Capturing Carbon — Tax Credits: A Reinvigorated Climate Opportunity for Developers and Investors

by Morrison & Foerster LLP
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The powerful momentum behind clean energy promises real progress in the fight against global climate change. Mounting scientific evidence urges, however, that to win: We cannot just reduce the carbon-intensity of the energy we use – we also need to catch the carbon pollution already in the atmosphere. To achieve our climate stabilization targets, we will likely need to achieve negative emissions at the gigaton scale within a decade, and quickly ramp up.[1]  And although the technology to achieve this feat is known, it has not hit its stride commercially.

Fortunately, this technology for carbon removal – catching carbon pollution to either sequester or use – is now getting an additional boost from the federal government. Building on earlier investments through direct spending and tax incentives, the U.S. Congress passed a new tax credit in February 2018 designed to spur investment in carbon removal technology. In addition, the U.S. Congress is currently debating legislation that would create yet additional grant and prize authorities for certain federal agencies to directly spend on innovation in this arena, and encourage the rapid regulatory development needed to remove barriers to at-scale deployment of carbon removal technologies.

Revamped Tax Incentive

On February 9, 2018, Section 41119 (“Enhancement of Carbon Dioxide Sequestration Credit”) of the Bipartisan Budget Act of 2018 became law.[2]  The law revises the current Section 45Q carbon dioxide tax credit, which has been part of the federal tax code since late 2008.  The law revamps the tax incentive in a number of key ways, including:

  • Removing Overall Cap on Credits: For projects already placed in service as of February 9, 2018, the prior law’s overall limit of allowable credits remains: the IRS will only issue credits for up to 75 million tons. This cap provides that no more tax credits may be claimed by anyone after the IRS announces the cap has been reached and chilled earlier carbon sequestration development by making it impossible to know, when planning a project, how much in tax credits a developer would receive. However, projects placed in service after enactment of the new law do not face such a cap. In place of this overall cap on credits, the new law allows any new project that commences before January 2024 to claim credits for 12 years.
  • Increasing Value of Credit (per ton): The new law significantly increases the value of carbon removal; while retaining a premium for sequestration that does not involve co-production of oil and natural gas (i.e., Enhanced Oil Recovery), it adds a new third category of eligible use cases: carbon removal that stores the carbon in products like cement or chemicals, rather than in the ground, or geologically. Unlike the prior law, the new law also includes a significant ramp up of the credit (in addition to inflation-related increases). Figure 1 summarizes these changes.

Figure 1

Use Case

New Law ($/ton CO2)[3]

Old Law ($/ton CO2)[4]

Geologically Sequestered CO2 (with Enhanced Oil Recovery)

Increasing annually from $12.83 (2017) to $35 (2026)

$10 (2017 value was $11.24)

Geologically Sequestered CO2 (without Enhanced Oil Recovery)

Increasing annually from $22.66 (2017) to $50 (2026)

$20 (2017 value was $22.48)

Non-Geologically Sequestered CO2 (e.g., used as feedstock)

Increasing annually from $12.83 (2017) to $35 (2026)

N/A

  • New Thresholds for Qualification: While the prior law contained an across-the-board qualification threshold requiring projects to catch and sequester no less than 500,000 metric tons of carbon dioxide per year, the new law creates three different thresholds depending on source and use case of the project. Specifically, the new law treats power plants and non-power plant industrial facilities differently. In addition, the new law reduces the threshold further for carbon dioxide that is put to use in products like cement or chemicals. Figure 2 summarizes these changes.

Figure 2

Source + Use Case Profile

New Law (ton/yr.)

Old Law (ton/yr.)

Electric Power Plant

> 500,000

> 500,000

Industrial Facility

> 100,000

> 500,000

Industrial Facility + Non-Geologically Sequestered CO2 (e.g., used as feedstock)

25,000 – 500,000

N/A

The new law, however, does leave a number of unanswered questions regarding how IRS will implement the credit. For example, developers and investors need additional information regarding:

  • Measurement of Carbon Removal: The new law directs IRS to use the sort of life-cycle analysis defined in the Clear Air Act to measure the carbon dioxide (and, in turn, greenhouse gas) benefits of the projects and technologies to be credited by this incentive. In the past, IRS relied on the U.S. Environmental Protection Agency (EPA) reporting to measure benefits from geological sequestration;[5] it remains unclear whether that approach will be retained and how the IRS will approach the newly eligible use cases (e.g., where carbon is stored in products).
  • Transferability, Stacking, and Recapture: The new law leaves open questions regarding the details surrounding transferability of the credits, which the law allows but does not define. In addition, IRS will need to clarify whether and how one facility might generate different types of credits during its lifetime – i.e., how the credits stack, if at all. Finally, while the law includes a recapture provision, IRS will need to define how the recapture provision works to maximize uptake of the incentive.
  • Qualified Facilities: The minimum per ton threshold for qualification combined with transferability raises some uncertainty around how easily carbon removal activities can be aggregated into a single qualified facility for purposes of the tax credit. Clarification on this issue will determine how this industry builds out and where in the supply chain monetization of the credit becomes commonplace.

In the coming months, the IRS – in consultation with the EPA and U.S. Departments of Energy and the Interior – is expected to issue both guidance and new rules that will likely add clarity to these and other open issues and aid in robust implementation of the incentives. We noted, however, that the IRS 2017-2018 Priority Guidance Plan does give a time frame for the issuance of new 45Q guidance beyond just the notice setting the inflation adjustment factor for the 45Q credit for 2018. We may understand the IRS’ timing more clearly when the third quarter update to the Priority Guidance Plan is published.

Sustained Federal Focus

Congress is not done legislating on carbon removal. Already this month, Congress is debating a new law S. 2602, the Utilizing Significant Emissions with Innovative Technologies Act, or USE IT Act.[6]  This bill could build on the new tax law by providing additional grant and prize authorities for federal agencies to directly spend on innovation in this arena and encouraging the rapid regulatory development needed to remove barriers to at-scale deployment of carbon removal technologies.  While the law remains in committee and continues to evolve, the directionality is clear: on a bipartisan basis, the Congress appears to be backing carbon removal.

The full potential of the incentives in place and being contemplated is not yet realized, but the federal government has reinvigorated this climate opportunity for developers and investors. The tax credits alone could deliver tens – if not hundreds – of millions per project in tax cuts for developers and investors in carbon removal.

 


[1] See, e.g., Johan Rockström, Owen Gaffney, Joeri Rogelj, Malte Meinshausen, Nebojsa Nakicenovic, Hans Joachim Schellnhuber, A roadmap for rapid decarbonization. Science24 Mar 2017: 1269-1271 available at http://science.sciencemag.org/content/355/6331/1269.

[2] Public Law No: 115-123, see https://www.congress.gov/bill/115th-congress/house-bill/1892/.

[3] Annual adjustment for inflation in years after 2026. For years 2017-2026, increases to be based on linear interpolation.

[4] Annual adjustment for inflation started after first year of enactment.

[5] See https://www.epa.gov/sites/production/files/2015-07/documents/subpart-rr-uu-factsheet.pdf.

[6] See https://www.epw.senate.gov/public/index.cfm/hearings?ID=55DD866C-BEE0-49C7-8491-E042F051C947.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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