A once-in-a-generation opportunity to control carbon pollution
Nine months after Clean Air Task Force wrote that the proposed enhancements to the 45Q tax credits offered a “once-in-a-generation” opportunity to advance carbon capture, removal, use, and storage, these enhancements are no longer proposals: they are law. With the enactment of the Inflation Reduction Act of 2022 (IRA), the United States is choosing to support the use of these carbon capture technologies. But more consequentially, it is choosing to place a high value on controlling carbon pollution from sectors that have previously been unable to consider such reductions because carbon capture technologies have long been financially out of reach.
What’s so significant about the carbon capture provisions in the IRA?
The passage of the IRA means that for the first time, carbon capture, removal, use and storage technologies are within reach for industries with the hardest-to-abate emissions, like steel, cement, refineries, and chemicals, as well as other key sectors like natural gas-based power generation. This is critically important since these sectors combined account for over a third of emissions in the U.S.1
Companies that manufacture these building blocks of our modern world, now have the option to significantly reduce or even eliminate their emissions. Prior to the passage of the IRA, these companies did not realistically have that option because there was no underlying market incentive for them to adopt carbon capture, which is necessary to help them decarbonize. Specifically for industries with significant process emissions (CO2 released from chemical reactions in the manufacturing process), post-combustion carbon capture is often the only practical decarbonization tool.
Before the IRA, the 45Q tax credit allocated $50/tonne of CO2 captured and stored, which significantly undervalued the costs of capture, transport, and storage for the industrial sector. By increasing the 45Q tax credit to $85/tonne, the IRA has created a new market for these industries: one where they can differentiate their products based on how little CO2 is released during the production process. Furthermore, by significantly increasing the credit value for direct air capture (DAC), the IRA has also given these industries the opportunity to differentiate their products based on the removal of historical or legacy emissions for which they are responsible.
What are the 45Q enhancements in the Inflation Reduction Act?
CATF has outlined the specific 45Q provisions in a fact sheet.
The major changes to 45Q are:
- Raising the credit values to $85 and $180 for both point source and direct air capture respectively;
- Providing a direct pay and transferability option for developers who claim the credit;
- Extending the commence construction window for projects to 2033; and
- Broadening the definition of qualified facilities by reducing capture thresholds.
We will explore the significance of each one of these changes in the section below.
Why are the 45Q enhancements in the IRA so important?
- Raising credit values makes carbon capture cost-effective for more sources.
The combined cost of carbon capture, transport, and storage varies greatly by application. As a rule, the more dilute the stream of CO2, the more expensive it is to capture. In the table below, fermentation processes at ethanol plants produce a highly pure CO2 stream that is not very expensive to capture. Going down the table, the concentration of CO2 becomes more dilute, and capture costs rise. CATF modeling based on 2020 U.S. dollars suggests that cement and refineries would likely encounter combined capture, transport, and storage costs between $65/tonne and $100/tonne for Nth-of-a-kind projects. Steel, petrochemicals, hydrogen, along with natural gas and coal fired power generation all pencil out in the $80-$90/tonne range. DAC is the most expensive type of capture with future capture cost estimates in the $100-200/tonne range and current ones likely far in excess of $200/tonne.2
Hence, $50/tonne in the previous iteration of 45Q was vastly undervaluing the capture, transport, and storage costs for the industrial and power generation sectors which need this technology the most to decarbonize. $85/tonne, on the other hand, makes carbon capture within the cost range for these industries and especially if the Department of Energy (DOE) and Environmental Protection Agency (EPA) can leverage the bipartisan infrastructure law’s carbon management provisions to build out the common carrier transport and storage infrastructure needed to reduce costs across the board.
Likewise, $50/tonne represented a paltry incentive for DAC. Though advanced market commitments continue to fuel growth in the industry, a 12-year fixed price of $180/tonne will likely be rocket fuel for the industry to takeoff.
- Direct pay and transferability make 45Q much more attractive to investors.
As discussed above, 45Q profit margins are razor thin, particularly for the first-of-a-kind projects that install carbon capture equipment or invest in DAC. For that reason, developers must extract as much value as possible from the credit to finance the greatest number of carbon capture facilities. The new 45Q direct pay and transferability provisions will likely do just that because they essentially allow developers to monetize the credit. With direct pay, developers can opt to receive a fully refundable tax credit. Without direct pay, 45Q is only a tax credit that requires the owner of any carbon capture equipment to have a sufficiently large tax liability from which to offset. Absent the large tax liability, the owner of the equipment must enter a tax equity partnership to essentially sell the right to use their tax credits to a larger investor in exchange for project financing. This introduces additional transaction costs and significantly dilutes the value of the credit, reducing the appetite of investors for carbon capture projects.
The direct pay option allows the lifeblood of markets – cash to flow freely through the carbon capture ecosystem. Direct pay also makes the carbon capture market much more attractive to a broader array of investors who do not operate in the $20 billion tax equity market, but might be keen to bundle carbon capture investments under the Environment, Social, and Governance (“ESG”) label that collectively encompasses over $45 trillion in assets. Though direct pay can only be realized for five years of the 12-year credit realization period for for-profit companies,3 the broad transferability provisions can serve to monetize the credit. They allow the carbon capture equipment owner wide latitude to make a one-time transfer of any portion of the credit to any tax-paying entity in exchange for a non-taxable cash payment.
- Extending the window to build projects will allow the carbon capture ecosystem to fully develop.
Carbon capture equipment is conceptually simple – analogous to putting a filter on a smokestack or vacuuming CO2 out of the sky – but technically complex to construct and operate. Developers cannot claim one penny of 45Q until they are securely storing CO2 underground, which requires the entire capture and storage ecosystem to be in place for any one project (usually transport from capture to storage site as well). The potential benefit here is that once a storage site and pipeline are developed and operational, they can be used for offtake of CO2 emissions or reductions from multiple capture facilities.
Right now, the component parts of the carbon capture ecosystem are being developed in different regions of the country. Thanks to funding under the Infrastructure Investment and Jobs Act (IIJA), there is an opportunity for a more coordinated approach to link many capture facilities to an integrated hub of transport and storage. But it’s important to note that in 2022, carbon capture facilities on steel, cement, refineries, hydrogen, petrochemicals, or natural gas power are only in developmental stages.4 Hence, there will be significant challenges in bringing many first through Nth-of-a-kind projects to commercialization. Even projects that can currently avail themselves of carbon capture (ethanol specifically) require a few years to construct from planning to operational stages. Thus, extending the commence construction window to 2033 was essential to support the long-term growth of the new carbon capture market.
4. Broadening the definition of qualified facility encourages innovation, “learning by doing,” cost reduction, incremental growth, and economies of scale.
A pre-IRA requirement stipulated that a point source facility must meet a high capture tonnage threshold5 before being eligible to receive 45Q. This was a measure that discouraged investment and would likely have stifled the market for emissions reductions and removals. The thresholds were counterproductive since a developer must commit to the entire capture and storage (likely transport too) ecosystem by actively storing CO2 underground before receiving even one penny of the 45Q credit. Investors would shy away from an investment with the possibility of no return if the capture project was even a few tonnes short of the threshold in any given year. It would disincentivize important gains – learning from small project development before tackling a big one – which is the well-trodden path of innovation. The IRA enhancements to 45Q that significantly lowered tonnage capture thresholds now allow project developers to start small before going big.
It is also important to note, that this enhancement is especially important for the DAC industry. There are currently 14 operational point source carbon capture facilities in the U.S. but no operational DAC facilities because the technology is not as mature as point source capture. The lone DAC facility that captures and stores several thousand tonnes of CO2 per year is in Iceland. Prior to the passage of IRA, a first-mover like this Icelandic facility would have been ineligible for 45Q purely because it did not capture and store 100,000 tonnes per year. Good DAC technology will likely be commercialized in the U.S. now that investors can back reasonable development goals – starting with smaller facilities before tackling larger ones.
How will the IRA’s 45Q enhancements create a new market and jumpstart an emissions reduction and removal industry?
In summary, the IRA’s enhancements to an obscure tax credit (45Q) have created a new market that will likely jumpstart a carbon emissions reduction and removal industry. Businesses that are savvy will take advantage of the opportunity and create thousands of well-paying jobs in the process. Carbon capture, which was once elusive or unthinkable for so many companies, has now become tantalizingly realistic.
Where do we go from here? Unanswered questions remain about the potential new 45Q market
The purpose of the IRA’s 45Q enhancements is to create a market in which carbon capture, removal, and storage can thrive across broad swaths of the industrial and power generation sectors. Until now, market conditions, not technical readiness, have been the reason for the small number of operational carbon capture facilities in the United States. The IRA’s 45Q enhancements finally value the reduction or removal of CO2 to a sufficient degree to spur whole systems of decarbonization based on carbon capture rather than isolated projects.6
Furthermore, carbon capture is distinct from most other technical climate solutions. Unlike renewables, nuclear, or hydrogen, which generate or transport a product (energy) with inherent value, carbon capture is a suite of pollution control technologies that deal with a waste product: CO2. The significance of the IRA’s 45Q enhancements is that the United States is finally making a significant push to deal with this pollution in sectors of the economy that cannot stop producing carbon. In that sense, this nation is finally enabling carbon capture to work.
With few exceptions, strong government incentives are necessary to undergird the development and deployment of carbon capture technology because there is a limited market for CO2 reductions and removals apart from policy. The question of how much emissions will be reduced or removed because of the IRA’s 45Q enhancements remains to be seen. Although additional work on carbon capture policy will be needed in the future, Congress made a giant step forward to incentivize the use of carbon capture by passing the IRA. Now, it’s time for companies to do their part to take advantage of enhanced 45Q incentives by capturing and securely storing significant amounts of CO2 as quickly as possible.
1 Combined, the industrial and power generation sectors make up around half of U.S. emissions: https://www.epa.gov/ghgemissions/sources-greenhouse-gas-emissions#:~:text=and%20Forestry%20sector.-,Emissions%20and%20Trends,increased%20by%206%25%20since%201990
2 It is hard to discern current DAC costs because there are so few facilities around the globe and only one, Orca in Iceland, that is both capturing and storing.
3 Nonprofits can claim a direct pay option for all 12 years of the credit.
4 Some facilities are in development for these various industries. See our project map tracker: https://www.catf.us/ccsmapus/
5 500,000 tonnes for power generation and 100,000 tonnes for all other projects including DAC.
6 The statutory language in IRA more broadly applies to the capture of “carbon oxides.”