House of Commons - Science and Technology

Select Committee on Science and Technology First Report

6 COSTS AND INCENTIVES

115. Most of the cost penalty associated with CCS comes from the capture process. Approximately 75% of the present cost of CCS in full scale plants derives from the CO₂ capture process. Transport costs depend on the amount being transported, the distance between the site of capture and that of storage and on whether existing infrastructure can be utilised. The costs of injection and storage are a relatively small component of the overall cost and are not expected to be prohibitive. Although it may seem superficially appealing to bypass the expensive capture step and directly inject the flue gas into the storage site, this would require extremely large and expensive pipelines and would not be desirable for a number of reasons. For example, it would use up the storage capacity at a much faster rate. Also, a relatively pure stream of CO₂ is required to minimise pipeline corrosion and the presence of pollutants could have unpredictable effects on the interaction of the gas with the storage site and other potential environmental implications. It would also change the regulatory framework with which the process would need to conform.

116. A wide range of costs have been cited in association with electricity generated using CCS. This largely reflects the array of factors that need to be taken into account, such as the technology chosen for the base case scenario, site-specific issues, national circumstances, oil and gas prices and the predicted benefits of economies of scale.

117. According to the Royal Academy of Engineering, the typical additional cost of CCS is about 1-2.5 pence per kilowatt-hour (p/kWh).[200] UKCCSC also estimates additional costs required to produce electricity from CCS to be in the range of 1-3 p/kWh.[201] The IPCC report states that application of CCS to electricity generation would increase costs by approximately $0.01 to 0.05 per kWh, depending on the fuel, specific technology, location and national circumstances.[202] At current exchange rates, this equates to approximately 0.5-2.8 p/kWh.

118. In view of the different approaches adopted to the calculation of costs associated with CCS, we have produced a standardised set of cost data based on common assumptions defined by us (see Annex B). The data represent the average of the figures submitted by DTI, E.ON, BP, Progressive Energy and the UK Carbon Capture and Storage Consortium.

Table 1: Cost of electricity generation with CCS

	Without CCS	With CCS
Coal	2.6p/kWh	3.7p/kWh
Gas (£4/GJ cost)	3.4p/kWh	4.3 or 5.7p/kWh

Source: average of cost data presented by 5 sources in response to questions aimed at producing data on a standard basis.

119. The data on gas power generation with CCS from three of the sources suggest an average cost of 4.3p/kWh, whilst two sources suggest an average of 5.7p/kWh. The reason for the difference is not clear and could not be established on the basis of the information available. Otherwise there is good agreement between most of the information provided by these 5 sources. In summary, the data suggest that under the conditions specified:

use of CCS with coal (irrespective of whether it is post-combustion or pre-combustion capture) leads to a cost of generation of about 3.7p/kWh compared with a cost without CCS of 2.6p/kWh;
electricity generation with CCS from gas costs about 5.0p/kWh (this is the average of the range 4.3 to 5.7p/kWh) at £4/GJ gas price compared with a cost without CCS of 3.4p/kWh;
at a lower gas price (£3/GJ), which may be more representative of planning assumptions today, the cost of electricity generation with CCS is probably about 4.3p/kWh (but the data were insufficient to be confident in the precise number).

Another way of measuring cost which is often discussed in the literature is to express the extra cost of a plant using CCS in relation to the amount of CO₂ emissions avoided. For coal plant, the cost of avoided emissions compared with the plant which would be built today is £17/t CO₂ avoided. For gas plant, the corresponding cost would be about £40/t CO₂ avoided - the higher cost of avoidance in this case in part reflects the smaller amount of CO₂ produced by such plant.

120. Overall, the data collected in this inquiry indicate that the cost of electricity generated using CCS is 1-2 p/kWh more than without. Taking into account the uncertainties associated with these calculations, the data suggest that there is no clear 'winner' between gas- or coal-fired plant fitted with CCS. It would also appear that an increased gas wholesale price has only a weak effect on cost data.

121. Futhermore, the cost of electricity generation using CCS seems to be comparable with, or less than, published costs from other carbon abatement or low carbon technologies such as nuclear and renewables. E.ON UK, for example, gave a range of 3.9-5.1 p/kWh for electricity generated from coal using CCS compared to 2.5-4.0 p/kWh for nuclear, 4.2-5.2 for onshore wind and 6.2-8.4 pkWh for offshore wind.[203] [204] Others have estimated the cost of electricity from nuclear fission to be higher.[205] George Marsh, the DTI's adviser on carbon abatement technologies, acknowledged the competitiveness of CCS in his evidence:

206

Dr Marsh's crucial point about the need for an appropriate investment framework is addressed in paragraphs 128-147.

INFRASTRUCTURE

122. CCS and, in particular, transport of CO₂ between capture and storage sites requires a considerable amount of new infrastructure. The cost of laying new pipeline is a function of its length but also depends on factors such as the terrain: according to the IPCC Special Report, onshore pipeline costs may increase by 50-100% (or more) when the pipeline route is congested and heavily populated.[207] Costs also increase if the pipelines have to pass through mountainous areas or overcome obstacles such as rivers and major roads. Offshore pipelines are frequently up to 70% more expensive than onshore ones, usually having to operate at higher pressures and lower temperatures.[208]

123. It seems unreasonable to expect any one industrial project to bear the cost of installing large scale pipelines. The memorandum from BNFL stated that "Large-scale transportation of CO₂ would require an extensive pipe work infrastructure, on the same size and scale as that used today for the large-scale natural gas supply network".[209] BNFL also argued that it was "unlikely that large sections of the existing natural gas transmission system will become available for CO₂ transportation use from clean coal plant until natural gas is no longer used for power production and industrial heating".[210]

124. Dr Freund noted that transport infrastructure had significant cost implications for early projects : "The cost of pipelines for single capture/storage projects will tend to distort the cost […] To avoid this it will probably be necessary to transport 10Mt/y or more […] which may be more than one individual project could justify".[211] He therefore called for Government to provide "incentives for establishing a CO₂ infrastructure", using the analogy of transmission systems for electricity and gas: "The common good makes a commanding logic to establishing such infrastructure by use of government support, more so than subsidising an individual plant or storage project".[212] BP noted in its memorandum that the "significant" cost of CO₂ transport can "be offset if the re-use of existing infrastructure is possible and encouraged".[213] It seems unreasonable to expect industry to bear the full costs of the infrastructure required for CCS, particularly in the case of the first demonstration projects. The Government must make sure that this is not a deal breaker for the first demonstration projects.

OPPORTUNITIES FOR COST REDUCTION

125. Part of the cost of CCS reflects the loss of energy efficiency associated with the capture process. Much of the evidence comments on the need to improve the energy efficiency of plant if CCS is to become viable. The Royal Academy of Engineering highlighted the need to characterise better, and reduce, the efficiency loss associated with CCS: "The overall loss in efficiency is about 30% but this estimate is subject to debate, and should be the area in which much of the R&D effort should be directed".[214]

126. George Marsh, a DTI adviser, argued that "there is a technical potential to reduce [CCS] costs by the order of 50 per cent".[215] Gardiner Hill from BP, who has been heavily involved in the Carbon Capture Project (CCP) initiative to reduce the costs of capture had a similarly optimistic view.[216] Nick Otter from Alstom also noted that cost reduction was likely to emerge as a result of learning and economies of scale, using the analogy of Flue Gas Desulphurisation [FGD] technology which is fitted to plant to reduce toxic sulphur dioxide emissions:

₂

217

It seems reasonable to expect that new technological developments and benefits derived from increasing experience and economies of scale could collectively lead to significant reductions in the costs associated with CCS.

127. The cost to the operator might also be offset by income from EOR and, in the future, by carbon credits for reductions in emissions. Additional benefits or costs could arise from other Government support, fiscal or regulatory measures. These are the focus of the next section.

Market incentives

128. One of the most striking conclusions of the evidence we received was that there are no inherent technological barriers to CCS and industry is ready and willing to launch demonstration projects. The sole obstacle, therefore, is the lack of a policy and incentive framework to provide industry with confidence that it will have a potential means of recouping costs in the long term. Provision of the framework is the responsibility of the Government. Brian Morris, Head of Carbon Abatement Technologies at the DTI, acknowledged this in oral evidence:

"We recognise that there is a need for some sort of incentive. We also recognise that carbon trading in itself is not enough and that there needs to be some sort of way to bridge the gap. How we bridge that gap is difficult to say at this point".[

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There are no fundamental barriers to the development and deployment of CCS in the UK, apart from the lack of a suitable long term policy framework to provide industry with the incentives and confidence it requires to make the substantial investments entailed in CCS projects. The Government must put this framework in place as quickly as possible-it is already at risk of holding back UK industry.

129. We were pleased to hear Malcolm Wicks, the Energy Minister, support the idea of a framework that incentivises CO₂ emissions reductions rather than any particular technology. He told us:

219

The Minister rightly pointed out that "as we move towards that, there is a case for incentivising and helping fund certain technologies", for example through the Renewables Obligation (see paragraph 139).[220] The Minister also made it clear who held the purse strings, telling us: "fiscal and tax matters are best left to the Treasury and I am not going to trespass in that territory".[221] In the longer term, the Government should seek to provide a level playing field for all carbon abatement technologies. This does not exist at present and there is, moreover, little prospect of it emerging in the near future. A technology neutral incentive framework would better reflect the overall objective, which is to reduce CO₂ emissions. It would also be more efficient to let the market decide which technologies provide the best solutions to meet this challenge.

130. It is argued by some that since everyone will reap the benefits of climate change mitigation, industry should not be expected to foot the bill. Rio Tinto told us: "Everyone, including future generations, will benefit from a stable climate. Industry on its own cannot be expected to bear the full cost of developing and demonstrating new technologies".[222] Sussex Energy Group also asserted that "There is a strong rationale for UK government support for CCS technologies because the market value of carbon emissions is well below their full social cost, and the full economic benefits of innovation cannot be captured by private innovators".[223] Dr Douglas Parr from Greenpeace took a different stance, arguing that "We've given tax breaks to companies for getting oil and gas out of the ground, we shouldn't subsidise them to put the subsequent pollution back underground".[224] We acknowledge the need for Government support during the early stages of technology development. Ultimately, however, a market-based mechanism that puts a price on carbon is the best way to incentivise industry to invest in CCS and other carbon abatement technologies. Possible approaches to incentivising industry are discussed further below.

EU-ETS

131. The EU-Emissions Trading Scheme (EU-ETS) was introduced to enable the EU countries to meet their CO₂ emissions reductions targets under the Kyoto Protocol. The EU-ETS was established by Directive 2003/87/EC in October 2003 and transposed into UK national legislation via the Greenhouse Gas Emissions Trading Scheme 2003. The EU-ETS covers roughly 12,000 industrial plants across the EU's 25 Member States, accounting for around 46% of Europe's total CO₂ emissions. The EU-ETS comprises, in the first instance, two phases: Phase I runs from 2005-2007 and Phase II from 2008-2012 (to coincide with the first Kyoto Commitment Period). Further phases are expected thereafter but no firm commitments have been made.[225]

132. The scheme is based on a system of allowances, whereby each allowance entitles the holder to emit one tonne of carbon dioxide per year. The total number of allowances granted to each Member State is capped to reflect that country's Kyoto commitment (e.g. for the UK, this is a 12.5% reduction). National governments then allocate allowances to companies (free of charge). Since the total number of allowances available is restricted, companies emitting more CO₂ than their allowances permit are forced to either reduce their emissions or purchase extra allowances. Conversely, companies which reduce their emissions below the level permitted by their allowances have the opportunity to sell their allowances. Thus the EU-ETS creates both an incentive to reduce emissions and a market for carbon. This kind of scheme is sometimes referred to as a 'cap and trade' system.

133. The EU-ETS received widespread support from a range of witnesses in this inquiry. Many witnesses felt that a market-based mechanism was the best way of delivering the level playing field referred to in paragraph 129. E.ON UK's Director of New Business, Colin Scoins, told us for instance: "we need a market in carbon. That is what will drive the technology and its deployment".[226] However, at present CCS is not recognised within the EU-ETS. Although the European Commission guidelines for the monitoring and reporting of emissions from installations covered by the EU-ETS published in 2004 did not include specific guidance on the monitoring and reporting of emissions from CCS projects, they did allow for the inclusion of CCS in the EU-ETS subject to approval of interim guidelines from the Commission.

134. We asked the Government what the prospects were for including CCS in Phase II of the EU-ETS. The DTI responded that following work by an EU Ad Hoc Group of Experts, recommendations have been made to the Director General Environment (DG ENV) and the European Commission and further work on EOR and the EU-ETS is being commissioned. The DTI also told us: "We understand that DG ENV wishes to include consideration of the issue of CCS and the ETS in the European Climate Change Programme, and to use the CCS working group's meeting next year to develop policy recommendations (reporting later in 2006)".[227] In addition, Brian Morris assured us in oral evidence: "We have already been discussing this with the Commission and we have been told that, provided the correct regulatory regime is in place, there is no reason why [CCS] cannot qualify for carbon credits in the next phase of the Emissions Trading Scheme".[228]

135. Despite supporting the EU-ETS in principle, witnesses' enthusiasm for the EU-ETS was tempered by two main factors. The first was the low carbon price achieved so far within the scheme. The second was the lack of visibility beyond Phase II of the EU-ETS, exacerbated by uncertainty over the details of Phase II itself (including whether CCS will be recognised). These concerns were summarised by BP, who told us that although "a properly functioning Emissions Trading System would be of enormous benefit to CCS projects", the "specific European system is currently insufficient, even if the rules were to be clarified, because it fails to provide a framework of sufficient duration and the current (and indeed, forecast) level of carbon price is inadequate to encourage business to invest the very large sums required".[229]

136. In oral evidence on 7 December, industry witnesses told us that they needed visibility "15 years beyond 2012" and a minimum carbon price of around £20 to £40 per tonne during this period.[230] BP suggested that even this carbon price would not suffice, asserting that £40 per tonne would be at the lower end of what was required for BP to break even on CCS projects. Dr Jon Gibbins, leader of UKCCSC, argued in oral evidence 16 November that there was a role for Government in underwriting the price of carbon in order to provide industry with the long term visibility and minimum carbon price they need.[231] The EU-ETS has the potential to provide the requisite incentive framework to stimulate investment in CCS and other carbon abatement technologies in the long term. At present, however, the scheme delivers neither the long term visibility nor a sufficiently high carbon price to fulfil this function.

137. Interestingly, the environmental NGOs argued that a properly functioning EU-ETS would provide the best incentive framework to stimulate CCS investment and proposed that tightening the emissions cap was the best way of boosting the carbon price. Green Alliance concluded that "a robust EU Emissions Trading Scheme and a tight national cap on emissions should be used to support the development of Carbon Capture and Storage", noting that "Key characteristics of the scheme must be a carbon price that is high enough to drive development, and a long-term market that is secure enough to attract investment in low-carbon technologies".[232] Greenpeace and Friends of the Earth also asserted in oral evidence that the best incentive for CCS was the EU-ETS in conjunction with a tighter cap on emissions.[233] Government should redouble its efforts to ensure that CCS is included in the next Phase of the EU-ETS and to get agreement for limits beyond 2012. Government should also make the case for a substantial tightening of the emissions cap in the next round in order to stimulate a higher carbon price.

138. We do not consider it reasonable that Government should underwrite the carbon price or unilaterally tighten the UK emissions cap in the meantime. There is, therefore, a need to put in place interim measures to provide a means of incentivising CCS investment until the EU-ETS is able to deliver this function.

DECARBONISED ELECTRICITY CERTIFICATES

139. BP has called for Government to introduce Decarbonised Electricity Certificates (DECs), analogous to Renewables Obligation Certificates, as a stopgap until the EU-ETS can provide the necessary framework to incentivise CCS. Renewables Obligation Certificates are issued to generators who comply with the Renewables Obligation to generate 15% of electricity from renewable sources by 2015. They can be traded to allow electricity suppliers to meet their targets at the lowest cost. Helen Fleming, Head of the Treasury's Competition and Economic Regulation Team, told us:

"An obligation is certainly one of the options that we considered in relation to carbon capture and storage. It is not necessarily going to be the right answer for it. In particular, because renewable generation is not exposed to basic fuel price volatility as you would burning gas or coal, a CAT subsidy scheme might not be the best in terms of revenue certainty for a developer".[

234

Green Alliance also considered the possibility of a DEC-like subsidy but asserted that drawbacks would include "disrupting investor confidence in the RO [Renewables Obligation] market; the possibility that carbon-neutral projects could claim some of the subsidy currently distributed to renewable technologies" as well as the fact that it would "add further complexity to an already complex market".[235] In oral evidence, other companies also made it clear that they did not support BP's proposal for DECs on the grounds that "you should not be trying to incentivise technology, but you should be trying to incentivise the reduction in carbon emissions".[236]

OTHER INSTRUMENTS

140. On our visit to E.ON UK, we heard that it would be in favour of the Government introducing capital grants which could be bid for competitively as one means of getting the first demonstration projects off the ground. BP, by contrast, told us: "We do not think a capital grant is sufficient because we need some sort of long-term commitment […] in place so that these projects will remain economic over their entire life".[237] Competitive capital grants may be needed to encourage the first demonstration projects but they are not a substitute for developing a long term incentive framework.

141. Prior to the introduction of the Renewables Obligation, the main instrument used by Government to encourage the growth of renewable energy technologies was the Non-Fossil Fuel Obligation (NFFO).[238] NFFO provided generators with premium payments over a fixed period for electricity generated using renewables. Originally, NFFO was introduced to support the nuclear industry. The money needed to support the industry was raised through imposing a levy on electricity bills, known as the Fossil Fuel Levy. Green Alliance raised the possibility that the "fossil fuel levy mechanism, which is currently dormant, could be revived to provide a long-term funding stream for zero carbon technologies".[239] This has the potential to generate a substantial amount of income. However, a recent report claimed that of the £321M raised for the NFFO fund, only £60M has been spent on capital grants for renewable energy, with most of the rest having been diverted to the Treasury.[240] It is unacceptable that income from the Non-Fossil Fuel Obligation is not being used to support the renewable energy industry. We recommend that revenues generated through levies imposed in the name of 'green' energy be used in a manner consistent with that objective.

142. Another alternative to the market-based framework provided by the EU-ETS would be to introduce a carbon tax. This would form a direct payment to Government, based on the carbon content of the fuel being consumed. Our predecessor Committee called in its 2003 Report, Towards a Non-Carbon Fuel Economy: Research, Development and Demonstration, for the "replacement of the Climate Change Levy and the Renewables Obligation with a unified Carbon and Renewable Energy Tax to be levied on the electricity generators".[241]

143. In 2001, the Government introduced a Climate Change Levy, essentially a tax on energy used in the non-domestic sector (industry, commerce, and the public sector) aimed at encouraging these sectors to improve energy efficiency and reduce emissions of greenhouse gases.[242] The revenue generated by the Levy is recycled back to businesses in the form of lower National Insurance contributions. The Levy rates vary depending on the fuel used and certain sources, such as renewables, are exempt. Progressive Energy pointed out that "High quality CHP [Combined Heat and Power] is supported by being given enhanced capital allowances and eligibility for Levy Exemption Certificates under the Climate Change Levy".[243] According to Progressive Energy, "Giving IGCC [with CCS] the same treatment as CHP has the same rationale" and would "overcome any barriers associated with perceived technology risk by investors.[244] We note that this suggestion has not received widespread backing and are doubtful that the Climate Change Levy would be able to deliver the degree of support that other major companies have argued is necessary to promote investment in CCS.

144. It is also worth noting that some of the evidence we received argued for specific incentives to promote EOR. Fiscal incentives have been used to good effect to stimulate EOR in the US. The costs of offshore EOR are greater than for onshore projects and we heard that, without such incentives, EOR was unlikely to be viable in the North Sea. The Institution of Chemical Engineers suggested that Government should "Encourage the use of CCS technologies for EOR through financial incentives, such as a reduction in royalty payments on recovered oil, as is being considered in Norway".[245] Air Products Plc also called on Government to undertake a "review of the tax treatment for oil produced by tertiary means using CO₂ enhanced oil recovery techniques".[246] However, BP told the Committee during its visit to Sunbury that the economic benefits of EOR were nowhere near sufficient to offset the costs of the DF1 project and, moreover, indicated that EOR-specific incentives would not significantly influence its investment decisions.

145. A complicated mix of incentives have been used to stimulate investment in different forms of low carbon energy generation in the UK. There is now a pressing need for a policy that will provide the level of financing and long term framework necessary to persuade industry to start investing significantly in CCS. Since the Government is currently conducting extensive reviews of its climate change programme and energy policy, it is not feasible for us to determine which specific policy instrument would best meet these needs - the choice would depend on the approaches being taken to incentivise or support other technologies, such as renewables and nuclear energy. It is clear to us that urgent action is required. Doing nothing while waiting for the EU-ETS to come good, or postponing a decision on the policy beyond summer 2006 when the Energy Review reports, would have disastrous consequences for the UK's competitiveness in this area. The Government should also ensure that incentives are in place which will encourage development and deployment of CCS in industries other than power generation, such as steel and cement production and oil refining.

146. In the longer term, as well as working towards an effective EU-ETS, the Government should continue to make the case for a global framework for trading carbon. Ideally, this would eventually include China and India (as well as industrialised countries such as the US and Australia which have not ratified the Kyoto Protocol). In the meantime, the Government should also support efforts to enable CCS to qualify for the Joint Implementation and the Clean Development Mechanism, which were established by the Kyoto Protocol to allow investment in emissions reduction projects in developing countries and economies in transition. Under these mechanisms, the reductions in emissions resulting from such projects could then be credited to the investor and used towards meeting their targets.

147. In addition, we believe that there may be an argument for the Government to consider introducing a mechanism which would take into account the environmental credentials of its trading partners. This could, for example, take the form of preferentially purchasing goods from countries which have taken demonstrable steps to reduce their greenhouse gas emissions. Any such measures would obviously need to be designed in a way that takes into consideration the UK's existing commitments to free trade.

200 Ev 77 Back

201 Ev 149 Back

202 IPCC, Special Report on Carbon Dioxide Capture and Storage, Autumn 2005. Back

203 Excluding the cost of back-up power for wind. Back

204 Ev 81 Back

205 E.g. Performance and Innovation Unit, The Economics of Nuclear Power, Cabinet Office, 2001 and Massachusetts Institute of Technology, The Future of Nuclear Power: an interdisciplinary MIT study, July 2003. Back

206 Q 48 Back

207 IPCC, Special Report on Carbon Dioxide Capture and Storage, Autumn 2005. Back

208 As above. Back

209 Ev 122 Back

210 Ev 122 Back

211 Ev 66 Back