Questions & Answers on the Expanding Carbon Capture through Enhanced Oil Recovery Act of 2014

by NEORI on May 5, 2014

• Why is the Rockefeller bill needed?

The Expanding Carbon Capture through Enhanced Oil Recovery Act of 2014 will greatly expand enhanced oil recovery using man-made carbon dioxide in the United States. A decades-old, proven commercial practice, carbon dioxide enhanced oil recovery (CO2-EOR) involves injecting CO2 into already developed oil fields to enhance production. CO2-EOR has the potential to increase domestic oil production, create jobs, avoid CO2 emissions, and drive innovation in carbon capture and storage technology.

The bill expands and reforms an existing incentive, the Section 45Q Tax Credit for Carbon Sequestration, to capture CO2 from power plants and industrial facilities. Expanding this incentive could boost U.S. oil production from existing oil wells by billions of barrels, while storing billions of tons of CO2 underground and generating net federal revenue over time.

The availability of an expanded and reformed 45Q tax credit would help developers of CO2 capture projects obtain private capital to finance their projects and deliver CO2 at an affordable price to EOR operators. Including a bankable tax credit in an application for financing would help numerous CO2 capture projects overcome the relatively high upfront costs and risks of investing in emerging technologies. Furthermore, as explained below, the expanded 45Q tax credit would only cover the incremental cost, beyond what is covered by the sales revenue of selling CO2 for EOR, of integrating CO2 capture, compression, and transport with an electricity generation or industrial project.

• How could an expanded and reformed 45Q program work efficiently and cost-effectively?

The expanded and reformed 45Q tax credit targets the “cost gap,” or the difference between what EOR operators are willing to pay for CO2 and the cost to capture and transport CO2.

Cost Gap = Cost to capture and transport CO2 – Willingness of EOR operators to pay for CO2

The cost to capture and transport CO2 from a variety of man-made sources varies considerably.  There is an early opportunity to capture CO2 from certain industrial sources, which have relatively low capture costs (potentially $38-$48 per ton of CO2). In comparison, capturing and transporting CO2 from other industrial and power plant sources is more expensive (potentially $55-$85 per ton of CO2), because it requires less mature technologies that have not been demonstrated commercially.  However, these more costly sources offer considerably larger supplies of CO2.

Based on the current economics of CO2-EOR, oil companies typically pay approximately 2% of the price of a barrel of oil for one million cubic feet (mcf) of CO2.  This means that, if the price of a barrel of oil is $100, an EOR operator would be willing to pay approximately $37.80 for one ton of CO2. The cost gap could therefore range from less than $5 to more than $45 per ton of CO2 for different sources. The Rockefeller bill ensures that 45Q tax credits are available for both low-cost and high-cost sources of CO2 in order to develop a sufficient supply for EOR.

• What are the Rockefeller bill’s provisions for expanding and reforming the 45Q program?

Under the current 45Q program, a taxpayer may claim tax credits for each ton of CO2 that is captured and safely stored underground.  The current program is capped at 75 million tons, and many of those credits have already been claimed. An expanded 45Q program is needed to take advantage of the significant potential of CO2-EOR by capturing more CO2 from man-made sources. Under an expanded 45Q program, tax credits would be allocated in a competitive bidding process designed to meet two goals:

1) Minimize the cost of additional tax credits by taking full advantage of the cheapest sources of captured CO2; and

2) Drive innovation in CO2 capture from a wide range of man-made sources to expand the CO2 supply available for EOR.  There is a near-term opportunity to capture CO2 from a variety of industrial sources at a lower cost and with commercially mature technology.  However, more expensive CO2 sources, most likely from other types of industrial facilities and power plants offer considerably larger supplies of CO2 for EOR.

In order to realize these goals, the Rockefeller bill introduces the following key provisions to the 45Q tax credit program:

1. Separate tranches for different CO2 sources

2. Allocation of credits via competitive bidding

3. Certification of projects

4. Revenue positive determination and program review

5. Annual tax credit adjustment based on changes in the price of oil

6. Ability to elect to transfer credit to the entity disposing of the CO2

1.       Separate tranches for different CO2 sources

Three different pools of tax credits, or tranches, are established for electric power and lower-cost  and higher-cost industrial CO2 capture projects so that only projects of a similar nature and cost will bid against each other for tax credits. This provision ensures that high-cost CO2 capture projects (power plants, steel and cement manufacturing, for example) for which CO2 capture technology remains expensive and has not reached full commercial maturity will not have to compete against low-cost industrial sources of CO2 (such as natural gas processing and fertilizer and ethanol production).

 2.       Allocation of credits via competitive bidding

An applicant will bid against other applicants for 45Q tax credits within a tranche.  Applicants will bid for a certain dollar-per-ton level of credit and for a given number of tons of CO2 (equivalent to how much CO2 a project will capture over 10 years; projects may receive allocations of credits for 10 tax years).

Applicants will base their bids on the cost gap, or the difference between what EOR operators will pay for CO2 and their incremental cost of investing in CO2 capture and transportation equipment.  By introducing competition among tax credit applicants and by taking advantage of the existing market demand for CO2, there will be several inherent features to limit the cost of the overall tax credit program.

Tax credits will be awarded first to the applicant who bids the lowest dollar-per-ton level of credit.  If additional credits are available, the applicant with the next lowest dollar-per-ton bid is awarded tax credits, and the process will be repeated until available funding in a given year is allocated.

 3.       Certification of projects

Upon a successful bid for tax credits, an applicant will seek certification for allocated credits, a process that allows the applicant to reserve credits for claiming in future tax years. Certification provides certainty not found in the existing 45Q program. This certainty is critical to securing financing private sector investment in a COcapture project.  A certified project must be under construction and then become operational according to specified time frames, or it shall lose certification.  This provides a safeguard to the program that credits are only held by projects that are moving forward in a timely manner.

 4.       Revenue-positive determination and program review

After the seventh annual round of competitive bidding, the Secretary of the Treasury, in consultation with the Department of Energy and Securities and Exchange Commission, will determine if the federal revenue from incremental CO2-EOR production exceeds the cost of the newly allocated 45Q tax credits.  If the Secretary determines that the program is revenue-positive, annual competitive bidding will continue for another four years when another revenue-positive determination will be made. If the program is not revenue-positive, the Secretary will deliver a report to Congress, which will decide whether annual competitive bidding shall continue.

Beginning after the third annual round of competitive bidding, a panel of independent experts will periodically review the 45Q program at the direction of the Secretary of the Treasury. This panel will provide recommendations regarding potential changes to the program to ensure the program achieves its purpose, including being revenue-positive. In response to the panel’s recommendations and based on program operations and outcomes, the Secretary of the Treasury will have the authority to modify certain aspects of the competitive bidding process to achieve program objectives.

 5.       Annual tax credit adjustment based on changes in the price of oil

In most cases, a CO2 capture project enters into a contract to sell its CO2 to an EOR company for a price that is tied to the price of oil.  Thus, to reflect changes in CO2 sales revenue, a CO2 capture project will adjust the value of allocated 45Q tax credits each year based on annual changes in the price of oil. When oil prices fall, a CO2 capture project will claim a higher tax credit to make up for decreased revenue from selling CO2 for use in EOR. When oil prices rise, a CO2 capture project will claim a lower tax credit, ensuring that the federal government does not provide more of an incentive than needed.

 6.       Ability to elect to transfer credit to the person disposing of the CO2

In general, the tax credit will go to the taxpayer who captures and disposes of the CO2 through EOR, either directly or through a contracted partner.  In the case where applicants lack sufficient income or the tax status to benefit from a tax credit, they may elect the partner responsible for disposing of the CO2 through EOR operations to receive the allocated credits. This provision is intended to facilitate tax equity partnerships.

But some CO2-EOR is already happening – would an expanded 45Q program provide unnecessary support?

The growth of the carbon dioxide enhanced oil recovery (CO2-EOR) industry depends upon capturing substantially more CO2 from man-made sources.  To date, the majority of CO2-EOR has been performed with natural (and low-cost) CO2, but supplies of natural CO2 are limited and mostly committed already to existing CO2-EOR projects.  Currently, there are shortages of CO2 in several EOR-producing regions of the United States, thus creating the need to capture CO2 from industrial and power plant emissions.  Yet, the cost of capturing and transporting CO2 from these sources exceeds the ability of CO2-EOR operators to pay for it.

The expectation is that most potential commercial-scale CO2 capture projects, even those with lower capture costs, would need a tax credit to secure financing and begin construction.  For example, a tax credit may be needed for a lower-cost CO2 source if it does not offer a sufficiently large supply of CO2 to justify the construction of a dedicated CO2 pipeline.  For higher-cost industrial and power plant sources of CO2, the cost to capture CO2 is expected to remain relatively expensive even after the initial deployments of capture technology.  To ensure that unnecessary support is not provided, 45Q tax credits will be allocated via competitive bidding, and applicants must meet certain criteria to be eligible to submit a bid.  Also, the Secretary of the Treasury should determine if the program will become revenue-positive to the federal government after seven years and undertake mandatory periodic reviews of the 45Q program to ensure that it meets stated fiscal and performance objectives.

Finally, the estimated size of CO2-EOR resources in the United States suggests that any near-term increase in the supply of affordable CO2 would be matched by the EOR industry’s ability to use it.  Therefore, even if certain CO2 capture projects come online without an incentive, other incentivized projects could supply CO2 for EOR production that would be considered additional.

How does CO2-EOR raise revenue for the federal government?

Under existing tax treatment, CO2-EOR generates federal revenue from three main sources:

1. Corporate income taxes

2. Individual income taxes on royalties from CO2-EOR production on private land

3. Royalties from CO2-EOR production on federal land

Advanced Resources International estimates that if a barrel of oil produced by CO2-EOR sells for $85, federal and state governments could expect to receive $21.20 in revenue from the three sources mentioned above (approximately 25 percent of the barrel of oil’s sale price). Subtracting a state’s expected share of revenue, the federal government is expected to receive 20 percent of the revenue, mostly from the corporate income taxes.

The Rockefeller legislation does not make any changes to the existing tax treatment of revenue from oil sales.

Under the existing tax treatment of oil sales revenue, the federal government likely would receive sufficient revenue to cover the cost of expanding the 45Q tax credit program within a 10-year window. Analysis by the National Enhanced Oil Recovery Initiative (NEORI) indicates that an expanded and reformed tax incentive could be substantially revenue-positive over the long run.  In fact, federal revenues from incremental oil production could exceed the fiscal cost of the incentive itself by over $80 billion over 40 years.  Overall, NEORI expects that a new tax credit would quadruple the amount of oil produced through CO2-EOR (now 5 percent of U.S. domestic production), generating an additional 8 billion barrels of domestic oil over 40 years, while reducing U.S. CO2 emissions by approximately 4 billion tons.

What factors influence the cost of an expanded 45Q program to the federal government?

Numerous factors could influence how quickly an expanded 45Q program would pay for itself.  However, sensitivity analyses conducted by NEORI suggest that even under the most difficult circumstances, the federal government breaks even within 13 years and the program becomes revenue-positive over the long-run.  Lower oil prices, lower market demand for CO2, higher costs to transport CO2, and higher volumes of CO2 needed to stimulate EOR production are expected to be the most important factors that could extend the time frame under which the program would break even fiscally.  To ensure that the 45Q program meets its cost objectives over time, the Rockefeller bill allocates 45Q credits through competitive bidding. In addition, after seven years, the Secretary of the Treasury should determine if the federal revenues from incremental CO2-EOR production will exceed the cost of new tax credits. The Secretary also should have authority to modify the 45Q program, and an independent panel of experts should complete mandatory periodic reviews of the program to ensure that it is meeting stated objectives.

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