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Inflation creates new urgency for passage of 45Q enhancements 

June 3, 2022 Work Area: Carbon Capture

According to the IPCC’s recent Working Group III report, policymakers have ample reason to  hasten the widescale development of carbon management technologies, which include carbon capture, direct air capture (DAC), and geologic storage. The choice is stark: either make massive investments in the policies that will ensure these technologies (as well as others) become widely used, or greatly increase the probability of foregoing a future where global warming is kept to 1.5ºC or even 2.0ºC — the point beyond which climate scientists predict we could pass irreversible tipping points.  

In the U.S., the 45Q tax credit is the main policy driving the adoption of carbon capture and storage. Since the credit value was raised to $50 per tonne in 2018, U.S. carbon capture projects have surged, and while the growth is promising, it’s simply not enough.  

In order to ensure that we can decarbonize heavy industries like steel and cement manufacturing (accounting for about 15% of CO2 emissions) and that we can remove significant amounts of carbon dioxide  from the atmosphere through DAC, we must improve the 45Q tax credit. Now, against the backdrop of the highest inflation rate in a generation, the need to pass the 45Q enhancements that were proposed in the Build Back Better Act along with an adjustment for inflation is even more urgent. If lawmakers don’t pass these measures, the high rate of inflation that the U.S. is currently experiencing threatens to erode the credit value well below levels that are economically feasible for project developers. 

Lawmakers must pass the following 45Q policy enhancements to ensure the tax credit spurs the turbo-charged growth of carbon capture and storage consistent with a larger unparalleled transformation of our energy system to address climate change:  

  • Raise the credit value of 45Q to $85 per tonne for carbon capture and storage and $180 per tonne for DAC. 
  • Adjust 45Q for inflation from enactment with 2020 as the base year, as is currently proposed for other energy tax credits. (The previous draft of the budget reconciliation clean energy tax package does not index 45Q to inflation until 2027). 
  • Ensure the 45Q credit is available through direct pay. 
  • Extend the commence construction deadline from 2026 to 2032. 
  • Lower emissions eligibility requirements to 18,250 tonnes per year for power plants, 12,500 for industrial facilities, and 1,000 for DAC. 

Raise 45Q to $85 per tonne for carbon capture and storage and $180 per tonne for DAC 

Raising the credit value of 45Q from the present value of $50 per tonne of CO2 stored in saline formations is the cornerstone of proposed 45Q enhancements. As shown in Figure 1, $85 allows the credit to incentivize projects in hard-to-decarbonize industries in a way that the current rate of $50 cannot. $180 per tonne for DAC also begins to bridge the gap between the current credit value and the cost of capturing directly from the ambient air. 

$85 45Q helps enable the development of projects in all
industries suitable for capture (2020 $)

Figure 1

In total, an $85 per tonne credit could allow the U.S. to sequester 48 million tonnes of CO2 by 2031 in the industrial sector, and an estimated 75 million tonnes from power generation (Figure 3). Keeping 45Q at its current $50 per tonne value means it is unlikely the U.S. will be able to decarbonize heavy industry in a timely manner. Furthermore, raising the credit value to $85 per tonne would have the additional benefit of creating between 4,000 and 4,800 project jobs and between 2,500 and 3,600 operations jobs, according to a study by the Rhodium Group

Index 45Q for inflation 

When the capture costs in Figure 1 are adjusted for inflation, an increase of 45Q from $50 to $85 per tonnes meets the financing needs of many carbon capture and storage projects, particularly when costs are adjusted to 2022 dollars. Steel and petrochemical production as well as gas power are no longer cost effective even in the lowest-cost scenarios. Other industries see their higher and even medium-cost range excluded. Only high-cost chemical production projects would still be viable.  

In the most recent draft of the clean energy tax package developed by the Senate Finance Committee for budget reconciliation, the 45Q credit value is increased from $50 per tonne to $85 per tonne, a significant enhancement. The amount of the credit would be adjusted for inflation beginning in 2027. However, the analysis that indicated that $85 per tonne would be sufficient to commercialize carbon capture and storage on a suite of power and industrial sources was based on the assumption of ongoing low inflation rates. Without ensuring that the inflation adjustment for point sources and DAC begins upon enactment (with 2020 as the base year), record-high inflation will likely erode the real value of the credit significantly and once again render 45Q insufficient to incentivize carbon capture on most industrial and power sources or DAC (Figure 2).  

In fact, inflation has already eroded the value of the 45Q credit. In 2021, the Consumer Price Index (a standard metric of inflation) rose by 7% and is projected to rise by 8% in 2022. In 2020 dollars, a 45Q credit increased to $85 per tonne would only be worth $74. Likewise, an increase to $180 per tonne for DAC would be reduced to $156. If inflation continues to rise at 5% (below the rate at which it is rising now), this erosion will reduce 45Q to $61 for point source carbon capture and $128 for DAC (Figure 2). This is a decrease of almost 30%, which will significantly slow the growth of carbon capture and storage projects. 

To prevent this erosion, the 45Q credit must be set to $85 per tonne for industrial and power sources and $180 per tonne for DAC and also be indexed for inflation using 2020 as the base year. This is consistent with the automatic inflation adjustments currently proposed for the clean hydrogen credit and other clean energy credits in the most recent clean energy tax draft being developed by the Senate for budget reconciliation. 

Without indexing 45Q, inflation erodes the real value 30% by 2026,
which disincentivizes project development

Figure 2

Make 45Q accessible through a direct pay option 

Under current law, energy projects financed with federal tax incentives, including 45Q, require the owner to have sufficient tax appetite to fully monetize the tax credits. If they don’t, they must find a tax equity partner that is willing to invest in the project largely for the tax incentives. This has not always been the case. As part of the renewable energy portion of the American Recovery and Reinvestment Act of 2008, Congress provided an alternative source of financing allowing taxpayers to claim a grant instead of the tax incentive. This innovative approach triggered the most expansive period of growth in renewable energy in the U.S. It allowed project developers a third financing option which untethered them from tax equity financing or their own tax appetite.  

This concept has been modified and improved in the current reconciliation bill by creating “direct pay.” This option allows taxpayers to use the credits in the traditional way or to claim an equal amount as if it is an overpayment of taxes. This option creates increased market efficiency and reduces concerns that the tax equity market would be stretched and likely more expensive, particularly for less established technologies such as carbon capture, removal, and storage. It also preserves the full value of the credit for project development rather than devoting a significant percentage to compensating the financial industry. 

From a budgetary standpoint, while direct pay will greatly increase the efficiency and cost of capital for investments in carbon capture, removal, and storage projects, it is unclear if removing this option will have significant impact on the revenue cost of the bill based on the methods and assumptions being used by the Joint Committee on Taxation. In other words, eliminating direct pay from the bill might not result in significant tax revenue savings, but could result in higher cost of financing and energy for consumers. 

Extend the commence construction deadline 

Carbon capture projects are complex and require several years of planning before construction begins. Under current statutory requirements, projects must begin construction by the end of 2025 to qualify for 45Q. With only three and a half years remaining in the commence construction window, effectively a new project would need to begin planning in 2022 or 2023 to have a realistic chance at qualifying for the credit. The most recent draft of clean energy tax credits extends this window to 2032, giving time for projects to be properly planned and developed. 

Lower emissions eligibility thresholds 

Currently, 45Q limits eligibility to only the largest emitters: facilities emitting more than 500,000 tonnes of carbon dioxide per year from power plants and 100,000 tonnes from industrial facilities. DAC would require the capture of at least 100,000 tonnes. The most recent draft of clean energy credits lowers these arbitrary thresholds to 18,250, 12,500, and 1,000 tonnes respectively. Eliminating these thresholds expands the pool of eligible projects and spurs innovation that often starts with smaller facilities that can more easily garner investor support.  

Small tweaks to 45Q yield significant growth 

Clean Air Task Force’s modeling finds that 45Q enhancements in combination with provisions enacted in the Infrastructure Investment and Jobs Act (IIJA) have the potential to unlock a 13-fold increase in the number of carbon capture projects (Figure 3). By 2031, the proposed 45Q enhancements in combination with IIJA could spur between 72 and 125 million tonnes of CO2 captured per year. More importantly, they would put the United States on the path to achieving gigatonne-scale carbon capture by mid-century which will be necessary to keep global warming to manageable levels. 

The cost of these 45Q policy changes is very small: the Joint Committee on Taxation (JCT) estimates the federal government’s proposed expenditures on 45Q would be just $2 billion. The benefit of these changes would be reaped for generations. That is a big win for the American people. Congress must pass these enhancements now.  

Figure 3

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