepreferred forcombatingglobalwarmingastheextradamagedonebythereleaseofonemoretonneofCO2isrelativelylow.However,inreality, these economic considerations have been less important in determining the choice between taxes and tradingschemesthansomepoliticaleconomyissues.
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presence of acarbonprice that currently internalises the GHG externality, the risk of a futurechangeinpolicymaydeterinvestorsfrominvestmentincapitalintensiveassetssuchasCCS.Onesolution to this problem is to create an independent agency to determine the keyimplementationaspectsofacarbonpolicyanalogous to the role thathasbeendelegated tocentralbanksincontrollinginflationinmanycountries(Helm,HepburnandMash,2003).
Buildingontheseideas,amoreradicalapproachtoestablishingalongtermcarbonpricesignalisto create a set of longterm permits granting (diminishing) GHG emission rights over the nextcentury.This iscomplementedbyacentralbank ofcarbon,analogous toaclassicmonetarycentral bank, that can issue additional emission permits in the short run, thus influencing thevalueofpermits.Thelongtermpermitsaregivenoutforfreetohouseholdsandfirms,creatingapolitical constituency with an interest in a high carbon price and a private financial motive toreduce their emissions. Longterm permits would be freely traded, creating a longterm pricesignal that gives a degree of certainty for investors, much like a longterm bond yield curve.Furthermore,thecentralbankofcarboncan issueadditionalpermits intheshortrunatafixedprice,effectivelycreatingapriceceilingorsafetyvalve,toensurethatcompliancecostsremain
manageable.This
hybrid
system
(McKibben
and
Wilcoxen,
2007)
may
be
particularly
suitable
for
encouraging and financing capitalintensive CCS investment: the market for longterm permitsgivesinvestorsanideaoffuturecarbonpricesandallowsthemtohedgeagainstvolatility.Underthissystem,installingCCStechnologywouldbringagreaterimmediatepayoff,asitwouldallowafirmtosellnotjustasingleyearsworthofemissionrightsinthepresent,butitsentireholdingoflongtermemissionrightscorrespondingtotheemissionsreduction.Thisfrontloadedpayoutstructuremayfacilitatetheprocurementofprojectfinance,thusallowingmoreCCSprojectstogoahead.
Otherpolicyinstrumentsforspecificsectors
There are circumstances in which, rather than an economywide carbon price, sectorspecific
instrumentssuch
as
aCO2
purchasing
contract
can
be
used
to
correct
the
carbon
externality
and
maystimulateCCS.Thiscanbedesirablewhere:
itispoliticallydifficulttointroduceaneconomywidecarbonprice;
thereisaneedtodecarboniseaparticularsectorquickly;or
theeconomywidecarbonpriceneededtomeetaparticularemissionstargetresults inadverse economic effects (for example, damaging the competitive position of firmscompetingwithinternationalrivalsthatdonotfacesimilarcontrols).
Assessingpolicyoptionsforcontrollingcarbonemissions
Thesepolicy
options
can
be
judged
against
four
criteria:
environmental
effectiveness,
cost
effectiveness,easeofapplication,andpoliticalacceptability(Table1):
Environmental effectiveness: This is a function of how widely the instrument can beappliedacrossdifferent sectorsandassets, the strengthof the incentive itprovides toinvestinabatement,andwhetherornotitislikelytoincreasethepriceofproductsandhencereducedemandforemissionsintensiveproducts.
Costeffectiveness:This isa functionofwhetherornotthe instrumentencourages theleastcost abatement options and whether it helps to reduce costs of the individualoptions. For example, the costeffectiveness of CCS can be enhanced by policy, whichfacilitatescoordinationbetweeninvestmentincapture,downstreamtransportationand
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storage.
Easeofapplication:Policiesmayrequiredifferentlevelsofinstitutionalcapability,oftenlinkedtothe levelofdiscretionusedinoperatingthem.Therelative lackofinformationheldbypolicymakers(comparedtocompanies)maybemoreorlessrelevant,depending
onthe
policy.
Politicalacceptability:Policiesmaybemoreor lesspoliticallyacceptable,dependingonfamiliarityandconfidenceintheoutcome,trustininstitutions,impactonspecialinterestgroups,orthedistributionofcostsbetweenfirms,consumersandtaxpayers.
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Table1AnassessmentofinstrumentstocontrolcarbonemissionsPolicy tool Environmental
effectivenessCost-effectiveness Ease of application Political
acceptability
Cap-
and-trade
scheme
Can be applied across
wide range of sectors
with knowledge that capwill be met. Allowance
price volatility may
reduce policy efficiency.
Abatement only
takes place if the
market reveals that itis needed to meet
the cap, but cost will
not be known in
advance.
The choice of market rules
may stimulate lobbying,
especially with morecomplex designs.
Provision of free
allowances can offset
the total cost increase.Supports other low-
carbon options such
as fuel switching and
renewables.
Carbon tax Can be applied across
a wide range of sectors,
but emission reductions
will not be known in
advance.
Abatement only
proceeds if it is cost-
effective at tax rate,
so cost is controlled.
An existing tax collection
infrastructure may make
introduction easier, but
firms may lobby for
exemptions or reliefs.
Introduction of a new
tax may be politically
challenging, but
expected revenues
can be used to
facilitate this.
Hybrid:
long-term
emission
certificates
coupled
with central
bank of
carbon
Can be applied across
a wide range of sectors,
with knowledge that the
cap is likely to be met.
Overshooting of
emissions is possible
due to central bank of
carbon printing
additional permits.
Abatement only
proceeds if the
market reveals that it
is needed to meet
the long-term cap.
Costs can be
controlled by the
central bank of
carbon, which can
print additional
permits in the short
run to cap prices.
Challenging, as new
institution would be
required, but similarity with
monetary central bank
may facilitate set-up
procedures. Temptation
for central bank of carbon
to constantly print short-
term permits is offset by
political pressure of long-
term permit owners.
Free distribution of
long-term permits may
greatly ease
introduction and
create a constituency
interested in a high
and rising carbon
price. Resistance from
treasury/finance
ministry is possible, as
an opportunity for
government revenue
is foregone.
Baseline
and credit
The lack of overall cap
limits environmental
effectiveness.
Abatement only
proceeds if costs are
below credit price,
but lack of penalty
for emissions maylead to some cost-
effective reductions
not being pursued.
Requires expertise in
monitoring and evaluation.
Absence of cash cost
on emissions below
the baseline makes it
attractive to regulated
parties.
Feebate Allows some flexibility
around a target
emissions level. Difficult
to cover multiple
sectors with one
feebate.
Abatement made
only if costs are less
than the fee rate;
costs are kept within
limits.
Scope for lobbying for
level of baseline.
Technical aspects of
setting and updating
baseline (sufficient to
stimulate investment, but
no higher than that) also
very challenging.
Attractive mixture of
environmental
certainty and cost
control, but difficult to
administer.
Emission
performance
standard
Effective in controlling
emissions. Ambiguous
impact on demand for
goods. Has less effect if
only applied to new
plant, as life of old plant
may be prolonged.
Can impose high
costs by setting the
same standard for
all players,
preventing
efficiencies from
trade.
Difficult to impose on
heterogeneous sectors.
Standards are vulnerable
to lobbying, but
comparatively easy to
enforce, if general GHG
accounting standards are
high. More challenging
otherwise.
Attracts little political
attention, but may be
fiercely lobbied
against. Likely to be
popular with
supporters of
renewables, as no
competition for state
resources.
CO2
purchase
contract
Easily measured
emissions savings.
Can be cost-
effective, especially
if contracts have
long tenor and are
competitively bid
Care is needed when
drawing up contract,
particularly with regard to
liability arrangements.
Once in place simple to
administer.
May be unpopular with
those not offered
contracts. There may
be objections to
paying the polluter.
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Promotinglearning
Learninggeneratespublicbenefitsandmeritssupport
Whether they are classed as part of the demonstration phase of a technology or duringpreliminary
stages
of
mass
deployment,
early
CCS
projects
produce
learning
effects,
which
benefit others who are not directly involved. Knowledge of what works and does not work atincreasing levels of scale becomes public knowledge, as do opportunities for cost reduction.Everyone benefits, not only the company that makes the investment. This is additionalknowledge, beyond that generated through R&D programmes, which focus more on thetechnologycomponentsofCCS.AstheIPCCnotes(IPCC,2005),individualcomponentsoftheCCStechnologychainaremature;andwhatisnowrequiredistheirintegration.Hencetheemphasisinthisreportonlearningobtainedduringdemonstrationanddeployment.
Incontrasttopolicyinstrumentsthataremoreorlesstechnologyneutral,thepolicyinstrumentsdiscussedinthissectionaimtosecureknowledgespecifictoCCS.Successismeasuredintermsof
costreduction
or
deployment
of
CCS,
rather
than
in
terms
of
abatement
achieved.
This
is
the
argument, sometimes explicit, for support of renewables in the presence of carbon prices(Philibert,2011).
Learningsupportedearlyonbygrants,laterbyquantityinstruments
Thehighunitcostsandrisksofdemonstrationprojectsatthisstagenecessitatepubliclyfundedgrants.ThesearebeingusedtodeliverearlydemonstrationprojectstoatotalinvestmentcostofbetweenUSD26.6billionandUSD36.1billion(IEA/CSLF,2010).Thesehavebeenusedaspartofthepolicymix in theUnitedStates tosupportCCSdemonstrationprojects (Box3).After theseinitial demonstration projects, there is still much knowledge to be obtained, but the largernumberofCCSplantsinvolvedinfurtherlearningputsthescaleofinvestmentbeyondthereach
ofmany
governments.
There
are
increasing
benefits
from
mechanisms
that
place
more
of
the
performanceriskontheprivatesector.
Facedwithasimilarchallenge intherenewablessector,policymakershavegenerallytendedtoadoptpoliciesthatencouragedeploymentbyfixingpricesorquantitiestomakemarketrevenueslargerandmorecertain,whilealsoplacingdeliveryriskonfirms(VividEconomics,2010).Therehas been considerable debate about whether mechanisms that fix prices or those that limitquantitieshaveprovidedthebetterincentivetodeveloprenewables.Anumberofstudieshaveconcluded that feedin tariffs have been more costeffective at securing capacity (IEA, 2008;Butler and Neuhoff, 2008; Lipp, 2007). However, in other cases, feedin tariffs have beencontroversial, providing excessive returns to investors. Given that CCS does not generate any
revenues
outside
the
carbon
market
(with
the
possible
exception
of
plants
supplying
CO2
for
CO2
EOR),caremustbetakenwhenapplyinglessonsfromthedebateonincentivesforrenewablestotheCCScontext,butacomparisonisnonethelessinstructive,especiallyasithighlightsimportantdifferencesinthecoststructureofmanyrenewabletechnologiescomparedtoCCS.
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Acharacteristicofmanyrenewableelectricitytechnologiesisthatthemarginalcostsofelectricity
productionare
low
and
stable.9
Consequently,
afixed
price,
such
as
through
afeed
in
tariff
(FIT),
providesreasonablecertaintyovertheprofitmarginoneachunit.However,inthecaseofCCSinthepowersector, theenergycostsofoperating theCCSunitareconsiderableandvaryas theprice of fuel changes. When electricity prices change in response to fuel price changes, thisprovidesanaturalhedge.Thiswouldbe lostundera fixedpriceFIT.Forthisreason, itmaybepreferable topay theFITasa fixed topup tomarket revenue (apremium).Thisapproachhasbeen used to promote the development of combined heat and power in Germany and, until
9Thisdoesnotmeanthatthetotalcostofrenewabletechnologies(asmeasuredbythelevelisedcostofelectricity)islow.In
manycases,suchtechnologiesremainmoreexpensivethanconventionalthermalgeneration(withoutCCSadded).However,inthecontextofafixedprice,itisthesizeandvolatilityofthemarginalcoststhatwilldeterminetheprofitvariabilityoverthelifetimeoftheasset.
Box3CCSlearningsupportpoliciesintheUnitedStates
IntheUnitedStates,twotypesofpolicycurrentlysupportCCSandhelpsecureearlystagelearning:
federalfinancial
support
(including
grants,
federal
loan
guarantees
and
operating
subsidies)
and
astatelevelquantityinstrument.
TheUSDepartmentofEnergy(DoE)providescofundingforalargevarietyofCCSprojects,coveringboth industry and the power sector. Direct funding programmes include the Clean Coal PowerInitiative, providing approximately USD800million in cofunding to one retrofitted and two newlyconstructed CCS coal power plants (DoE,2011a). According to the DoE, this leverages more thanUSD2.2billioninprivatefinanceandmayleadtothecaptureofmorethan4.5milliontonnesofCO2per year (DoE, 2011a). In addition, USD1billion in federal funding has been awarded to theFutureGen2.0 project, aiming to demonstrate both CCS and oxycombustion technology. Onceoperating, this project is predicted to capture approximately 1.3million tonnes of CO2 per year(DoE,2011b).TheDoEalsoprovides funding forCCS from industrial sourceswithaUSD1.3billionfund, dedicated to largescale industrial CCS projects, and a USD100million fund, dedicated to
innovativeconcepts
for
beneficial
CO2
use
projects
(DoE,
2009).
So
far,
funding
from
these
two
has
beenallocated tomore than25projects,with the three largestprojectsexpected tocaptureandstore a total of 6.5million tons of CO2 per year [] by the end of the demonstration period inSeptember2015(DoE,2011c).
Furthermore the federalgovernmenthasofferedup toUSD8billion in federal loanguarantees forprojects that employ advanced technologies that avoid, reduce or sequester emissions of []greenhousegases intheareaofcoalbasedpowergeneration, industrialgasification,andadvancedcoal gasification facilities (DoE,2008). So far one guarantee has been extended, coveringUSD2.6billionofloanstoTenaskaCorporationforitsUSD3.5billionTaylorvilleEnergyCenter,whichmaycaptureandstoreupto3milliontonnesofCO2perannumwhenfullyoperating(Tenaska,2009).
The federal government also offers a USD20/tCO2 tax credit for up to 75million tonnes ofgeologicallystoredCO2,reducedtoUSD10/tCO2usedinEOR),withapossibleaggregatevalueofup
toUSD
1.5
billion
(GCCSI,
2009).
ThestateofIllinoishasledthewayinintroducingaquantityinstrument:startingin2015,thestateselectricpowerutilitiesarerequiredtosource5%oftheirelectricityfromacleancoalpowersource.Whilethelawexpressesatargetof25%by2025,thereisnoprovisioninthecurrentlawforaregularannualincreaseinthelegallyrequiredpercentage.Plantsoperatingbefore2016qualifyascleancoalaslongasatleast50%ofCO2emissionsarecaptureandsequestered.Thisrequirementrisesto70%forplantsexpectedtocommenceoperatingin2016or2017,andto90%thereafter.(IllinoisGeneralAssembly,2009).
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recently,biomasselectricityinChina,withconventionalfixedpriceFITsusedforotherrenewableenergysources.
AquantityinstrumentintheformofaportfoliostandardrequiresthatanamountorproportionofoutputinamarketbesuppliedbyCCSequippedplants.Anumberofstudieshavefoundthese
instrumentsto
be
somewhat
ineffective
at
supporting
renewables
deployment
(see
Carley
(2009)
for adiscussion in the US context).However, thismay reflect the cost characteristicsof manyrenewable technologies which, as explained above, are well suited to fixedprice incentivemechanisms.Bycontrast,inthecaseofCCS,wherecostsareunknownandorvolatile,quantitybased instruments may provide greater profit certainty to CCS investors in comparison to aconventionalFIT.10Aswithrenewableportfoliostandards,costeffectivenesscanbeimprovedbymaking the obligation tradable, so that those on whom the obligation is placed may eithercomplydirectlyorpurchasecertificatesfromotherswhoareinsurplus.Ifthetradingtakesplacethroughanexchange, ithas theadvantageof revealing further informationabout thecostsofCCSinvestment.
An important potential benefit of a quantity instrument is that it indicates the future level of
demandto
developers
of
transport,
networks
and
storage,
so
(as
discussed
in
Section
2.4)
it
might support the development of CCS infrastructure. Investors in these downstream servicesfacelessvolumeuncertaintyasaresult,andmorecapacitymaybebuilt.
Otherapproachesmaybeneededoutsidethepowersector
Therangeofpolicyinstrumentstoconsiderinthepowersectoriswider,becauseelectricitytradeacross borders is limited in many countries. In other sectors, the range of options available islikely to be more restricted (ERM, 2009). For example, without substantial international coordination,itwouldbedifficulttodeveloparrangementstoprovideafixedprice(orpremiumtothatprice)onsteelorcementproductsthatwereproducedinplantswhereCCSwasfitted.
Someof
the
more
attractive
options
that
are
particularly
(although
not
exclusively)
relevant
outsidethepowersectorinclude:
Productionor investment taxcreditswhich reduce the tax liability facedbycompaniesoperatingorinstallingCCS.
PaymentsbygovernmentsforeachtonneofCO2capturedandstoredbyaCCSplant.Thesizeofthesebonusescouldbedeterminedeitheradministrativelyorbycompetitivebids.Like the quantity instruments referred to above, a bidding approach might have theadvantage of providing more demand certainty to downstream transport and storageproviders.
In regions with emission trading schemes, but where allowances are allocated for free, thefunding for these incentive schemes may be met in part by transferring some of the implicitsubsidyassociatedwiththefreeallocationofallowances.
10Inparticular,tradablecertificateregimeshaveoftenbeencriticisedforcreatingavolatilerevenuestreamwhichreducesits
value for investorscontemplatinga renewables investment (Stechowetal.,2011).However, in thecaseofaCCS tradableportfoliostandard,thisvolatilitymaynotbeasdamagingto investorconfidenceasthecertificateswould increase inpricewhen the costs of operating a CCS plant became more expensive (i.e. when fossilfuel prices increased). This correlationbetweencostsandthevalueofcertificatecoulddampenprofitvolatility,improvinginvestment.ItisnoteworthythattheIEA(2008) reports that while FITs have generally delivered more costeffective renewables deployment than quantity fixingmeasures,theresultsaremoreambiguousforbiomasstechnologieswhich,likefossilplantswithCCSfitted,havesignificantmarginalcostvolatilityandmaybeunsuitedtofixedpriceFITs.
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Assessingpolicyoptionstopromotelearning
Thefollowingpolicyinstrumentscouldbeusedtoencouragelearningbenefits:
capitalgrant:publicfundingtowardsCCSconstruction(allocatedeithercompetitivelyoradministratively);
investmenttaxcredits:areductionintaxliabilitiesforfirmsthatmakeaCCSinvestment;
production subsidy: a payment for every tonne of CO2 stored as a result of aCCSinvestment(paymentdeterminedadministrativelyorcompetitively);
productiontaxcredit:areductionintaxliabilityforfirmsoperatingaCCSasset;
FIT:afixedpriceforalloutputwhereCCSisfitted;
premiumFIT:apremiumaddedtopriceofallproductsproducedwhereCCSisfitted;and
CCSportfolioobligation:requirementthatacertainpercentageoramountofoutputbeproducedfromCCSfittedplants(caneitherbetradableornontradable).
Thecriteriausedtoassessthese instruments(Table2)arethesameasthosedescribedearlier,withoneexception:toreflectthetechnologyspecificsupportofthesepolicies,thefirstcolumnexaminesthestrengthoftheinvestmentincentivecreatedforCCS.
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Table2Policytoolsusedtotackleknowledgemarketfailuresandpromotelearning
Policy Investment incentive
for CCS
Cost-effectiveness Ease of application Political acceptability
Capital grant Environmentaleffectiveness varieswith size andconditions of grant; canbe applied to allsectors and assets.
May weaken incentiveto minimise lifecyclecosts; governmentmay fail to pick mostcost-effective projects.
Expertise required toselect recipients andset appropriate grantlevel; prone to lobbying.
Consumes scarcefiscal resources; mayface opposition fromsupporters of otherlow-carbontechnologies.
Investmenttax credit
Incentive depends onsize of credit; can beapplied to all sectors,but only relevant forfirms with tax liabilities.
Market selects whichprojects to implement.Does not guaranteeoperation of the plant.
Straightforwardadministration; sometechnical expertiserequired to setappropriate level.
Consumes scarcefiscal resources; mayface opposition fromsupporters of otherlow-carbontechnologies.
Production
subsidy
Can cover every sector
and encouragesoperation.
High utilisation is
encouraged, andmarket selects whichprojects to fund.
Expertise required to
select recipients andset appropriate subsidylevel; prone to lobbying.
Consumes scarce
fiscal resources; mayface opposition fromsupporters of otherlow-carbontechnologies.
Productiontax credit
Effectiveness dependson size of credit; canbe applied to allsectors but onlyrelevant for firms withtax liabilities;encourages operation.
High utilisation isencouraged, andmarket selects whichprojects to fund.
Expertise required toselect recipients andset appropriate subsidylevel; prone to lobbying.
Consumes scarcefiscal resources; mayface opposition fromsupporters of otherlow-carbontechnologies.
FIT Difficult to implementoutside electricitysector; in electricity
sector, exposure tofluctuating fuel pricesmay lesseninvestment.
Market selects whichprojects to implement;but increased
exposure to fuel pricevolatility may raiserisks.
Templates transferablefrom the renewablessector, though volatility
of fuel costs for CCSmay require differentcontractualarrangements,
Country-specificfactors will determinewhether resulting
higher prices havelower or higher profilethan fiscal measures.Likely to faceopposition fromsupporters of otherlow-carbontechnologies.
Premium FIT Difficult to implementoutside electricitysector; in electricitysector can be effectivein delivering output.
Market selects whichprojects to implement,and hedging of fuelcosts is preserved.
Templates transferablefrom the renewablessector.
Country-specificfactors will determinewhether resultinghigher prices havelower or higher profilethan fiscal measures.Likely to face
opposition fromsupporters of otherlow-carbontechnologies.
Portfoliostandard
Unsuitable for sectorswith few plants perfirm; offers quantitycertainty.
Unit costs are notlimited, but marketforces may deliverleast cost outcome.
Similar expertiserequired to otherinstruments andtemplates transferablefrom renewablessector.
Country-specificfactors will determinewhether resultinghigher prices havelower or higher profilethan fiscal measures.
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Capitalandfinancialmarkets
Investors lackof information regarding theperformancecharacteristicsofCCSand thecapitalcostsofsettingupnewcommercialarrangementscandiscourage,limitorevenpreventtheflowof capital to CCS projects. This is only likely to be a difficulty while CCS is an earlystagetechnology. Government intervention can help, in effect purchasing knowledge anddisseminating it tocapitalmarkets. Over time,as the risksbecome betterknownandpossiblydecline,theneedforinterventionmaydecline,withtheprivatesectormorewillingtotakethemonandprovideagreaterallocationofcapitalforCCSprojects.
Severalapproachestonovelty,capitalandfinancialmarketrisk
DuringtheearlystagesofCCSadoption,capitalfinancialmarketsmaybeslowtoprovidefinance.Capital providers and financial intermediaries may have insufficient knowledge to distinguishgoodprojectsfrombadones,andthismaymakethemreluctanttosupplymuchoranycapital.
Thepublicsector,eithergovernmentsorInternationalFinancialInstitutions(IFIs),canassistinanumberofways,includingdirectcontributionofcapitalorriskmitigationinstruments:
Directcontributionofcapital:Thisexpands thepoolofavailablecapitalandhelps thesector to achieve scale and experience. This approach has been used by somegovernments to support the development of nuclear power plants where financerequirementsaresubstantialandthereareanalogouspublicpolicyissuesregardinglongtermliabilityandstorage.Itrequiresahighlevelofsophisticationindraftingthetermsofdebtor equity participation toavoiddampening incentives tomanageprojectswell. Itonly works where the principal project sponsors are motivated to seek coinvestment.Provisionofcapital isanappropriatepolicywhen theoverall levelofcapitalallocationwhichprivateinvestorsarewillingtomaketoCCSfallsbelowtheambitionofaparticular
policyprogramme.
Public
sector
capital
provision
can
help
relieve
such
constraints
and
bringasectorthroughitsnovelphasetoamorematurephase.
Risk mitigation instruments such as credit guarantees and insurance: These toolsexplicitlyaltertheriskallocation,andaimtoleverinriskaverseprivatesectorcapital.Indoing so, they would have to avoid diluting the project managers incentives andattracting poor qualityprojects. These instruments maybe particularlyappropriate forcrossborder investment. These have also been used in the nuclear industry in somecountries, including the United States. In contrast, as noted above, risk mitigationinstruments alter the distribution of risk. Insurance may help when there are specificrisksthatdeterprivatesectorinvestment,andinsurancecanbeusefulwhereriskscanbediversified across projects within the sector. Insurance can create problems, however,
particularlyif
it
encourages
excessive
risk
taking
(moral
hazard).
Both policies allow the public sector to be involved in supervising projects, which offersopportunitiestoacquireinformation.Forinstance,allCCSprojectsthatarecofinancedbytheUSDepartmentofEnergyincludeknowledgesharingaspartofthetermsandconditionsofprovidingcofinancing.
However,toprotecttheircommercial interests,coinvestorsmayseekto limitthepublicsectorfrom sharing theacquired informationmorewidely. If thegovernment isable to facilitate thesyndicationofcapitaltoprojectsoncetheyhavebecomeestablished,itwilllikelybebetterabletodistributeinformationwhentheprojectisrefinanced.InsomecasesIFIsmaybebetterplacedtoprovidetheseinstrumentsthannationalgovernments,asdiscussedinthenextsection.
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Theriskswillgraduallybecomebetterknownandcontrolled,andtheprivatesectorwillbemorewillingandabletotakethemon.Hencepublicinterventioncanbetransitory,perhapslimitedtodemonstrationprojectsandthefirstfleetofcommercialplantsinasector.
Assessingpolicyoptionsforcapitalandfinancialmarkets
Giventhefocusednatureofthe instrumentsinthissection,inthisassessmentofpolicyoptions(Table3)thefirstcolumnalsoexaminesthestrengthoftheinvestmentincentivecreatedforCCS.
Table3Policiesusedtotacklecapitalandfinancialmarketfailures
Policy Investment incentive forCCS
Cost-effectiveness Ease of application Politicalacceptability
Co-
investment
equity
Increases scale more
quickly and accelerates
learning. Gives investor
confidence about long-
term policy because thestate is involved.
Public participation
may enable greater
inter-sponsor
cooperation and
system integration.
Requires financial and
commercial expertise
within government and
ability to carry out due
diligence on projects.Only works if projects
sponsors are
supportive.
Depends on existing
precedents and
political outlook.
Provision
of debt
May give assurance to
other debt providers and
help to prove commercial
models.
Will not affect project
costs directly, but
may accelerate
learning.
As above. Depends on existing
precedents and
political outlook.
Credit
guarantees
Effective where projects
are already close to
achieving a working
capital structure.
Any weakening of
incentives on
managers or other
investors is to be
avoided; otherwise
costs may rise.
As above. It may be difficult for
government to take
on liabilities which
could be triggered
by poor managerial
decisions.
Insurance
products
May help to achieve
broader capital
participation.
May enhance
competition between
capital providers, but
may also reduce
incentives to control
specific risks.
As above. It may be difficult for
government to take
on liabilities which
could be triggered
by poor managerial
decisions.
Transportandstorage
CCS deployment may be affected by a lack of certainty about the provision of transport andstorage infrastructure;and thenaturalmonopolies in transport (andpotentially storage)could
createatendency
to
under
provide
services.
Policies
may
be
used
beneficially
to
steer
the
developmentof infrastructure,givingmorecertaintytocaptureplantoperators,andpromotingadequateprovisionofinfrastructure.
Remediesforlackofcertaintyindemandforinfrastructure
Seeing uncertainty in demand, private investors may hesitate to invest in CCS infrastructure.Demand for infrastructure services depends on government policy, the development ofCCStechnology, the development of substitute technologies and the commercial fortunes ofenergy users. A comprehensive infrastructure solution is therefore unlikely to emerge or,indeed, be desirable until some uncertainties have diminished. During early stages of
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deployment,tominimisethescaleofassetsatriskofstranding,transportinfrastructureislikelyto develop as pointtopoint links between emitters and stores, or as small clusters linked tostores.Thislimitsthequantityofcapitalexposed,andmeansthatsomecouldbedeliveredonaverticallyintegratedprojectbasis.
Overtime,
vertically
integrated
bilateral
links
could
be
superseded
by
infrastructure
clusters,
in
linewithCCSdeployment inasinglesector.Thiswouldprovidebettercoverage,reducedcoststhrough economies of scale, and higher resilience. Government, acting directly or through anagent,couldaggregatevolumeinformationfromcaptureplantoperatorsandprovideplanningofinfrastructuresystemdevelopment.
Ifandwhen thewidespreaddeploymentofCCSbecomesprobable, infrastructureclustersmaybecombined intoan integrated system solutionwithpublic supervision.Sincevolumemaybemoreuncertainoutsidethepowersector,itmayhavearoleinunderwritingaproportionofthefixednetworkcosts
Policyoptionstoimprovecertaintyfornetwork,storageandcapture
operators
To give security to network and/or storage operators, governments could boost demand,guarantee market share,guarantee returnsoncapitalorunderwrite riskoncontracts. Itcouldalso undertake a number of these options simultaneously. For example, it could increase thecertaintyandlevelofdemandbysettingupinstrumentstobuytheoutputofcaptureplant(suchas a CO2 contract or producer obligation), thereby increasing the volume of CO2 produced forstorage.Havingdonethis,itcouldalsorequiretheupstreampartytowriteatakeorpaycontractwhere that party must pay the value of the contract, whether or not they make use of theservice.Thisiseasiertoimplementwhenthepartyisstateownedorhassomewaytopasscostsontoitscustomers.
Aguarantee
of
demand
at
market
level
does
not
translate
into
aguarantee
of
demand
for
a
networkorstoreoperator,becausethereisariskthatrivalswillcompeteandtakemarketshare.Thisriskcanbeeliminatedbycreatingafranchise.Afranchiseallowscompetitionforthemarketwhenthefranchise isbeingsetup,butonceithasbeensetup,thereisnofurthercompetitionwithinthemarket.Certainty is improved fortheoperator,butthere isa lossofthebenefitsofenduringcompetition.
Afurtherpossibilityisthatgovernmentcouldguaranteerecoveryofcostsfornetworkorstorageoperatorsbyestablishingaclaimonotherparties,perhapsthroughalevyortheregulatoryassetbaseofanestablishedutilitywhosefinancingisguaranteed.Thisisawaytoachievealowcostofcapital,but itcomesattheexpenseofweaker incentivestosetcapacity inresponsetomarket
demand.Finally,
the
government
could
write
contract
insurance
to
offset
counterparty
risk.
Togivesecuritytocaptureplantoperators,governmentcouldintroducearighttoconnecttothenetworkandestablish termsofcontractwhichprovide forcompensation in theeventthatthenetwork or storage becomes unavailable. Government could also provide a long term for thecontracts and include clauses that ensure reasonable prices and terms upon contractrenegotiation. Counterparty risk could be reduced through a special administration regime forthenetworkandstorageoperator,suchthattheserviceissuretocontinueintheeventthattheoperatorgoesoutofbusiness.
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Publicsupervisionofmarketpower
Due to economies of scale and land use restrictions, entry into the transport market may beextremely difficult for competitors once an incumbent is established. Transport infrastructuremay therefore become a natural monopoly, requiring regulatory oversight of pricingand third
partyaccess
rights.
Storage may require more or less public supervision than transport. The composition of thestoragemarketwilldependonthegeologicalavailabilityofstoragesites,economiesofscaleandpoliticalchoices.Inascenariowherethenumberofindependentstoresconnectedtoanetworkissmallandownedbyjusta limitednumberof firms,public supervisionwouldbe required topreventadversemonopolybehaviour.Alternatively,storagecouldbe integratedwithtransportor publicly owned. In a scenario with multiple independently owned stores, competition mayflourish,and interventionbeyondestablishingenvironmentalandsafety regimesandprovidingforliabilitiesmightnotbenecessary.
There are inherent advantages and drawbacks to the different models for development and
oversightof
storage
markets
and
infrastructure
(Table
4).
Table4Modelsforinfrastructuredevelopmentandoversight
Model Description Advantages Drawbacks
Vertically integrated
point-to-point
infrastructure
Bilateral link from source to
storage site; integrated
ownership of transport and
storage, possibly by capture
plant owner.
Vertical integrationprevents storage hold-up.Volume certainty.
Suitable only fordemonstration phase.Early pipelines may becomeobsolete once demandgrows.
Local clusters with
government support
Local sources club together to
fund infrastructure; government
aggregates volume information
to avoid collusion and sharing ofcommercially sensitive
information.
Greater resilience.Economies of scale.Possibility of linking upmultiple clusters.Risk shared out amongcompetitors.
Requires governmentexpertise to process volumeinformation and planinfrastructure.Risk of distorting competitionby favouring some firmsover others.
Concession for
integrated system
Comprehensive system of
transport and storage
infrastructure in common
ownership, possibly with
financially protected regulated
asset base; public supervision of
pricing and third party access.
Low cost of capital.High resilience.Comprehensivecoverage.Vertical integrationprevents storage hold-up.
Risk of stranded assets.Natural monopoly.
Competitive storage
market
Geology allows for multiple
storage sites connected to a
transport network; small
economies of scale; small fixed
costs of finding, exploring,licensing and installing storage;
multiple, independently-owned
stores are connected to transport
infrastructure
Government interventionlimited to environmental,and safety and liabilityprovisions.
Competition may driveinnovation and costreductions.
Not possible under point-to-point transport infrastructure.Unlikely under clustertransport infrastructure.
Regulated storage
market
Geology allows for few storage
sites; there are large economies
of scale; there are large fixed
costs; only a small number of
stores are explored and
operated.
Small number of storeswith economies of scale.
May require public oversightto prevent adversemonopoly behaviour.
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Sectorandcountryassessment
Many
challenges
associa
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