Other than Enhanced Oil Recovery (“EOR”), which is effectively banned in California, there is no market for captured CO2; no direct economic benefit, product or service to be bought or sold. Thus, Carbon Capture and Sequestration (“CCS”) is only possible through governmental subsidies provided by the state and federal governments.
Congress has provided the most significant economic incentive for CCS through the so-called “45Q” tax credit, initially introduced in 2008 (26 U.S.C. §45Q.) The 45Q statute was most recently updated in the Inflation Reduction Act (“IRA”) of 2022 to provide a tax credit of $85 per metric ton for CO2 captured from stationary sources such as oil refineries, and $180 per ton for carbon captured through from direct air capture (“DAC”), i.e., directly from the atmosphere. The tax credit is available to project owners for 12 years from the date the CO2 facility is initially placed in service. Excess credits can be carried forward or back by CCS project owners. Thanks to the IRA, both for-profit (for the first 5 years) and non-profit companies have the ability to receive direct pay, meaning that project owners can receive the credit as a cash rebate from the IRS. CCS project owners also are eligible for preferential depreciation on their CCS equipment and facilities.
Congress also made the 45Q credits transferable to a third party who enters into a contract with the project owner to (i) dispose of the qualified CO2, (ii) use the CO2 in a qualified EOR project (not applicable in California), or (iii) “utilize” the CO2. Under Section 45Q(5), “utilization” is defined as (i) fixation of CO2 through photosynthesis or chemosynthesis, such as through growing algae or bacteria, (ii) chemical conversion of CO2 into a compound in which the CO2 is securely stored; or (iii) subject to certain exclusions, use of CO2 for any other purpose for which a commercial market exists.
While the 45Q credit provides significant economic benefit to CCS project developers, there are ongoing questions and concerns. Projects are only eligible for 45Q credit if they are built and maintained using prevailing wage labor, adding to capital and operating costs. The 45Q credit also places a significant burden on the federal budget. 45Q credits are estimated at $30.3 billion between 2022 and 2032 according to the Congressional Research Service report, updated as of August 25, 2023. As a result, the 45Q credit has been a target of serious congressional debate. In early 2023, some Republicans in Congress threatened to remove or reduce the 45Q credit as a part of a debt-ceiling deal. They argue that it places a significant cost on American taxpayers, and that its environmental benefit may not be worth the cost. Yet even in the Republican controlled House, the 45Q credit survived the debate due to the benefit it provides to oil and gas producing states and districts, leading many to believe that the 45Q credit ultimately will survive changes in partisan control of Congress or the White House.
Another concern is that, despite its significant benefits, the 45Q credit is not providing enough economic incentive for investors to commit to projects. Financial markets are concerned with the political stability of the credits as well as its 12-year term; perceived to be too short to recover the 15+ year debt financing often needed for these projects.
Also, CCS projects are not eligible for the 45Q credit if they are also receiving other federal energy tax credits such as the 45V hydrogen credit or 45Z clean fuel credit. In 2023, despite significant political pressure from CCS project developers, the U.S. Treasury Department determined that allowing project developers to take more than one type of credit would be double-dipping, and upheld the prohibition against a project owner taking more than once credit. This led many so-called “clean” fuel producers to choose the fuels credits over the 45Q credit. (The overlap between the federal 45Q credit and the California “low carbon fuel standard” credit will be the topic of a future blog.)
Despite the concerns about the 45Q credit, its future seems relatively secure because it is essential to developing the CCS industry, and CCS currently is considered to be a proven means by which the US may obtain carbon neutrality. In California, there are several well-established players in the CCS market, including Chevron and California Natural Resources Corporation (through its subsidiary Carbon TerraVault, LLC). Still, that market is in its infancy. Only one CCS project has received initial permit approval from EPA. Exactly how the CCS industry will mature, and how much CCS activity the 45Q credit will actually stimulate in California, have yet to be seen.
This blog is part of a series that explores the economic benefits, development processes, and legal issues arising from CCS projects in California. For more information, or to learn how we might be able to help you navigate a CCS project, please reach out to us at 805-557-8081, email us at dossentjuk@oandblawyers.com, or visit our contact page.