SmokeStacks_G637149576_Feature_1920X945

09.22.20

Energy Insights: 45Q carbon capture insurance solutions

BY , , Ellen S. Friedman

With the increasing interest in carbon capture and the related Section 45Q tax regulations, there is an increased need for mitigating risk, including through insurance solutions. Insurers and insurance brokers, in anticipation of the need for derisking 45Q carbon capture projects, are crafting insurance products to benefit the various stakeholders in this nascent sector.

Why is having an insurance solution important for carbon capture and storage/sequestration (CCS) projects?

In the tax credit world, insurance solutions help protect the tax equity investor from tax loss by allocating certain defined “tax” risks to the insurer. This reduces exposure of these risks to the sponsor, which, in many cases, is not sufficiently capitalized to absorb such risks.

The categories of loss commonly insured for solar and wind projects today are associated with three different types of tax risks: (i) tax equity structure risk, (ii) tax credit qualification risk, and (iii) tax credit recapture risk. Each of these risks is present with CCS projects. Structure risk is whether the transaction to monetize the tax credits itself will be respected by the IRS. Qualification risk is whether the tax credits will be claimed in full—credit qualification is the most common tax risk that is insured in the solar and wind tax equity markets and is expected to be similarly common with CCS projects. Historically, for qualification risk, the insurable issue is centered around “begun construction” risk. The tax code allows projects to qualify for credits based on when construction began on a project rather than when it is placed in service, and the IRS has provided guidelines to achieve such qualification. Based on discussions with insurance industry experts (see link below to watch the full discussion), for CCS projects, begun construction-related issues will be one of the areas of focus given the proposed IRS regulations, and the insurance markets are expected to remain robust in this regard for CCS projects. Lastly, recapture risk is the risk that the IRS will take back, or recapture, any provided tax credits. Basically, for CCS projects, when capture carbon ceases to be captured, disposed of, or used as a tertiary injectant, the IRS can recapture the benefits provided under Section 45Q(f)(4) of the IRS Code. The IRS has proposed a rolling five-year window to recapture credits if captured and sequestered carbon “leaks” during such five-year period (i.e., credits generated in year one are subject to recapture for leaks until year six, credits generated in year two are subject to recapture for leaks until year seven, etc.). One major concern identified during our recent webinar on Insurance Solutions for 45Q Carbon Capture Projects was that tax credit policies might not be available to match the full twelve-year credit term, which results in a total of a seventeen-year time period during which recapture is a risk.

Market participants are also focused on additional risks for CCS projects that are not commonly discussed in the context of insurance on solar and wind projects. For example, additional insurance products are being considered to support third-party take-or-pay or deliver-or-pay obligations, which are expected to be a common feature of certain CCS projects. The common tax equity risks may also overlap more with other types of insurance policies in the CCS world as compared to the wind and solar markets. One takeaway from our webinar was that tax credit insurers are expected to work together with their colleagues providing environmental policies—although their products are separate and issued pursuant to different terms and conditions.

What is the underwriting process for getting an insurance policy for CCS projects?

The underwriting process depends on the size of the project, the project counterparties, and the amount of money that is ultimately being invested. Based on discussions with insurance industry experts (see link below), it is helpful to have insurance discussions with the insurers early in the life of CCS projects to ensure a smooth process for underwriting. Part of the underwriting process is ensuring that the proper permits are obtained. One of these permits is a Class VI permit in the case of “pure sequestration” projects not associated with enhanced oil/gas recovery. This is required by the Environmental Protection Agency (EPA) to safeguard underground sources of drinking water. The important takeaway about the Class VI permit process with the EPA is that it is a multi-year process, which means it is important to start early. Insurers will require this, so it is necessary for the underwriting process.


Subscribe to receive the latest Nixon Peabody energy updates.

Author

Ramin Mohammad

Associate

Posts By this author

author img

Author

Shariff Barakat

Partner

Posts By this author

author img

Author

Ellen S. Friedman

Partner

Posts By this author