Peter Connors Orrick

1. Carbon Capture Summit—USA
How Tax Incentives Impact Carbon Capture
October 19 to 20
Long Beach, California
Peter Connors
1

2. Agenda
• The Basics—-Section 45Q
• Changes Made by the Inflation Reduction Act of 2022.
• The Tax Equity Structure
• Direct Pay and Transferability
• Common Deal Terms
• The Low Carbon Fuel Standard
2

3. The Basics--What is the Section 45Q Tax Credit?
• Section 45Q is the credit for carbon capture and sequestration
(“CCS” or “CCUS” for “use”)
• The credit is a specific dollar amount (per metric ton of
carbon) captured and sequestered.
• Unlimited for 12 years from placed in service date.
• Both capture and sequestration must be in the United States.
• No impact on tax basis in the equipment (unlike ITC).
• Carryforward 20 years, back 1 year (section 39)
• Credits are subject to recapture if the carbon ceases to be
captured or disposed of in a manner consistent with the
statutory requirements.
3

4. The Basics--Qualifying for the Credit
• Carbon oxide must be:
– “Captured”:
○ from industrial sources that otherwise would be released into atmosphere OR
○ directly from the ambient air (“direct air capture”)
– “Measured and Verified” at source of capture and at disposal, injection or utilization
– At a “qualified facility” - a facility meeting minimum size requirements
– AND “sequestered, used, or disposed of”
○ in secure geological storage
○ used for tertiary or enhanced oil and gas recovery (“EOR”)
○ utilized in other chemical or commercial applications approved by Treasury, e.g.,
petrochemicals, fertilizer, carbonated beverages
4

5. The Basics--Utilization of CO2
• Utilization (other than in EOR) is defined in
section 45Q(f)(5) as:
– Fixation of carbon oxide through
photosynthesis or chemosynthesis,
such as through the growing of algae or
bacteria
– The chemical conversion of carbon
oxide to a material or chemical
compound in which the carbon oxide is
securely stored
– The use of carbon oxide for any other
purpose for which a commercial
market exists (other than EOR), as
determined by regulations.
5

6. How the IRA Impacted Section 45Q
• Under pre-IRA law, beginning in 2025, the credit was $50 a metric ton for carbon that is
sequestrated and $35 a metric ton for carbon oxide which is used either in enhanced oil
recovery or which is utilized in certain processes.
– To be eligible for the credit, construction of the facility must have begun prior to 2026.
– Minimum quantities of CO2 must have been captured
• The IRA both extend the existing credit for projects that begin construction before 2033 and
increase the credit value as illustrated in the table on the next slide.
• Consistent with PTCs and ITCs for wind and solar, the 45Q credit would take on a two-tier
approach.
• The credit amounts would be significantly increased, especially for carbon oxide captured
through direct air capture.
6

7. The revised credit amounts would be as
follows (in $ per metric ton):
Impact of the IRA (cont’d)
• Pre-IRA Law reflects 2025 value.
• Credit amounts are adjusted for
inflation.
• The IRA would significantly reduce the
minimum capture amounts required to
qualify for the credit, some as low as
1,000 metric tons annually for direct air
capture, with most requiring
12,500 metric tons annually.
• The revised 45Q provisions are
effective for facilities or equipment
placed in service after 2022.
7
Capture End Use
Pre-IRA
Law
Base
Increased
Credit
Traditional
Carbon Capture
Carbon Oxide Used
or Utilized
$35 $12 $60
Carbon Oxide
Sequestrated
$50 $17 $85
Direct Air
Capture
Carbon Oxide Used
or Utilized
$35 $26 $130
Carbon Oxide
Sequestrated
$50 $36 $180

8. Tax Equity Structure
8
Tax benefits (tax credits
and depreciation) pass
through to an equity
owner.
Project receives low-cost
financing in return for a
sharing of the tax
benefits.
The equity owner must
have economic
substance.
Investors are primarily
banks or other financial
institutions.

9. Typical Partnership Flip Structure
Sponsor
Tax Equity
Investor
Class B
Member
(SPV)
Project
Assets
• Overview
– Most common tax equity structure.
– Tax equity’s investment is usually sized based on a
financial model designed to achieve certain pre-tax and
after-tax internal rate of return parameters based on the
forecasted performance of the project or a fixed period.
– Rev. Proc. 2007-65 (Wind) describes structure.
– Rev. Proc. 2020-21 (Carbon Capture) describes
structure.
– Pre-Flip Period. Tax equity is allocated 99% of tax items;
cash distributions are shared as negotiated.
– Post-Flip Period. Tax equity is allocated 5% of tax items;
cash is shared in accordance with the partners’ residual
interests (95%/5%).
– PAYGO limited to a percentage of fixed investment: 25%
for Wind and 50% for Carbon Capture.
– Termination. Developer or investors has a right to
purchase at fair market value (Wind) or a right to put at
fair market value (Carbon Capture) 9
TEP
Post-Flip
Purchase
Option/Put
Class B
Interests
Class A
Interests
Pre-Flip
1% P/L + ITC/PTC
x% Cash
Post-Flip
95% P/L
95% Cash
Pre-Flip
99% P/L + ITC/PTC
1-x% Cash
Post-Flip
5% P/L
5% Cash

10. Direct Pay and Transferability
• Direct Pay
– Allows taxpayers to receive value of the PTC or ITC from a cash refund payment from the IRS.
– Avoids need to have sufficient tax liability to take advantage of the credit.
– Mostly limited to certain tax-exempt entities (including municipalities and state and local
governments).
– Taxable entities can elect direct pay for a limited subset of credits: carbon sequestration,
hydrogen production, and advanced manufacturing.
– Same concept was in the BBBA, but this is more limited.
• Transferability
– Allows taxpayer to sell PTC or ITC outright to an unrelated person for cash.
– As with direct pay, avoids need to have sufficient tax liability to take advantage of the credit.
– New concept.
10

11. Common Deal Terms
• Payment for the CO2
– Pricing
• Volumes of CO2
• Timing – when is capture equipment placed in service.
• Sequestration/Injection Service
– Pricing
• Compliance
– IRS Form 8933
– EPA – UIC (protection of underground water sources) and Subpart RR (greenhouse gases)
– LCFS
• Credit Support
– Guarantees and Indemnities
11

12. The Low Carbon Fuel Standard
12
The LCFS Program
• Persons supplying fuel in California need to comply with fuel density restrictions.
• Fuel suppliers with high density fuel need to purchase credits to compensate for the high density.
• In 2018, the CCS Protocol was adopted.
• Companies involved in the delivery of fuel to California with CCS can create credits under the program
• Credits can be obtained for CO2 captured with direct air capture, regardless of where the capture
occurs.
• The credits can be sold on the Credit Clearance Market.
Three states, California, Oregon, and Washington, as well as British Columbia,
have the program and a number of states are considering implementing similar
programs.
• https://theincubex.com/states-and-provinces-with-lcfs-markets-2/

13. Thank You!
13
Presenter Contact Information:
Peter Connors
Orrick LLP
pconnors@Orrick.com
212 -506-5120
Special thanks to Barbara De marigny for the
artwork!