DR.CHENJIAZI ZHONG

Although carbon emissions occupy a relatively small space on the spectrum of environmental, social and governance issues, as more and more countries and companies commit to Net Zero, they are steadily gaining attention from investors. Companies have relied on offsets to help avoid or reduce emissions for decades. Long associated with the “cap and trade” market, they are traded globally in two ways: (a) as allowances among companies to comply with mandatory emissions caps or (b) as part of various abatement initiatives in the voluntary markets. Offsets are generated through carbon-reduction activities across two broad categories: industrial and nature-based. Carbon capture and storage, for instance, are examples of industrial initiatives to remove carbon emissions.

Moral justifications are supporting the decisions to make strategic investments in carbon dioxide capture and storage. Investing in carbon capture and storage plays a significant role in a portfolio of global solutions to climate change in response to The Paris Agreement targets. Drawing on moral claims about protecting economic and energy access, carbon capture and storage capacity should be available to the regions with hard-to-decarbonize infrastructure.

The key question is, where to pursue the strategic investment? There are near-term and long-term considerations when investing in carbon capture and storage projects. Near-term global distributive justice and undermining legitimate expectations, which we favor investing in developing regions, especially in Asia. We also consider long-term climate impacts and the best uses of resources, and so we favor investing in the relatively wealthy regions that have the best prospects for successful storage development.

The investment risks of carbon capture and storage projects include (a) the risks directly associated with the operational activities of carbon capture and storage; and (b) the planning risks inherent in an over-reliance on large-scale, future deployment of carbon capture and storage. As such, generally, the investment risks of these projects are two aspects: general project risk or mitigable risks and hard-to-reduce risks, which refer to the risks that cannot be mitigated in the same way by private-sector actors. The hard-to-reduce risks can only be addressed by governments. 

Financing Models for Carbon Capture and Storage Projects

During the early stages of deploying carbon capture and storage projects, financial support from governments is necessary to mobilize private capital for these projects. In addition to government and public funding, private funding can come from a wide range of investors, especially banks, as they are experts in funding infrastructure projects. There are corporate-finance models and project-finance models: 

• Corporate-finance model: the corporate-finance model involves a single corporation that develops the project and finances all of its costs. The corporation may choose to implement the project through a subsidiary, which would then be consolidated into the corporate’s financial accounts. Since it has full ownership of the subsidiary, the corporation reaps all the benefits of the project. Still, it is also exposed to all of the risks and liabilities, which can be significant should the project not perform as expected. Such an arrangement makes it possible to raise debt at the corporate level, with the lenders having recourse to all the corporate’s assets in the event the project should not perform. This significantly reduces the interest rate applied to debt, making the latter relatively cheaper. Also, since the project management is internalized, this makes the entire corporate-finance process attractive in terms of cost of capital and speed of implementation. 
• Project-finance model: a more scalable funding model is project finance. It allows multiple equity investors to participate in a single project. Debt provided through project finance is referred to as non-recourse debt, and it is for this reason that this form of debt is charged at higher interest rates than corporate debt. Under project finance, the project is set up through a special purpose vehicle, with each investor having an equity stake. Capital for the project is raised based on future cashflows, so both equity and debt investors are exposed to any uncertainty in the performance of the project, thereby increasing the investment risk and subsequently the cost of debt. The ratio of debt to equity can vary significantly and will be dependent on the project specifics, availability of capital and the risk profile of the project owners. Some projects may have a very high gearing of up to 85% debt, whilst others will be much lower, at approximately 50% debt.

Innovative financing for carbon capture and storage projects includes sustainability-linked loans and green bonds. Sustainability-linked loans are particularly popular despite their recent emergence. Whilst green bonds have supported the deployment of other sustainable infrastructure projects, such as offshore wind and solar farms, issuances of green bonds have accelerated over the past decade and yields of green bonds are now often less than conventional debt. Green Climate Funds and their agencies can provide concessional financing to support the capital needed.

Typically, large companies, such as utilities, will find that corporate finance suits their needs better than project finance. This is because large corporations have two distinct advantages: their ability to use cash flows from other operating activities and use their general creditworthiness to borrow money to fund projects. Smaller companies, which do not have the large balance sheets of corporations will find the project finance structure to be the more attractive and accessible option for funding these projects. Key to their participation in the project finance model will be their capacity to partner up with other investors. Project owners will need to form consortia to raise equity, whereas lenders will come together to provide syndicated project loans on the debt side.

Investor Considerations

Unlike conventional private investments, a material value is placed on carbon capture and storage projects. This can be in the form of a carbon price or a financial reward for carbon dioxide storage. For investors, this value must be sufficient to incentivize investment in carbon capture and storage. Or the value placed on the carbon dioxide captured, transported and stored needs to exceed the cost of the carbon capture and storage projects.

Rather than a quantifiable IRR, the only way to maintain an acceptable return on investment is by reducing the capital required from investors. Also, there are trillions of dollars currently locked up in the private sector across financial markets, capital markets as well as other sources of funding such as sovereign wealth funds. So liquidity is another criterion to consider.