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Carbon-Capture Projects Face Uncertain Future Amid IRS Delays

Feb. 11, 2020, 9:38 PM

Keith Tracy, a project developer and consultant, has half a dozen carbon capture projects in the works.

But all of them are experiencing some level of delay due to a lack of IRS guidance that would give investors much-needed clarity. Potential backers are ready to pull the trigger on more than $500 million of financing but won’t do so until the agency acts, he said.

The largest and most expensive projects are suffering most.

“The bigger the project and the more money involved, the more clarity and certainty that you want,” said Tracy, president of Cornerpost CO2 LLC and a former executive for the oil and gas company Chaparral Energy.

“The smaller projects some folks might be willing to take a little bit more risk on,” he said.

Carbon capture and storage is the process of trapping waste carbon dioxide from power plants and industrial facilities and depositing it in a place where it won’t enter the atmosphere. While many scientists question whether the technology can be developed to the point of significantly reducing greenhouse gas emissions, Congress in 2018 enhanced and extended tax credits under tax code Section 45Q to encourage the development of projects that would use it.

But more than two years later the IRS still hasn’t released guidance to interpret parts of the new law that need to be cleared up, including definitions and rules on the types of structures that can be used to finance projects. The lack of clarity has scared off potential investors who worry they won’t be reimbursed for their contributions.

Large oil and gas companies like BP Plc., Chevron Corp., Shell Oil Co., and Exxon Mobil Corp. have asked the IRS to issue clarifying guidance so that projects, which have seen some initial interest from investment firms like Goldman Sachs Group Inc., can move forward.

“We don’t see any project being able to reach the final investment decision without the Treasury rules,” said Kurt Waltzer, managing director of the Clean Air Task Force, which is part of the Carbon Capture Coalition and a proponent of providing incentives for capture projects.

The IRS in 2019 released a notice requesting comments on planned regulations and guidance under Section 45Q. The agency on Tuesday told Bloomberg Tax that it plans to issue guidance within the next few weeks on construction start dates and partnership structures.

Tipping Point

The longer the agency waits, the greater the likelihood that projects won’t move forward at all because of how long it takes to vet, design, and secure permits and financing before a project can break ground.

To qualify for the tax incentives construction on a project must begin before 2024.

Developing a carbon capture project can take as long as five years and require investments of close to $50 million before construction can begin, according to a document posted to the Clean Air Task Force’s website.

That means some projects may already be doomed.

“Only those folks who have started the process, only those folks who have already invested some time and understand that they want a project so they’ve begun to go down that road have any chance if the current time frame stays at 2024,” said Steven Carpenter, director of the Enhanced Oil Recovery Institute at the University of Wyoming.

There are Democrat and Republican lawmakers who are open to extending that deadline. But competing priorities, including the upcoming presidential election, could make it difficult for any sort of agreement to be reached.

Two Approaches

Section 45Q offers slightly different incentives according to the type of carbon capture project.

The largest credit, worth up to $50 per metric ton, is available for projects where carbon dioxide is captured and securely stored underground. This includes “saline storage,” which involves pumping the gas into briny or salty water formations deep underneath the Earth’s surface. The carbon dioxide reacts chemically with the salt water to form solids that can’t migrate back towards the surface.

Deep saline formations in the U.S. could potentially store more than 12 trillion metric tons of carbon dioxide, according to estimates cited by the Energy Department on its website. This large capacity for cutting carbon dioxide emissions makes saline storage an attractive option, even though it doesn’t produce any valuable byproducts, according to DOE.

Despite Congress wanting to provide the largest incentives to encourage these types of projects, they’re the ones hurting most from the lack of IRS regulations.

Saline storage projects require an entirely new infrastructure, so they take longer and are more expensive to develop than enhanced oil-recovery projects, which can use existing oil fields and pipelines, Tracy said.

“Enhanced oil recovery” is a method that involves injecting carbon dioxide into existing oil reservoirs to create enough pressure to push more oil to the surface. It is eligible for a smaller credit, worth up to $35 per ton.

It takes less time to secure the necessary permits for these types of projects. They’re also an attractive option because there’s an opportunity to bring in money outside of the credit as the carbon dioxide is ultimately sold to oil companies, said Jeffrey Brown, principal at Brown Brothers Energy & Environment LLC.

The amount generated from those sales wouldn’t be enough to sustain a project on its own but it’s more than the zero dollars generated from saline storage absent some kind of tax credit, he said.

Some environmentalists have been skeptical of enhanced oil recovery as a long term option for addressing climate change, in part because it leads to more oil and gas production.

Burning Questions

The carbon capture industry has many questions for the IRS but there are a few that are most pressing.

Tracy said he’s involved in a project that would inject carbon dioxide into a nearly abandoned oil field and guidance on tax equity partnerships would help most to move that project forward.

Partnership flip transactions are common structures used in the wind and solar markets. Under that transaction a tax-equity investor and a project developer form a partnership to own and operate a project. The investor is allocated 99% of all income, loss, and tax credit until it achieves a target return, at which point the partnership “flips” and the investor’s share drops to 5%, lawyers at Latham & Watkins LLP explained in a 2019 client alert on the Section 45Q credit.

“The IRS formally blessed a typical wind-flip partnership in 2007 with a safe harbor that forged the template used to finance tens of billions of dollars in wind and solar projects over the past decade,” the law firm said.

Tracy and others have submitted written comments to the IRS seeking a similar safe harbor for carbon-capture projects.

In addition, the industry has asked the IRS to clarify several definitions—including what qualifies as “beginning construction"—and how they interact with existing definitions and terms used by the U.S. Environmental Protection Agency.

The IRS is also mandated by the law to write regulations requiring taxpayers to return credits they have claimed if stored carbon dioxide leaks. Key questions on this “recapture” provision include whether the agency will provide any exceptions—for example, if the leakage is the result of an event that is out of the taxpayer’s control, such as an earthquake or other natural disaster. Such exceptions would help attract more investors to these projects, the Latham & Watkins lawyers noted.

Without guidance, projects will remain in limbo.

“There’s too much risk that we could spend time, money, and energy and get down the path and turn around and they say, ‘Sorry, you missed the mark,’” Carpenter said.

—With assistance from Dean Scott and Amena Saiyid.

To contact the reporter on this story: Allyson Versprille in Washington at aversprille@bloombergtax.com

To contact the editors responsible for this story: Patrick Ambrosio at pambrosio@bloombergtax.com; Colleen Murphy at cmurphy@bloombergtax.com

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