Policy Strategy for Ccs

7/31/2019 Policy Strategy for Ccs

1/562012

A POLICY STRATEGY FOR

CARBON CAPTURE AND STORAGE

January

INFORMATION PAPER


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3/562012 January

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: [email protected]

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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OECD/IEA2012 APolicyStrategyforCarbonCaptureandStorage

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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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APolicyStrategyforCarbonCaptureandStorage OECD/IEA2012

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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:[email protected]


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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.


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.


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

Documents

Policy Strategy for Ccs