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Risk Management and Optimal Contract Structures for the CCS-EOR* Value Chain

Risk Management and Optimal Contract Structures for the CCS-EOR* Value Chain. Anna Agarwal, John E. Parsons Center for Energy and Environmental Policy Research Massachusetts Institute of Technology October 10, 2011.

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Risk Management and Optimal Contract Structures for the CCS-EOR* Value Chain

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  1. Risk Management and Optimal Contract Structures for the CCS-EOR* Value Chain Anna Agarwal, John E. Parsons Center for Energy and Environmental Policy Research Massachusetts Institute of Technology October 10, 2011 *CCS-EOR stands for Carbon Capture and Storage-Enhanced Oil Recovery

  2. CCS (carbon capture and storage) value chain consists of three key components CapturingCO2 (at large stationary CO2 source such as coal-fired power plant) Storing CO2 (in geological formations – in oil fields for enhanced oil recovery (EOR)) Transporting CO2 (by pipeline) Source: IEAGHG Weyburn-Midale Project Update Source: IPCC Report on CCS Source: Bellona Foundation

  3. Motivation • CCS is pure cost, enabling financial value captured elsewhere in the value chain. • Commercial deployment would require enabling commercial structuring of the value chain. • Our Focus: Contract structures to distribute profits and allocate risks among the involved entities. • Optimal contract structures maximize the overall project value.

  4. Approach • We develop a cash-flow model for a prototype CCS-EOR project. • Project involves collaboration between two entities: power plant company and oil field company (pipeline jointly owned) • Analyze impact of market risks on the CCS-EOR project and evaluate optimal contingent decisions. • Evaluate risk-sharing offered by standard contract structures and resulting incentives for optimal decision-making. Coal-fired Power Plant 500MW IGCC with 90% CO2 Capture Pipeline (dedicated) 50 mile Oil Field 190 million bbl of recoverable oil

  5. Project Risk Exposure (if market risk factors changed 3 years after start of operations) • Volatility in oil price is the dominant risk factor.

  6. Optimal Contingent Decision-Making example of re-optimizing CO2 capture rate contingent on oil price 90% at $70/bbl 70% at $50/bbl 60% at $30/bbl No capture below $20/bbl • Re-optimizing CO2 capture rate leads to financial gains of • $130 million at $30/bbl, and $247 million at $20/bbl.

  7. Key Questions • Who bears the different risks along the value chain? • Are the ex ante negotiated contract terms still profitable ex post? • Are the profit maximizing contingent decisions for the individual entity aligned with the overall project? Lets look at two standard contract structures Fixed price CO2 contracts Ex ante range of profitable contract prices (per ton CO2): $62 - $ 76 Indexed price CO2 contracts – indexed to oil price Ex ante range of profitable contract prices (per ton CO2) : 82% - 101% of oil price

  8. Risk-Sharing and Incentives - Evaluating Financial Gain by Optimizing CO2 Capture Rate Fixed Price Contracts Indexed Price Contracts • Fixed price contracts result in conflict of interests, as the power plant company has no incentive to adjust the CO2 capture rate. • Risk-sharing offered by indexed price contracts incentivizes optimal decision-making and creates alignment of interests.

  9. Risk-Sharing and Ex post Insolvencies - Evaluating Resulting Ex-post NPV Indexed Price Contracts Optimal CO2 Capture Fixed Price Contracts 90% CO2 Capture • High risk of ex post insolvency in fixed price contracts can lead to inefficient investment decisions. • Risk-sharing through indexed price contracts not only maximizes the project value, it also minimizes the insolvency risks.

  10. Summary • Market risks are significant in a CCS-EOR project. • Choice of contract determines : • Who bears the risks? • What incentives does the risk allocation produce? • Standard contracts have weaknesses in terms of ex post insolvencies and poor incentive structures that result in sub-optimal project value. Future Work • Extend analysis to technical risks such as uncertainty in CO2 storage operations. • Analyze how contracts would evolve as the CCS industry matures.

  11. Thank you

  12. Extra Slides

  13. Project Timeline

  14. Ex-post Risk Factor Values

  15. Sensitivity of ex-ante negotiable contract prices • Depending on the overnight cost – • minimum negotiable price can vary from $11-$73 per ton CO2.

  16. Contractual Profit-Sharing Negotiable Contract Terms $62-$76 per ton CO2 delivered (for indexed price contracts: 82%-101% of oil price)

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