ESG continues to be a hot topic within the oil and gas industry. Although the majority of publicly traded companies have embraced ESG requirements, there are still many cases of what I’ll call an “ESG pushback.” Some of this should be expected, because of the lack of clarity in the ESG reporting requirements and in quite a number of the standards that exist.
Although there has been some consolidation in standards, there are still a multitude of standards—many of which have very subjective requirements—that leave a lot of room for interpretation. This is why I mention the lack of clarity. But one area of ESG that is being more widely adopted and is growing significantly is decarbonization, partly because there is clarity.
The IRA brings clarity. This clarity has come because of the Inflation Reduction Act (IRA). On Aug. 16, 2022, the IRA was signed into law. Although originally introduced as the “Build Back Better Act,” it became the IRA after being significantly reworked. The IRA included many topics, such as healthcare, deficit reduction, domestic energy, tax reform, clean energy, and emission reductions.
Tucked away within the IRA were changes for the 45Q tax credit for carbon dioxide capture and sequestration. The oil and gas industry has participated in this program in enhanced oil recovery (EOR) for conventional wells, where carbon dioxide (CO2) flooding or combinations of water and CO2 flooding are used to improve oil recovery in conventional wells. Prior to the IRA, the tax credit was only $35/ton of CO2 and increased to $60/ton. The IRA also raised the tax credit for carbon capture and sequestration to $85/ton from $50. Previously, carbon capture could be direct capture from the air or capture from an emission source. Under the IRA, direct capture was separated out and increased from $50/ton to $180/ton. And now decarbonization is on everybody’s radar.
A new industry has developed. And just like that, a new industry has emerged. With Oxy, ExxonMobil and Chevron leading the charge, billions of dollars are invested and beyond that, ExxonMobil buys Denbury Resources for $4.9 billion. Denbury had recently transitioned into a decarbonization company, expanding their CO2 pipeline network and adding Class 6 sequestration wells. Sounds like Denbury’s transition was successful.
Oxy also got into the action, buying a direct air capture company—Carbon Engineering—for $1.1 billion. I expect we’ll see an announcement from Chevron soon. The IRA was the sound of the starting gun, but with all of the controversy around ESG, what makes decarbonization different?
The economics of decarbonization. Many conventional carbon capture systems are promoting costs in the $50-$60/ton range, with the right scale, and many are projecting sequestration and transport in the $10-$30/ton range. At $85/ton, there are projects where you can offset your costs by the tax credit—a credit that can be paid out as cash for the first five years.
Additionally, most public companies expect an increase in share price, as they achieve carbon zero goals, creating additional value for decarbonization. In the area of direct air capture, the costs are projected to be higher—somewhere in the $120-$150/ton range—but here, the tax credit is $180/ton. Within oil and gas, however, there are CO2 sources like gas processing plants, where projected carbon capture costs are under $30/ton.
Over time, the expectation is that costs will decrease; remember, this is a new industry, so I expect more and more innovation will come—as will scale—helping reduce cost. We will see an increase in the use of CO2 in EOR, and we will see oil and gas pursue emission sources like gas processing, where the capture costs are relatively low. These efforts will generate positive cash by taking the cash option on the tax credit, but is that it—tax credit and the benefits from stock value by achieving carbon zero?
The carbon offset market. We currently have a voluntary carbon offset market and, within certain non-attainment zones, emission trading programs, which put a value on CO2 credits. These markets are taking off and are expected to grow at an aggressive pace. In a Wall Street Journal article I’ve referenced before, decarbonization income is projected to be as high as $300-$400/ton. This is a combination of tax credit and carbon offsets.
As Microsoft, Apple and others make commitments to achieve carbon zero, buying offsets is part of that equation, and they continue to increase in value. Vicky Hollub recently stated that Oxy low-carbon revenues are expected to outpace Oxy Chemicals. Morgan Stanley stated that the voluntary carbon-offsets market is expected to grow, from around $2 billion in 2022 to about $100 billion in 2030 and around $250 billion by 2050. In Europe, carbon offsets can go as high as $1,000/ton.
The carbon offset market will be the icing on the cake for decarbonization. Now, we are talking a tax credit that we can convert to cash and which can be traded as a carbon offset credit, creating more value. This bundling is where the growth and value in the carbon markets will come from.
A trillion-dollar industry. Decarbonization has been projected to be an industry that will grow to over a trillion dollars. Decarbonization is essentially the monetization of an ESG standard, and that is why all the super-majors have entered into the decarbonization market in a big way. The billions of dollars being invested today are not an accident; we are witnessing the emergence of a new industry that will grow significantly over the next few years.
What’s next. There are plenty of opportunities to improve the economics of decarbonization, from scale to CO2 utilization, as opposed to sequestrations, but one of the areas I believe is low-hanging fruit is the continued lobbying for, and amendments to, the existing 45Q program. We discussed the IRA, but also tucked away in the IRA is hydrogen as a clean fuel. In the hydrogen program, there are also carbon tax credits, but they use carbon equivalence or CO2e.
Under CO2e programs, you get credits for CO2, but you also get credits for NOx and methane. Methane gets 25 times the credit and NOx 298 times. If 45Q adopted CO2e, then all of the methane reduction and flare initiatives would receive a tax credit, as would reducing emissions like NOx. Carbon offset markets already use CO2e, so it’s not really a big departure. Essentially, we would monetize the emission reduction programs to accelerate their implementation.
Decarbonization is going to be an exciting area of development, and I expect more and bigger announcements from the supermajors while they lead the way. I’m excited to see where this new industry leads us.
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