risk management and optimal contract structures for the ccs-eor* value chain anna agarwal, john e....
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Risk Management and Optimal Contract Structures
for the CCS-EOR* Value Chain
Anna Agarwal, John E. ParsonsCenter for Energy and Environmental Policy Research
Massachusetts Institute of TechnologyOctober 10, 2011
*CCS-EOR stands for Carbon Capture and Storage-Enhanced Oil Recovery
CCS (carbon capture and storage) value chain consists of three key components
Capturing CO2 (at large stationary CO2 source such as coal-fired power plant)
Transporting CO2
(by pipeline)Storing CO2
(in geological formations – in oil fields for enhanced oil recovery (EOR))
Source: Bellona FoundationSource: IPCC Report on CCSSource: IEAGHG Weyburn-Midale Project Update
2
CCS is pure cost, enabling financial value captured elsewhere in the value chain.
Commercial deployment would require enabling commercial structuring of the value chain.
Our Focus: Contract structures to distribute profits and allocate risks among the involved entities.
Optimal contract structures maximize the overall project value.
-$791m -$74m
$1,057m
Power Plant
PipelineOil Field
Motivation
3
4
We develop a cash-flow model for a prototype CCS-EOR project.
Project involves collaboration between two entities: power plant company and oil field company (pipeline jointly owned)
Analyze impact of market risks on the CCS-EOR project and evaluate optimal contingent decisions.
Evaluate risk-sharing offered by standard contract structures and resulting incentives for optimal decision-making.
Approach
0 1,000 2,000 3,000 4,000 5,000 6,000Ex-post NPV ($million)
Upper BoundsLower Bounds
Price of Oil
Wholesale Price of Electricity
Price of Coal
CO2 Emission Penalty (no pass-through on electricity price)
68% 95% 99%95% 68%99%
CO2 Emission Penalty (with pass-through on electricity price)
Project Risk Exposure(if market risk factors changed 3 years after start of operations)
Volatility in oil price is the dominant risk factor.
5
Optimal Contingent Decision-Makingexample of re-optimizing CO2 capture rate contingent on oil price
Re-optimizing CO2 capture rate leads to financial gains of
$130 million at $30/bbl, and $247 million at $20/bbl.
6
800
1,000
1,200
1,400
1,600
1,800
2,000
2,200
0%10%20%30%40%50%60%70%80%90%
Ex-
post
NP
V ($
mill
ion)
CO2 Capture Rate
$70
$50
$30
$20
Oil Price ($/bbl)90%
70%
60%0%
90% at $70/bbl
70% at $50/bbl
60% at $30/bblNo capture below $20/bbl
Key Questions Who bears the different risks along the value chain?
Are the ex ante negotiated contract terms still profitable ex post?
Are the profit maximizing contingent decisions for the individual entity aligned with the overall project?
7
Lets look at two standard contract structures
Fixed price CO2 contractsEx ante range of profitable contract prices (per ton CO2):
$62 - $ 76
Indexed price CO2 contracts – indexed to oil priceEx ante range of profitable contract prices (per ton CO2) :
82% - 101% of oil price
-50
0
50
100
150
200
250
62 64 66 68 70 72 74 76Fin
anci
al G
ain
($m
illio
n)
Fixed Contract Price ($/ton)
0
50
100
150
82% 85% 88% 91% 94% 97% 100%
Fin
anci
al G
ain
($m
illio
n)
Indexed Contract Price (%oil price/ton)-200
200
600
1,000
82% 85% 88% 91% 94% 97% 100%
Ex-
pos
t N
PV
($m
illi
on)
Indexed Contract Price (%oil price/ton)
Overall Project
Power Plant Co.
Oil Field Co.
NPV in the 'High Risk' Scenario under Indexed Price Contracts Fixed Price Contracts Indexed Price Contracts
Risk-Sharing and Incentives- Evaluating Financial Gain by Optimizing CO2 Capture Rate
Fixed price contracts result in conflict of interests, as the power plant company has no incentive to adjust the CO2 capture rate.
Risk-sharing offered by indexed price contracts incentivizes optimal decision-making and creates alignment of interests.
8
Risk-Sharing and Ex post Insolvencies- Evaluating Resulting Ex-post NPV
9
-800
-400
0
400
800
1,200
1,600
2,000
2,400
62 64 66 68 70 72 74 76Ex-
pos
t N
PV
($m
illi
on)
Fixed Contract Price ($/ton)-200
200
600
1,000
82% 85% 88% 91% 94% 97% 100%
Ex-
pos
t N
PV
($m
illi
on)
Indexed Contract Price (%oil price/ton)
Overall Project
Power Plant Co.
Oil Field Co.
NPV in the 'High Risk' Scenario under Indexed Price Contracts
Fixed Price Contracts90% CO2 Capture
Indexed Price Contracts Optimal CO2 Capture
High risk of ex post insolvency in fixed price contracts can lead to inefficient investment decisions.
Risk-sharing through indexed price contracts not only maximizes the project value, it also minimizes the insolvency risks.
-800
-400
0
400
800
1,200
1,600
2,000
2,400
82% 85% 88% 91% 94% 97% 100%Ex-
pos
t N
PV
($m
illi
on)
Indexed Contract Price (%oil price/ton)
Summary
10
Market risks are significant in a CCS-EOR project.
Choice of contract determines :
•Who bears the risks?
•What incentives does the risk allocation produce?
Standard contracts have weaknesses in terms of ex post insolvencies and
poor incentive structures that result in sub-optimal project value.
Future WorkExtend analysis to technical risks such as uncertainty in CO2 storage operations.
Analyze how contracts would evolve as the CCS industry matures.
Thank you
11
Extra Slides
12
Power Plant
Overnight Cost $/kW
6,900
Fixed O&M Cost $/kW/year
50
Variable O&M Cost mills/kWh
9
Price of Coal $/MMBtu
2
Penalty for CO2 Emissions $/ton
5
Wholesale Electricity Price cents/kWh 10Oil Field
Capital Investment $/bbl
5
O&M Cost $/bbl
10
CO2 Recycle Cost $/ton
30
Price of Oil Recovered $/bbl 75Royalty Payment (% of oil production value) 12.5%Pipeline
Capital Investment $million/mile
1.7
O&M Costs $/ton
2.5
13
Project Timeline 2010 2011 …. 2017 2018 2019 2020 2021 …. 2044
Construction Starts Operation Starts
25 years
14
68% conf. int. 95% conf. int. 99% conf. int.
Volatility Base case High Low High Low High Low
Oil Price ($/bbl) 21% 75 108 52 155 36 223 25
Wholesale Price of Electricity (¢/kWh) 10% 10 12 8 14 7 17 6
Coal Price ($/MMBtu) 9% 2.0 2.3 1.7 2.7 1.5 3.2 1.3
CO2 Emission Penalty ($/ton CO2) 47% 5 11 2 25 1 57 0.4
Ex-post Risk Factor Values
0
10
20
30
40
50
60
70
80
4,000 5,000 6,000 7,000 8,000
CO
2C
ontr
act P
rice
($/t
on)
Overnight Cost ($/kW)
Minimum
Maximum
Negotiable contract price
Base Case
6,900
Sensitivity of ex-ante negotiable contract prices
Depending on the overnight cost – minimum negotiable price can vary from $11-$73 per ton CO2.
15
-1200
-1000
-800
-600
-400
-200
0
200
400
2017 2020 2023 2026 2029 2032 2035 2038 2041 2044
Ann
ualiz
ed C
ash-
flow
s ($
mill
ion)
Year
Annualized Cash-flows of the Power Plant and the Oil Field
Power Plant
Pipeline
Oil Field
start of operationsstart of construction end of operations
16
500
550
600
650
0%30%60%90%
Net
Pow
er O
utpu
t (M
W)
CO2 Capture Rate
10%
15%
20%
25%
Recoverable Energy Penalty
(from 90% to 0% capture)
Net Power Output as a Function of the CO2 Capture Rate for Different Levels of Recoverable Energy Penalty
17
18
Contractual Profit-SharingNegotiable Contract Terms
$62-$76 per ton CO2 delivered(for indexed price contracts: 82%-101% of oil price)