Summary

1. WORK UNDERTAKEN on ECONOMICS of CO2 CAPTURE, TRANSPORTATION, EOR, AND SEQUESTRATION in UK/UKCSProfessor Alex Kemp, Dr. Sola Kasim, Linda Stephen and Professor Joe Swierzbinski

2. Summary • Projections of possible availability of fields in UKCS for EOR/storage to 2030. Need to estimate “windows of opportunity”. • Possible incentives for CO2 Capture. Innovatory proposal of long term put option contracts to deal with CO2 market risks. • Development of dynamic linear programming least-cost optimisation model and application to range of power stations in UK, variety of transportation routes in UKCS to range of fields for EOR/Storage.

3. Window of Opportunity in UKCS • Detailed financial simulation modelling of future prospects for fields in UKCS with emphasis on timing of cessation of production and decommissioning. • Modelling undertaken for range of long term oil/gas prices. • Modelling updated to incorporate new information and to see trends. • Modelling shows when main pipelines become non-viable.

7. Incentives for CO2 Capture, EOR, Storage • Widespread agreement on need to reduce CO2 emissions. Many sources of emissions reductions including CO2 Capture and EOR/Storage. • Several different economic incentives have been proposed to promote CO2 reductions, including both “carrots” and “sticks” as follows: (a) Capital grants for relevant investments (b) Ongoing relevant income-related support (e.g. for electricity produced from “greener” sources) (c) Special tax reliefs for relevant investments (d) CO2 tax (e.g. Norway offshore) (e) CO2 emissions trading scheme (e.g. EU ETS)

8. Nature of CO2 Capture/EOR/Storage Investment CO2 Capture and EOR/Storage investments are (a) long-term, and (b) very expensive. Substantial risks surrounding: (i) costs of capture, transportation, injection and storage. (ii) market uncertainties regarding prices of (a) electricity (where relevant), (b) gas and coal (as likely inputs), (c) oil (from EOR), (d) value of carbon allowances.

9. C. Long-Term Put Option Contracts • Government (or agent) negotiates the sale of long-term put option contracts for CO2 emissions with investors. Government would be committed to buy a specified amount of CO2 allowances at a fixed price at a future date. Government receives option value when contract agreed.

10. Key features of the scheme are: • The option contract provides a mechanism for the Government to credibly commit to a minimum future price for the emissions covered by the contract. • The ownership of the options provides investors with a hedge against future price risks. • The Government raises revenue in the present from the sale of the option contracts.

11. The future maximum cost to the Government of the scheme can readily be calculated. If the price of the allowance becomes sufficiently high the cost becomes zero. • The liability of the Government is not open-ended because it can decide how many contracts to sell. This would be based on perceptions of how many projects are felt desirable to incentivise.

12. A well-developed put option market is not necessary to enable the scheme to function. Bilateral negotiations between the two parties suffice. The properties of the options (e.g. exercise date and price) can be tailored to the needs of specific projects. • The scheme is a market-related one, consistent with the philosophy of the EU ETS.

13. The UK Government has had much experience in negotiating emission-reducing agreements (CCAs), and has had involvement in the bond market for a very long time. • It is noteworthy that in the European Climate Exchange (ECX/ICE) there is provision for option contracts in CO2 allowances, though they are of relatively short term duration. • Carbon-reducing investments are long-term and the option contracts would also have to be long term (though not as long as the life of a typical investment project). Currently financial options can have a duration of 2-3 years (LEAPS).

14. k) A Government which wants to minimise the timing risk relating to its commitments may prefer the European option where the exercise price is only at a specified expiration date. (An American option allows the owner to exercise his option at any time up to the expiration date). l) Note that CFD gives similar protection to investor but gives away option value.

15. Economics of CO2 Capture, Transportation, EOR, and Storage in UKCS • Development of dynamic linear programming least-cost optimisation model of capture, transportation, injection, EOR, storage processes, including different market structures (vertically-integrated participants and non-integrated participants). • Application of model to CO2 Capture in 8 power stations in UK for period 2008-2032. • Current work is on least-cost optimisation modelling of transportation, EOR and storage in fields in UKCS.

16. Summary of study objective and approach • The global objective: To add relative realism to discussions on CO2 capture costs and early deployment of carbon capture technology in the UK. • The study proposes a methodology for determining the least-cost options for introducing carbon capture technology under the overarching assumption of increasingly stringent emission caps on fossil-fuelled power plants, which are universally recognised as large point sources of carbon emission. • The approach entails formulating and solving an optimisation model with clearly stated goals, and, explicit provisions for the various regulatory, technological and market conditions which offer opportunities and/or restrict corporate decision-making and action-taking, while using public-domain data on selected power plants’ proposed CO2 capture investment programmes combined with relevant data available in the literature. • More specifically, the objective of the study is to minimize the cost of CO2 capture, using the well-tested optimizing techniques of linear programming (GAMS model) to scan through all the possible cost-output combinations before selecting one as being the optimal. The model is applied to the UK but has a wider applicability.

17. Summary of results and future plans • Determination of the nature of the CO2 capture cost curve. • Establishment of a dynamism in the cost relativities of alternative carbon capture technologies. • Establishment of the importance of Government incentives. • Demonstration of the need for increasingly stringent emission allocation rights, to enhance and sustain the profitability of CO2 capture operations. • Current work is formulating and solving a transportation problem that would determine the least-cost option of matching the supply of the captured CO2 at the power plants with the potential demand for CO2 at the fields, for value-added (EOR, ECBM) and non-value added (permanent storage) uses.

18. A summary of the model Formally, the objective is to minimise the PV of a generalised environomic cost function: where: • kt = capital recovery factor of plant type i at time t • ait = unit CAPEX of the core power generating plant type i at time t • xit = effective electricity generating capacity of plant type i at time t • bit = unit CAPEX of the CO2 capture equipment of plant type i at time t • uit = installed CO2 capture capacity in plant type i at time t • fit = unit fuel OPEX of plant type i at time t • yit = the operating level (or output) of plant type i at time t • eit = unit non-fuel OPEX of plant type i at time t • hit = unit CO2 capture OPEX • qit = amount of CO2 capture in plant type i at time t • mit = unit emission penalty cost to plant type i at time t • vit = excess CO2 emission in plant type i at time t • git = unit Government intervention (tax or subsidy) rate in plant type i at time t • r = discount rate • t = time in years

19. Model summary (continued) • The aforementioned objective function is minimized subject to the satisfaction of a number of constraints determined by demand, supply, technological and capacity factors. These can be summarized broadly into two sets of constraints namely: • Supply and/or maximum capacity constraints: • Demand and/or minimum capacity constraints:

20. Application to the UK (continued)Key results (1a): The total cost curve of CO2 capture has 3 distinct phases

21. Application to the UK (continued)Key results (2): In terms of picking a “winning technology”, no capture technology has a permanent relative cost advantage or disadvantage.

22. Application to the UK (continued)Key results (2) (cont’d) • The main driver of the switch in the cost relativities of different capture technologies is excess emission penalty charges. • The 2 PCSCFGD plants (Drax and Teesside) are less expensive than the higher efficiency, less CO2 emitting plants (Peterhead and Killingholme) only as long as they avoid incurring heavy emission penalty charges. • However, once penalty charges have reached €57/tCO2 (carbon price €29/tCO2) (from 2025 onwards), the larger emitters incur high emission penalty charges, switching the cost relativities in favour of the CCGT and IGCC plants. • The least costly plant throughout is Ferrybridge, but it is likely that the project’s capital investment cost was underestimated. The SSE seems to agree as much in its Preliminary Results for the Year to 31 March 2007

23. Analysis of alternative carbon abatement policies Higher emission penalty charges vs Deeper cuts in EUA ratios

24. 3 scenarios distinguished as follows: • (i) Baseline scenario: The assumption is that the Government introduces a cost-sharing incentive scheme and the objective function and accompanying constraints in the original model hold. • (ii) Higher penalty scenario: The same assumptions are maintained as in the baseline scenario, except that, consistent with EU-ETS Phase 2 there is a 2.5 times increase in the unit emission penalty from €40/tCO2 to €100/tCO2 and a corresponding increase in the carbon price from €21 to €53/tCO2, rising at the same annual rate as in the baseline case. • (iii) Deeper EUA ratio cut scenario: The same assumptions are maintained as in the baseline except that in this case there is a 2.5 times reduction in the individual plant emission allowance allocation ratios. • The performance criteria to use in assessing the relative efficacy of the alternative policies include (a) the amount of CO2 captured, (b) the capture cost, and (c) the level of Government support required.

25. Future Work Economics of CO2 Capture: Systematic risk analysis, particularly on (1) plant costs, (2) primary fuel costs, and (3) EU ETS allowances (e.g. 100% power plant auction, price) Economics of CO2 Transportation, EOR and Storage: Systematic risk analysis of investment costs of above, and EOR response of reservoirs. Incentives and Regulations for CO2 Capture, Transportation and EOR/Storage: Systematic comparison of merits of long term put option contracts compared to other incentives such as CFDs, tax reliefs, feed-in tariffs etc. Legislative/regulatory changes required to facilitate the activities, including change of use of assets and liability in North Sea, and related taxation arrangements.