- Contracts giving incentives for reducing emissions by carbon capture have a valuable role to play in stimulating deployment of early CCS. Contracts may be Contracts for Difference (CfDs) on the market carbon price, but will not necessarily be so. The form of the contract will depend on how changes in carbon prices affect project income.
- Other mechanisms can also play a valuable role, include creating low carbon markets, procurement mandates, robust carbon pricing, and capital grants or other direct subsidies. In the long term is it expected that some combination of carbon prices and product standards will mean that dedicated support for CCS projects is no longer required.
- Contract incentives should be based on the amount by which CO2 emissions are reduced compared with continued operation without capture. They should not be based on amount of CO2 captured, which distorts incentives for efficiency and potentially distorts project choice. It is important to not incentivise CO2 production by making it a driver of remuneration.
- Project eligibility should require meeting basic quality thresholds. For example, minimum capture rates should be specified. Carbon Capture and Use (CCU) projects should be excluded unless the use results in the CO2 being permanently removed from the atmosphere, which will rarely be the case.
- Early projects should be chosen on the basis of strategic demonstration value as well as on cost of abatement. In particular this should favour projects where there are few if any alternative decarbonisation options, and that will be an important part of a net zero economy. In the UK context this may require enabling CCS at sites remote from project clusters.
- Contract duration should be a minimum of 10 years, with the full capital investment requiring at least this long for full remuneration. There should also be incentives to continue operation into the medium and longer term.
- A risk sharing mechanism should be included in contracts to take account of unexpectedly high or low out-turn costs or rate of returns.
- Separating support into components, for example including a proportion of fixed payments, should be considered to reduce risks and therefore costs.
- There are various options for managing risks around free allocation of emissions allowances under an ETS. If free allowances are not allocated to the project, then mechanisms need to be put in place to ensure the allowances are issued and retained by government for auction.
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