Category: Investing in the Energy Transition

CCS’ Finance Gateways

Source: MFUG

Key Points: Recent innovation in U.S. CCS financing include the first tax equity deal, which industry insiders indicate is more popular than direct pay or transfers. Meanwhile, project developers are looking beyond the 12 years of IRA tax credits to other revenue and to networks of CO₂ sources to raise expected financial returns.

First tax equity financing for CCS. Harvestone Low Carbon Partners LP (HLCP) and Bank of America announced a $205 Million (MM) tax equity financing in September. The deal was the first arranged for Carbon Capture and Storage (CCS); the structure has been widely used in renewable energy. It was also the first tax equity structure to offer the option of buying either 45Q or 45Z credits (i.e., the CCS and clean fuel tax credits, respectively, established in the Inflation Reduction Act or IRA); the selection of which of the two tax credits can be made every year.

In a tax equity financing, the investor (in this case Bank of America) receives a passive equity interest in the project (in this case the special purpose company HLCP). The investor funds a portion of the capital cost of the project and receives a set rate of return — via the losses generated on the project that the investor uses to offset its own tax obligations — for the 12 years of eligible credits. The investment vehicle is considered to have a limited risk/downside, in part because:

• any loans to the project are subordinated below this tax equity in priority of getting paid (unlike other equity, which is subordinated to debt); and
• only 20% of the investor’s cash outlay to the developer is required as of mechanical completion (with the balance due at the placed-in-service date), which minimizes delivery risk

The IRA includes provisions that allow for the government to “direct pay” tax loss credits to the developer and for the developer to transfer (i.e., sell) its credits to other parties. However, tax capital appears to be considered by industry participants the most attractive to investors, despite the structure’s complexity. Reasons for this include that direct pay is only available for five years and the government has paid very slowly; and in transfer transactions buyers are paying as little as $0.90 on the $1.00.

It is worth noting that it is possible that these tax incentives may be altered going forward, if, for example, the incoming Congress determines that extending the 2017 tax cuts requires funding offsets in other areas. With that said, CCS was looked on favorably in the first Trump administration, perhaps in part because it does offer a path to continued operation of legacy fossil-fueled power and other industrial facilities and has fossil industry support.

Projects look for more revenue sources to raise financial returns. If IRA tax credits are sufficient to enable some low cost CCS projects, generally developers appear to be evaluating projects assuming there will be additional revenue sources and often an ability to leverage their infrastructure investments. These could come from network hubs with multiple sources of CO₂, the addition of low carbon products (e.g. hydrogen), proceeds of credit sales (e.g., through California’s Low Carbon Fuel Standard) and, if passed, 45Q extensions. Notably, the need for multiple revenue sources is exacerbated as inflation (of construction costs) has undermined the value of the IRA 45Q credit .

CCS participants also continue to look to the Voluntary Carbon Markets (VCM) as a source of revenue. (Note there is one U.S. CCS project that has issued carbon credits.) The VCM is considered to have vast potential, particularly if its use can be “sanctioned” as a means to help countries meet their climate commitments (via Article 6 of the Paris Agreement); with that said, international governance bodies’ work to agree on rules for accounting for stored CO₂ is slow going. Using the VCM does raise questions about establishing project additionality, although there has also been consideration of a class of credits that would explicitly not require such an additionality test, but would also not allow buyers to make offsetting claims.

11/11/2024

Insurers Grapple with Climate Tech Coverage

Source: The Geneva Association

Key Points: A Geneva Association conference highlighted the many challenges insurers perceive in supporting new climate technologies. Specific to geologic storage of carbon, it was noted that traditional coverage doesn’t fit well with the damages if the CO₂ were to leak. Progress may lie in more collaboration, shorter policy periods, and government backstopping.

The Geneva Association’s Climate Tech Conference. Earlier this week, the Sustainable Finance Lab attended a Geneva Association (GA) symposium to discuss how to spur more commercial insurance engagement with new climate-related technologies and climate mitigation activity. The event followed the GA’s publication by of two related reports, Climate Tech For Industrial Decarbonization: What role for insurers? (January, 2024) and Bringing Climate Tech to Market: The powerful role of insurance (April 2024). In the former, the GA described the climate tech landscape. In the latter, the GA introduced an Insurability Readiness Framework (IRF). The IRF is designed to help insurers evaluate a new technology from an insurability perspective by identifying the key issues/risks related to technology, project development, legal/compliance, location, business interruption, long-term and ESG. The GA is an international group comprised of insurers’ and reinsurers’ CEOs.

Cataloguing the challenges for insurance participation. The insurance industry understands it has a role to play in supporting the financing of climate technologies to aid in global decarbonization. Yet the two reports and conference participants compiled a daunting list of challenges for insurance industry participation. Among them:

• New technologies lack that (loss) data to perform effective risk engineering.
• Insurers are short-staffed of engineering expertise to evaluate new technologies.
• Insurers is less collaborative / more competitive than it used to be, which slows new product development.
• There is a lack of education/understanding among entrepreneurs about risk management in general, making it harder to communicate with insurers to address insurer concerns.
• Because of the large scale of certain climate tech investment, project finance is increasingly being used to fund early-deployment stages, which is earlier than insurers traditionally get involved.

Carbon storage in focus. One of the conference focus areas was the potential liabilities resulting from leaked CO₂ from geological carbon storage. Panelists offered another long list of the various challenges confronting re/insurers, including:

• The geology of storage conditions is heterogeneous and the time scales to consider are vast, complicating risk assessment.
• There is price risk for coverage of credit reversals (if CO₂ leaks), given general expectations that carbon prices will rise over time. At the same time, insurers think buffer pools, such as those used in the VCM, are a poor — and inefficient — risk management tool, in part because the value sits idle/isn’t investable and in part because appropriate amounts to reserve are very difficult to determine.
• Potential losses appear to take shapes that are inconsistent with typical insurance profiles. To wit, quantifying losses and damages from any leakage is difficult and leakage may be more likely to be gradual vs. a large one-time occurrence.
• Re/insurers are being asked to write much longer-term policies than normal, presumably at least in part because of the project finance influence.

Solutions sought in early engagement, collaboration, more government partnership, and a little creativity. Conference speakers opined that for the insurance industry to break through these varied challenges, insurers needed to engage relatively earlier in individual project lifecycles — to understand technologies and to offer risk management expertise that would ease the path to getting coverage later as the projects matured.

Other speakers noted that the industry had overcome the challenges of insuring new-to-the-world technologies in the past — satellites was cited as an example. The industry had done so in part through collaboration among insurers to share technical/risk engineering knowledge; collaboration could include with (or it could be facilitated by) third parties (like respected NGOs). It was noted that if “loss” data for a new industry is difficult to acquire (the chicken-and-egg problem for insurance), other data is available that can give confidence (e.g., geological data to anticipate CO₂ movement in a storage zone). Pooling of risks through wider participation was also encouraged.

It was offered that public-private partnerships (PPPs) could assist, with government acting as an insurer of last resort and capping the exposure to a project to be carried by the private sector. The symposium did prominently note the roles government has already played in climate tech development. Speakers highlighted, for example, the U.S. Department of Energy (DOE) and EU as funders of development projects and supporters of carbon credits, along with the DOE’s introduction of an Adoption Readiness Level framework to support commercialization of new technologies.

4/18/2024

Albermarle Initiates Lithium Auctions

Exhibit: Spodumene Spot Price Trend, March 2023 – Present

Note: minimum 6% Lithium Oxide, cif China
Source: Fastmarkets

Key Points: Albermarle, a leading lithium producer, is introducing auctions; arguably this can improve price discovery and transparency, particularly for strategic buyers. Pricing may be finding its footing after an 85% drop. Price perception today is heavily influenced by Chinese exchange trading, which is said to be driven by speculators.

Albermarle conducts first of a series of auctions. In late March, leading Lithium (Li) producer Albermarle (NYSE: ALB) auctioned 10,000 metric tons of chemical-grade spodumene concentrate, a source of high purity Li. The company has indicated that it will conduct a series of auctions; Bloomberg noted ALB will auction 100 tons of battery-grade carbonate on April 2 and Fastmarkets reported that ALB is planning its next spodumene auction for April 24.

Although not necessarily apples-to-apples, ALB appears to be stepping in to auctions as a competitor steps away from them. Australian miner Pilbara (ASX: PLS) is reportedly pausing its spodumene auctions after having committed most of its product for 2024.

Auction pricing may point to “stronger” demand by strategics. ALB reportedly received ~$1,200 per tonne in the recently completely auction, approximately 15% higher than the midpoint of market intelligence agency Fastmarkets’ most recent spot price assessment (see Exhibit). (The implied premium actually appears modestly higher because the auction basis was ex-works, in which arrangement of shipping generally falls on the buyer, vs. Fastmarkets’ cost-in-freight basis, in which arrangement falls on the seller).

Intent of auctions is to aid price discovery and provide transparency from and to strategic buyers. Per initial reporting of company statements, ALB intends the auctions to aid in price discovery and transparency. The ALB auctions can offer “hard” pricing reference points from strategic buyers relative to what the market perceives as price measures that are heavily influenced by speculative forces in China currently.

This Chinese speculative influence takes its shape in the Guangzhou Futures Exchange (GFEX)-traded Li carbonate contract. The GFEX contract was only introduced in July 2023, but it has grown open interest (the total number of derivatives contracts that haven’t been exercised or closed) to over 300,000 tons. GFEX volume and price volatility is reportedly spurred by large amounts of speculative interest (as opposed to strategic activity from buyers); it is also reportedly difficult for non-Chinese entities to access the market.

For reference, recent trading on the CME in its Li (hydroxide) contract had open interest of ~23,000 tonnes — and is considered a success as it has only been listed since 2021. The London (LME) and Singapore exchanges have reportedly seen very little activity.

It is worth noting that other factors may have a bearing on the relative popularity of the GFEX contract. It is physically-settled, while those on the other exchanges are cash-settled. And the GFEX is that much closer to the 2/3 of the world’s Li that is processed in China, which creates a natural hub. That said, it is also believed that the GFEX’s growth has helped CME contract growth through arbitrage trading.

Auctions may also encourage commodity traders. With prices ~80% below 2023 highs but up ~25% from February 2024 lows (see Exhibit), ALB may be hoping to encourage opportunistic commodity traders to step in.

March 28, 2024

Largest CCS VCM Credit Issuance to Date

Exhibit: Schematic of BECCS Process Sourced from Ethanol Production

Source: University of ND Energy & Environmental Research Center

Key Points: Red Trail Energy’s BECCS credit issuance is the largest technology-based carbon removal project to date. Hints at the economics point to ethanol’s position at the lower end of the CCS cost curve. RTE is a partnership, which limits use of 45Q (affirming additionality for the credits). The issuance adds to momentum in carbon capture project finance.

Largest technology-based carbon removal credit issuance in the carbon markets to date. Earlier this month, Red Trail Energy LLC (RTE), an ethanol producer in North Dakota since 2007, issued 157 thousand (K) carbon credits on the Puro.earth registry. This was the largest listing of technology-based carbon removal credits in the voluntary market (though a registry) to date; it was also the first ethanol plant to produce carbon removal credits. RTE’s credits are based on the first 14 months of operation of the carbon capture program (beginning in June 2022), known in this case as Bioenergy with Carbon Capture and Storage (BECCS). (Note: Puro.earth refers to its credits as CO₂ Removal Certificates, or CORCs.)

RTE CORCs documentation appears to affirm low cost position for ethanol-based CCS. Documentation posted on Puro.earth provides some detail with respect to the cost basis for RTE’s BECCS-based credits, although the detail may be insufficient to characterize total (or per ton of stored CO₂) project costs. The 157K CORCs issued reflects the total CO₂ captured of 180K tons net of the emissions associated with the CCS process (largely electricity). Electricity used for the period was 33.4 Megawatt hours (MWh); if this reflects total power consumption, it would allow for energy costs below $20/ton of stored CO₂. Total capital investment for “buildings, equipment, contractor work and research” was given as $39 Million; if this reflects the total capex, then even assuming no extensions beyond the initial program term of 5 years, it suggests low $40s/ton of stored CO₂.

Additionality may rely on RTE’s status as an Limited Liability Corporation. The additionality audit avers that the project meets Voluntary Carbon Market (VCM) additionality principles, i.e. requires carbon credits to make it financially viable, in part because RTE is a partnership. The entity’s tax status (as a partnership it distributes profit to the partners and is not taxed at the entity level) suggest it cannot benefit from 45Q tax incentives (which for this activity would otherwise provide for $85/ton).

This is by far the largest listing on Puro.earth. Puro.earth, a registry dedicated to technology-based carbon removal projects, launched in 2019. In 2023, its listings totaled 81.5K CORCs (i.e. tons-equivalent) through 362 projects, or an average of 225 tons per project. Also in 2023, 80% of its projects and volume were sourced in biochar, with most of the balance sourced in “wooden building elements.” Puro.earth’s transactions have realized pricing between $110 and $180/ton since the beginning of 2023.

The move comes with momentum in future CCS funding commitments.  There have been notable commitments related to carbon capture support over the past year. These have, however, been structured through directly-negotiated (multi-year) agreements. Examples include:

• OXY-and-Blackrock-owned 1PointFive have over the past year has announced purchase agreements with ANA AT&T (just this past week), BCG, TD Bank Group, Trafigura, and Houston professional teams the Astros and the Texans to purchase Carbon Dioxide Removal (CDR) credits for removals to be delivered by 1PointFive’s under-construction Direct Air Capture (DAC) facility STRATOS.
• Microsoft committed an estimated $200 Million to purchase 315K credits from carbon mineralization startup Heirloom as part of Microsoft’s broader carbon removal portfolio commitments.
• Respira International, a carbon credit investor, committed to buy 50K credits from DAC company Carbon6. This follows Respira’s 2022 MOU with power producer Drax Group to buy up to 2 Million BECCS CDR credits over a five year period to be generated from an as-yet-to-be-built Drax facility in the U.S. Respira intends to resell the credits in the voluntary carbon market.

March 21, 2024