Regulation of carbon dioxide transportation and storage infrastructure in the UK

April 2024  |  SPECIAL REPORT: INFRASTRUCTURE & PROJECT FINANCE

Financier Worldwide Magazine

April 2024 Issue

The UK has committed to achieve net zero carbon emissions by 2050. Given the UK’s reported capacity to store up to 78 billion tonnes of CO2 under its seabed, it is no surprise that carbon capture, usage and storage (CCUS) is being prioritised as a key technology that will not only help the UK reach net zero, but also potentially boost the economy by up to £5bn per year by 2050.

In December 2023, the UK government spelled out in perhaps the clearest terms yet the role that CCUS will play in this journey. As well as setting out the amount committed (£20bn), the short-term aims (four CCUS clusters by 2030), and wider economic benefits (50,000 UK jobs), the government’s ‘CCUS Vision’ also outlines the potential benefits to the UK of being an early mover in the global CCUS sector.

For example, it is envisaged that initial clusters will have created supply chains, pushed forward technologies, and mitigated risks and costs across the market, reducing the need for government support and widening the pool of potential participants. Further policy developments will increase the commercial attractiveness of CO2 capture, including the continued evolution of the UK emissions trading scheme and the proposed introduction of a carbon border adjustment mechanism.

The liquidity (and complexity) of the market will also increase with the integration of new components such as non-pipeline transportation and cross-border transportation. Emitter network connection arrangements may be awarded via competitive tender (rather than government selection as for the initial clusters), and storage may ultimately be priced on a more competitive basis.

To deliver the government’s ambition to capture 20 to 30 million tonnes of CO2 per year by 2030, private sector investment will be needed as the onshore equipment costs alone are estimated to total over £3bn. Coupled with the potential for CCUS to be worth £100bn to the offshore oil and gas supply chain by 2050, CCUS presents a clear opportunity for project sponsors and funders that may be looking for energy transition projects to fund as part of their own mandates.

However, one factor which has been holding back investment into these large infrastructure projects has been a lack of regulatory certainty about how the transportation and storage of carbon dioxide (CCUS T&S) will be treated, and how the lessons learnt from either onshore or offshore licensing of other activities might be incorporated into this regime. The UK government’s first answer to this question was the passing of the Energy Act 2023, which came into force on 26 October 2023, and has introduced a much-awaited new licensing regime for CCUS T&S.

The licensing regime for CCUS T&S is modelled on existing regulated asset base (RAB) regulatory regimes for electricity and gas networks, with the aim of attracting private sector investment. The terms of this will be set out in a government-mandated licence that will be granted to transport and storage companies (TSCs).

It will apply to how they design, build, own and operate the transport and storage (T&S) network. While the language of the Energy Act is wide enough to allow the UK government to introduce other licensing models, it is expected that the first licences will provide for an RAB-based regime for end-to-end transportation and storage licensees.

The licence will govern some of the following key areas: (i) regulatory ringfence, including how a TSC should conduct its business, regulatory accounts and reporting, and provision of information to Ofgem; (ii) access to T&S networks, covering the connection by users to a T&S network and the operation and maintenance of the T&S network in accordance with the CCS Network Code; and (iii) the allowed revenue which a TSC may receive, which should reflect its efficient costs and a reasonable return on its capital investment.

On top of the foundations for a stable regulatory regime based on precedent familiar from the energy network context, the government has introduced the Government Support Package (GSP) and Revenue Support Agreement (RSA) for those investing in at least the first of the CCUS T&S activities.

The most notable protections for sponsors and lenders under the GSP and RSA comprise of: (i) an RSA counterparty, which enables TSCs to recover certain shortfalls in their allowed revenue from an industry counterparty (although not yet formally appointed, it is currently envisaged to be Low Carbon Contracts Company), funded by either taxpayers or energy consumers; (ii) a discontinuation agreement, which entitles a TSC’s equity and debt investors to be compensated where the T&S network becomes a stranded asset; and (iii) a supplemental compensation agreement, which provides for payments from the government to a TSC with respect to certain losses, in particular CO2 leakage scenarios in circumstances where commercial insurance is unavailable or insufficient.

Clearly, this level of support is not something that has been seen in the UK market before and is not available to other licensed networks. In some ways, this is a recognition that a large and critical industry such as CCUS cannot get off the ground on its own at this stage and such interventions are necessary to ensure that lenders and sponsors are able to take the crucial financial investment decisions to build the required networks.

Significantly, while the details of the GSP, RSA and licensing regime are being worked out and tested with the stakeholders in the first two selected CCUS clusters being promoted in England, their success will pave the way for the next wave of CCUS projects already gearing up for negotiations with the government.

Ultimately, financiers of such projects need to understand the risks that they are being asked to carry. As with other large infrastructure projects, actual development and construction costs remain with the private sector – the GSP, RSA and licence terms are there to support revenues in the operation stages.

In light of cost overruns seen in other infrastructure projects recently as well as the headwinds faced in the supply chain of renewables, the costs of constructing CCUS T&S networks will be a key lender look out. With engineering, procurement and construction contractors having difficulty offering fixed price contracts for projects at present, lenders will want to keep a close eye on cost overruns while retaining the flexibility and creativity needed to help fund these first of a kind projects.

Moreover, while the Energy Act has laid the groundwork, there are still a number of crucial uncertainties as the regulatory regime for CO2 T&S continues to evolve. Various secondary legislation remains outstanding, including in relation to licence exemptions and to implement the RSA regime. Substantial areas in the licence also remain noted for further development, including the provisions in relation to the scope of the CO2 T&S network development works and how this might develop over time, cost assessment and insurances.

Finally, the demand risks and international competition in the UK CCUS sector are material. For a CCUS T&S project to succeed, it will be essential that the T&S network and user base are set up in tandem. Without this the T&S revenue recovery will depend all too heavily on government support.

Even more significantly, without a credible CCUS T&S network, the UK risks getting left behind as other countries in northwest Europe look to develop an international market for cross-border sales of captured CO2. That said, one must not take away from the significance of the regime ushered in by the Energy Act for the regulation of CCUS T&S activities.

Now, we just need to see if the investors will offer the much sought after investments.

 

Dalia Majumder-Russell is a partner, and James Wright and Veral Chandiramani are associates at CMS. Ms Majumder-Russell can be contacted on +44 (0)20 7367 3634 or by email: dalia.majumder-russell@cms-cmno.com. Mr Wright can be contacted on +44 (0)20 7367 3615 or by email: james.wright@cms-cmno.com. Mr Chandiramani can be contacted on (0)20 7367 3833 or by email: veral.chandiramani@cms-cmno.com.

© Financier Worldwide

BY

Dalia Majumder-Russell, James Wright and Veral Chandiramani

CMS

©2001-2024 Financier Worldwide Ltd. All rights reserved. Any statements expressed on this website are understood to be general opinions and should not be relied upon as legal, financial or any other form of professional advice. Opinions expressed do not necessarily represent the views of the authors’ current or previous employers, or clients. The publisher, authors and authors' firms are not responsible for any loss third parties may suffer in connection with information or materials presented on this website, or use of any such information or materials by any third parties.