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UTILITY WEEK | 8TH - 14TH JANUARY 2016 | 23 Finance & Investment Market view I n November, (right aer the 2015 autumn statement) the government quietly can- celled the £1 billion capital funding grant that had long been promised for large-scale CCS demonstration in the UK. Most observers believe this is terminal for the White Rose oxycoal project and the Shell/ SSE Peterhead CCGT project. All technology development has risk reduction at its heart and good R&D projects are designed to pro- gressively retire risks while defer- ring spend. The CCS developers spent more than four years doing that: reducing technical, commer- cial, and operational and project- related risk to acceptable levels for investment decisions in 2016. The fortunes of the CCS indus- try arguably rested on that £1 bil- lion providing enough stimulus to enable the private sector to take on the extra "development risk" inher- ent in a "first of a kind" plant. Pre- sumably, the government believes CCS can be delayed – introduced in future years to resolve a loom- ing conflict between CCGT plant build and "legally binding" carbon targets – and/or hopes that developers will be prepared to pro- ceed using a subsidy mechanism designed to support nuclear and renewables. The "con- tract for difference" (CFD) seeks to encourage private investors to make multi-billion-pound capital investments against a promise that they will recoup their investment over the fol- lowing decades by receiving an elevated but fixed price for electricity – typically set at a "strike price" two to three times the current "unsubsidised" market price. There are issues with CFDs for CCS – fos- sil stations are currently the only plant that can be turned up, down, on or off to match supply and demand. A varying market price – not a fixed price set by a CFD – is essen- tial for this market to function. Perhaps some investors will eventually fund CCS plant using a CFD, but it will be at a much higher cost to UK households than the recently scrapped schemes. The cost of capital to investors capable of delivering these projects is far higher than the Treasury's because these companies simply have more compel- ling investment opportunities. And this is especially true when the cost of capital is borne over many dec- ades and the perceived policy risk in the UK power market is so high. Policy risk affects the whole power industry. The private sector has repeatedly invested in R&D and pilot projects designed to reduce technical risk, only to find the com- mercial driver – the subsidy/tax incentive, for example – withdrawn just before or aer commercial deployment. There are examples in most electricity generation technolo- gies. Each time a critical energy sub- sidy, which has been promised by a succession of recent governments to encourage a particular develop- ment, is withdrawn, it ratchets up perceived policy risk. And it takes the project's cost of capital and the cost of electricity up with it. Various governments have tried to address this – by, for example "grandfather- ing" subsidies for many years. But this typi- cally only addresses one part of a package of measures, so governments are free to change other parts of the package retroactively. Fur- thermore, "grandfathering" is usually only available once the final financial investment decision is reached so developers have to risk many years of R&D/project development. Eventually, technology developers, pro- ject developers and their backers will stop trying to develop anything involving a UK government subsidy. If that is the intention, surely it would be more efficient to simply stop offering new subsidies? In the case of the CCS programme, the government has made a "tough choice" and saved the tax payer £0.2 billion a year for the next five years by deferring (or cancelling) CCS invest- ment. But at what cost? Aside from the carbon and lost opportu- nity cost there is a real cost to the impact on perceived risk. Developers are great at reduc- ing technical and project risk but political risk is beyond their control. We are asking the private sector to invest an estimated £200 billion to replace power stations and power networks, all of which are long-term invest- ments and sensitive to risk. Simplistically, each extra percentage point of perceived risk premium represents £1 billion every year for 20 years in cost of capital before investors believe their risk is recompensed – equivalent to a £20 billion increase in net present cost. Jeremy Carey, managing director, 42 Technology The cost of abandoning CCS Jeremy Carey assesses the real cost of the government's decision to withdraw £1 billion of funding for the large-scale demonstration of carbon capture and storage technology. "Project developers and their backers will stop trying to develop anything involving a government subsidy" Loss of government support may spell the end of the Shell/SSE Peterhead CCS project