Financing carbon removal through public-private innovations

Introducing the Build-Own-Operate-Transfer (BOOT) model

We need new ways to finance and deploy carbon dioxide removal (CDR) projects, and a unique form of public-private partnership may be the answer.

As the recent State of CDR report indicates, climate stabilization requires the rapid development of “novel,” durable CDR solutions (such as direct air capture, biochar, ocean alkalinity enhancement, biomass burial and storage, mineralization, and more). However, novel CDR methods currently provide 1.3 million tons of carbon removal annually, which is only about one third of a city like San Francisco’s total emissions in a given year. On top of the necessary emissions reductions through industry-wide decarbonization, and in addition to more forestry and soil carbon storage, we must quickly get novel CDR solutions to be enabling a larger portion of the IPCC’s recommendation of 5-10 billion tons of CO2 removal by 2050.

The biggest issue is that novel CDR is generally too expensive (though this differs widely amongst each pathway). The cost curve can and will go down, which is only possible by providing capital for companies to do R&D and achieve economies of scale (via more deployments). These costs have been decreasing through the incredible leadership and market-building of CDR’s initial core buyers. However, because it’s still too expensive today, there are far too few corporations willing to provide this necessary capital through offtake and pre-purchase agreements. 

Barring any significant policy changes in the US that mandate corporations to purchase carbon removal (via compliance markets or a carbon tax), it’s unlikely enough buyers will enter the market for high-cost carbon removal credits in the near-term. A major blow to progress on this was the recent reversal of the SEC Scope 3 reporting ruling. With federal policy change implausible in the near-term (though state-level efforts in California offer a glimmer of hope), the United States is actively trying to bolster the voluntary market, as evidenced by their recent announcement around principles for high-integrity markets, the DOE’s purchasing challenge, and much more. 

Until policy changes manifest to incentivize large-scale corporate purchasing, more capital will likely need to come from the government in the form of public procurement. The $35 million Purchase Pilot Prize from the DOE is a fantastic start, which has been bolstered by an additional $20 million to continue the competitive program. Additional funding of CDR through grants and tax credits have been and will continue to be pivotal. However, it’s not quite enough today given the pace we need to remove CO2 from the atmosphere and our oceans…

So, how can we create conditions for more private and public capital to flow into CDR deployments – and in effect, decrease their respective cost curves – to enable the conditions for an inflection of new, continuous funding? We should look to public-private partnerships: specifically, a build-own-operate-transfer (BOOT) model.

What is a BOOT?

A BOOT is a type of public-private partnership, and a subset of the build-operate-transfer (BOT) models. In essence, it involves private companies creating special purpose vehicles (SPVs) to finance, build, and operate a project. After a certain period of time, the SPV transfers ownership of that project and its various services to a public entity. Investopedia offers a great high-level explanation: 

A build-operate-transfer (BOT) contract is a model used to finance large projects, typically infrastructure projects developed through public-private partnerships. BOT projects are normally large-scale, greenfield infrastructure projects that would otherwise be financed, built, and operated solely by the government. 

Under a BOT contract, an entity—usually a government—grants a concession to a private company to finance, build, and operate a project for a period of 20 to 30 years, hoping to earn a profit. In general, BOT contractors are special-purpose companies formed specifically for a given project. 

During the project period—when the contractor is operating the project it has built—revenues usually come from a single source, an offtake purchaser with a binding agreement. This may be a government or state-owned enterprise. After that period, the project is returned to the public entity that originally granted the concession [usually transferred with no cost or a nominal fee, depending on the terms of the contract].

Historically, this model is implemented to access the project finance necessary to fund large-scale greenfield infrastructure projects such as local power stations, toll roads, airports, water treatment facilities and sewage facilities, etc. 

*The BOOT delivery model is slightly different from the BOT delivery model. With a BOOT, the private contractor fully owns the project as an asset, rather than solely receiving a concession to operate it for a period of time. Moreover, if the SPV is owning the asset during the time horizon, they’re more entitled to any revenue coming from that asset, which could make the investment more appealing to project financiers (more on this later). For the sake of return on investments for the private sector, and financial and operating risk reduction for the public sector, BOOTs seem more appealing. 

The goal at the end of the day is dually for private investors to realize a return on their investment (annually and/or at the time of transfer), and the public sector to experience local/national socioeconomic and environmental benefits in perpetuity, while leaving the technical and financial risk, as well as the upfront costs, to fall on the shoulders of the private company. The public entity helps reduce risk and support the project’s bankability and success through concessions (such as land or facilities), tax breaks, and other potential benefits.

Bringing the BOOT to carbon removal

Carbon removal projects seem like prime candidates for this arrangement. Their primary revenue stream is offtake agreements for carbon credits; they are increasingly starting to receive government concessions through tax credits; and they typically require significant cap-ex investments that need to be financed off-balance sheet through SPVs.

In a BOOT project, the operator generally obtains its revenues through a fee charged to the utility/government. In this case, rather than the typical charging of toll fees or tariffs, a CDR project would be selling tonnage of carbon removed. The presence of both an offtaker (private or public) and an exit pathway will be compelling for project finance investors, which de-risks the project’s bankability and offers substantial returns.  The BOOT model could also provide additional incentives for state-level directives around CDR purchasing.

*The attractiveness of the BOOT model is also built on the premise that carbon removal should, over time, shift from a private enterprise to a public service.

Carbon pollution is a public waste disposal problem, despite being caused by private companies (many of which are receiving subsidies from the government). This New Republic article co-written by Holly Buck lays out the following case:

“Climate tech investors and entrepreneurs see carbon removal as a technological innovation problem, and carbon as a commodity. Rather, we need to think about carbon removal as what social scientists call a “sociotechnical system”: a system of social actors and infrastructure that includes institutions and regulators; individual users; and finance; as well as the pipes, land, soil, and material infrastructure that will do the work of moving carbon around and storing it. The question is then: Do we want this system to be privately run or publicly controlled?”

I think we can have a mix of both. Infinite and total procurement by the government from a private business does not seem attainable, at least in the near-term. Moreover, if all of CDR becomes a government-led service in totality, the rate of innovation and scale will slow down. Private markets and returns on capital for investors are key to getting projects financed and in the ground, and removing tons at the pace we need. However, setting up a system for the public to operate these systems in perpetuity presents a more ideal situation.

Public co-ownership and design of future CDR projects is pivotal to environmental justice and equity, especially given the private industrial sector’s abysmal track record of environmental wrongdoings in frontline communities. With BOOTs, the eventual transfer to a local community’s continued operation (be it the state, municipal, or tribal entities) brings exciting opportunities for government-sanctioned co-ownership and oversight, job creation, and economic windfalls. The aforementioned New Republic article illustrates what this could look like:

“Imagine a regional, community-run carbon removal authority that simultaneously pursues wetland restoration and forest management, safely operates an industrial removal facility and associated mining and geological sequestration operations, monitors carbon levels in forests, and works with farmers to maintain healthy fields that store carbon in the soil. The same organization could establish job retraining programs, run by democratically controlled unions, to transition workers away from polluting industries, including workers from fossil fuel companies who already have carbon removal expertise. This will have the additional benefit of facilitating the phaseout of fossil fuels by ensuring workers are protected by their communities during a just transition. Ambitious policies will gain further support from workers and voters by enabling them to participate in improving their own material conditions.”

This is what we need to aim for.

Source: Danny Lau

A theoretical example for CDR

Note: this is oversimplified for the purpose of getting the point across.

What’s exciting is this structure can be adapted to a number of different CDR solutions and their varying technoeconomics, including biochar pyrolysis plants, coastal ocean alkalinity enhancement (OAE) facilities, biomass burial and storage complexes, and more. For this example, I’m going to use direct air capture (DAC), given the relatively large number of companies looking to build today.

Let’s say a highly promising and quickly scaling startup, “DAC Co,” is looking for $160 million to build and operate a new facility. The company’s CEO has developed strong relationships with the City of Houston, which is optimistic about DAC Co’s solution and the economic benefits its new facility can bring to the city. After extensive engagement with local stakeholders and community-based organizations, Houston partners with DAC Co to construct a facility and helps grant them a permit to build.

As a precondition to the deployment, a community oversight board is established for the project. This community board is crucial and will mandate that DAC Co be accountable and proactive in working to identify and mitigate any potential unintended consequences that may cause environmental injustices to the local communities. This is a particular concern for any large infrastructure development, and especially those located in communities that have experienced past harms by the industrial sector.

DAC Co then signs agreements with 1) Houston to build, own, and operate the facility for 20 years, and 2) buyers for the procurement of 50,000 tons of CO2e/year at $250/ton*. This revenue is on top of the 45Q tax credit that DAC Co will earn from the federal government, which serves as a built-in concession. The facility will also be constructed on municipal land, which Houston decides to donate to DAC Co in the short-term, knowing it will be returned to them after the 20-year period.

*Side Bar: The procurement of the tons is one of the biggest outstanding questions and is subject to a few different scenarios:

In one hopeful situation, the United States’ Department of Energy (DOE) will continue purchasing tons of durable carbon removal credits, likely increasing past its current budget. These federal tons would count toward the United States’ National Determined Contribution (NDC) goals. While public procurement by itself is perhaps not enough incentive for the government to pay for extensive tonnage at scale; eventual ownership of the operation seems more attractive.

In this case, the government would decide to either purchase all or a portion of the 50,000 tons per annum. If the government is purchasing all the tons, this would be ideal and a clear additional concession for DAC Co.

However, the DOE doesn’t have the budget today to pay for all or most of this project. Buyers coming from the voluntary carbon market (VCM) would likely enter into offtake agreements with a discount on the $/ton given the period of the agreement, which guarantees fixed revenue for DAC Co and relatively cheaper credits for the buyers. Absent any federal purchasing of tons, the likelihood of a “transfer fee” to DAC Co on the backend of the 20 years seems more likely (see below).

DAC Co. creates an SPV company called “Hous-TONS LLC” (sorry it was too easy) and raises $160M in equity and debt (35/65 split) from institutional investors. The interest rate for debt investors is 8%, with the debt conservatively assumed to amortize on a straight-line basis over 15 years. 

If everything is added up, the projected revenue would be:

• 50,000 tons/yr x $430/ton x 12 years (adding in the $180/ton 45Q payments for first 12 years) = $258 million

• + 50,000 tons/yr x $250/ton x 8 years = $100 million

• Totaling $358 million

Each year, over the course of 20 years, the SPV returns $17.9M on average in tonnage revenue. At the end of each year, the residual cash flows first pay off debt, after which the equity investors (including DAC Co) are paid a dividend as a return on and of capital from the carbon credits. 

At the end of its 20-year contract, two options exist: either the transfer is completed without a transfer fee, or there is a nominal fee paid to the SPV. The latter situation provides a nice extra windfall to DAC Co and its investors, who are then incentivized to continue coordinating deals like this going forward. For this example, let’s assume a transfer fee of $25M is provided, giving an equity IRR of 14.5% over the course of the project for equity investors.

With the project complete, Hous-TONS LLC, dissolves and operations for the facility are fully transferred over to the City of Houston. The project’s community oversight board works with the City of Houston to maintain operations and/or hires a firm to do so, while ideally retaining the workforce that has been running things at the facility for years. 

From here on, Houston will now recoup the annual tonnage revenue that’s generated and transfer it into a fund that is managed and allocated by the community board. It seems pretty appealing for both the federal government AND private VCM buyers to purchase tons from a party like the City of Houston (versus a private company), given all the added governance and socioeconomic benefits. The City of Houston may also choose to designate ownership and economic windfalls to local communities within the city, for the sake of broader community co-ownership.

Outstanding thoughts, questions, and concerns

This example uses many assumptions to pencil out as a win-win. The biggest levers that determine the financial feasibility of these projects is the respective technology’s ability to hit said numbers on $/ton and tons/year relative to the CapEx and OpEx. I used a pretty hopeful technoeconomic scenario for direct air capture (DAC), though it is relatively more economically difficult than other CDR pathways at this example’s 50,000 tons per annum scale. That said, the vision is for these technologies to move down the cost curve and reach economies of scale, which should simultaneously increase the economic returns for investors toward highly attractive levels.

Another way to make the economics more enticing for investors is through sidestream valorizations. Technology systems that produce high-value byproducts as a result of their carbon removal – such as critical minerals, clean air and water, deacidified oceans, fuels, and more – have the ability to produce supplementary revenue to the carbon credits.

That said, there are undoubtedly risks that need to be mitigated in these agreements and questions to be answered. Some initial ones include:

• A total project period of 20 years may be an issue for certain investors and public entities. Depending on the economics, perhaps there’s an opportunity to shorten the timeline from 20 years to 15 or 10, which would also enable quicker community ownership. One option to shorten the duration, or to make a longer project more economically attractive, could be to spread the transfer fee out over several years, rather than as a lump-sum of revenue at the end of the period.

• Given the length of these commitments, governments need to forecast and evaluate alignment with the city’s long-term infrastructure & economic needs. Plus, locking into an agreement with a technology today may prevent the adoption or integration with advances tomorrow, especially at the current rate of CDR technology innovation. These development sites should have room for expansion in capacity and tech improvements/retrofits over the course of the project period, which would also positively affect the technoeconomics.

• Successful community oversight and co-ownership is much easier said than done, both during and after the transfer of a project to the public. Rather than project equity investors receiving the full portion of carbon credit revenue each year, there may be an opportunity to integrate community co-ownership during the project lifecycle and share in revenues from the beginning through the formation of local cooperatives. This is especially important for CDR pathways that don’t inherently provide as many local environmental or social co-benefits through their solution.

• Given this a relatively unused model in the US and involves a transfer to the public, there could be greater complexity around contracting, permitting, and additional regulatory hurdles (though not necessarily).

Concluding thoughts

We need innovative models to flow significantly more capital into carbon removal, which requires public-private partnerships and methods to lower risk for investors. This new BOOT model can help kickoff the required feedback loop: conditions for more funding → more deployments and CO2 removed → economies of scale and lower costs achieved for novel CDR → more appetite for carbon credit purchasing → more project funding → repeat.

BOOTs are just one option among a variety of offerings (see pg. 28 from this Energy Futures Initiative report). And the most promising models are those that help enable publicly owned carbon removal.

There are so many individuals and organizations working within the private and public sectors to make opportunities like this a reality. This truly is just the beginning of what carbon removal can and hopefully will be.

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A special thank you to those who provided important feedback and suggestions while writing this: Amir Chireh Mehr and Gwendy Brown from Elemental, Dustin Pool from Origen, and Frances Simpson-Allen from Ebb Carbon.