Economics of CCUS: Generating Revenue from Carbon Capture

In the first of a two-part series about the economics of CCUS, we'll examine the potential revenue streams applicable to a broad range of CCUS projects. The second part of this series will explore the typical capital costs associated with CCUS project investment.

Let's start by examining the cornerstone of CCUS project revenue: the 45Q tax credit.

Using the 45Q Tax Credit

The 45Q tax credit was first added to the US tax code in 2008, but the Inflation Reduction Act (IRA) of 2022 eliminated its reliance on corporate tax liability and its competition with other tax deductions and credits. Before the IRA, the potential to claim credits was limited, so the financial viability of most CCUS projects was impaired. The IRA transformed the credit into a direct revenue source, broadly stimulating CCUS project development. It also opened additional avenues for viable CCUS business models.

During the first 5 years of carbon sequestration, the project operator may possess the full credit income (“direct pay”) from the Internal Revenue Service (IRS), regardless of what it owes in taxes, and tax-free. Credits can also now be transferred (“sold”) at any time during the 12-year collection period. Logically, it makes sense to leverage direct pay during the first 5 years because transferred credits will generally sell at a discount relative to their original value. The sale of future credits does not, however, impact the ability of the project developer to claim current credits.

Additionally, because the credit price is fixed for the next few years, there is no volatility in the absolute credit value. However, in an interesting twist, although the current $85/MT (metric ton) is a static price through 2026, it will increase thereafter based on the Consumer Price Index (CPI). Therefore, projects that come online later may benefit from larger credit values per MT, barring any deflationary scenario.

However, the 45Q credits will be collected a year after they are generated, much like filing your individual taxes and getting the return the following year. This means that the credits will only produce revenue in the calendar year following their generation, including any credits intended for transfer. Additionally, although the value of the credits doesn’t technically change, the present value of the credits will reduce due to the additional time required to collect them from the IRS.

Presently, the current 45Q tax credit structure is authorized for only 12 years. This lack of long-term revenue potential creates a significant asymmetry between the total project revenue and the long-term liability that must be carried on these projects after the injection has ceased. The liability timeframe may be as short as 10 years in North Dakota to as much as 50 years for federal EPA projects. The credit has been modified before, so it’s possible that the 45Q tax credit structure could be authorized beyond the 12-year project timeframe. However, a present option to help reduce the revenue/liability asymmetry is the exploration and leveraging of carbon offset credits.

Using Carbon (Offset) Credits

Carbon offset credits (i.e., carbon credits, offset credits) can be traded in perpetuity if geologic storage continues to cooperate. Therefore, they can be a long-term revenue source well beyond the current 45Q tax credit timeline and collected in addition to the 45Q tax credits, as the two are mutually exclusive.

Unlike the 45Q tax credit, carbon offset credits trade through a market, meaning the value will be volatile and will fluctuate like a typical commodity. Historical carbon offset credit values have fluctuated from $5/MT to $25/MT for most carbon sequestration operations and more than $1,000/MT for direct air capture operations. Although carbon offset credit markets have been around for decades in varying degrees of viability (e.g., Kyoto Protocol’s Clean Development Mechanism, California’s LCFS Credit Market), the market for carbon offset credits is emerging. The market is anticipated to become more liquid over the coming years, but there is also a possibility that it may not be viable long-term if there is insufficient supply or demand.

Impact of Increased Depreciation

Although not a form of revenue, increased asset depreciation enhances a project's cash flow by reducing the overall tax liability of its corporate developer(s).

Before the IRA, the additional depreciation created by a CCUS project was largely counterproductive because it reduced the amount of tax credits that could be collected from the project, which in turn eroded the project’s value. That’s not the case now. As described earlier, the IRA detached 45Q from a company’s annual tax liability. The reduced tax liability created by the project’s additional depreciation now creates incremental project value for the developer(s).

However, because depreciation is related to the direct capital investment in a project, the higher the project's investment, or cost, doesn’t necessarily translate into a higher value for a project. Depreciation only benefits a tax liability, and large investment costs are detrimental to project economics.

Need More Information?

Trihydro’s CCUS team can help you navigate the opportunities. By combining technical proficiency with an understanding of potential financial drivers, we can help develop solutions tailored to your specific needs.

Connect with us to learn more.