Carbon capture is seen as a key part of the war on global warming, but that particular battle can't be won unless insurers come up with viable risk management solutions. Chris Gingell reports
The International Energy Agency (IEA) recognises carbon capture and storage (CCS) as a core component of a cost-effective strategy to limit global temperature rises to 2°C by 2050. However, the absence of viable risk management and insurance solutions is presenting a barrier to the development of CCS at scale in Europe.
ClimateWise is a global insurance industry leadership group formed to drive action on climate change risk. This article describes the key findings of the recently published report entitled Managing Liabilities of European Carbon Capture and Storage.
The development of CCS at scale in Europe brings with it a new portfolio of risks, for which risk management solutions need to be sought. The insurance industry has an important role to play and, with some innovation, can provide part of the financial security required to manage the risks arising from the liabilities that CCS operators would face. However, some liabilities are likely to remain uninsurable and risk-sharing with the government will still be required.
How does CCS work?
CO2 is separated from other emissions at power stations rather than being released into the atmosphere. The CO2 would then be transported, usually via pipeline, to a suitable reservoir for permanent containment. In the UK, the proposed sites are depleted offshore oil and gas reservoirs, into which the CO2 would be injected, mostly using existing oil and gas infrastructure.
Total investment in CCS projects is expected to be between $2.5 and $3 trillion and to contribute 19% of the IEA's overall projected reduction in CO2 emissions from 57 gigatonnes (Gt) to 14Gt per year.
Aside from being good for the environment, the main incentive for companies to set up CCS schemes is that they would not have to surrender their EU allowances (EUAs) for CO2. This refers to the carbon credits traded under the EU emission trading scheme. One EUA represents 1 tonne of CO2 that the holder is allowed to emit. EUAs are a tradable instrument under the European Emissions Trading Scheme (ETS).
Risks
CO2 is not a fundamentally dangerous chemical in a gaseous state. Unlike natural gas, it is not explosive, and it isn't a direct pollutant such as crude oil.
The EU CCS directive requires operators to have adequate financial security in place before the commencement of CO2 injection to cover the potential costs of mitigating a future CO2 leak from the store.
Aside from the costs of bringing such a leak under control, the store operator would have to surrender its EUAs for the volume of CO2 lost, at the prevailing market price at the time of loss.
This presents a serious hurdle for any would-be storage operators because the future EUA price is unknown. Potential liabilities are also of unknown value and are theoretically uncapped.
The risks of a leak from a store are remote. The oil and gas reservoirs had previously held hydrocarbon reserves for many millions of years. The Department of Energy and Climate Change (DECC) estimates the most likely source of a leak to be from a previously abandoned well and the probability of a leak to be in the order of 1 in 10,000 to 1 in 100,000 over a 100-year period for a single storage site with six abandoned wells.
Estimated maximum loss
The financial consequence of a leakage would depend on the flow rate, the duration and the prevailing EUA price. An estimated maximum loss (EML) scenario involving a 200m tonne leak in 2035 would require approximately £412m for the surrendered EUAs, at present value, based on the central carbon price estimate provided by DECC. In extreme scenarios, the drilling of a relief well could cost up to £100m.
The ClimateWise collaborative group was challenged with solving the problem of how the insurance industry could provide risk transfer for these liabilities.
The report concluded that insurance can and does have an important role to play as a tool to manage some of the risks arising from the EU CCS directive, even if some risks remain fundamentally uninsurable.
Key challenges
Pricing - There is no historical loss data for this risk and there is a lot of uncertainty over future EUA prices. However, given the very remote probabilities involved, it is likely that pricing will be driven by the marginal cost of capital requirements for insurers providing initial capacity. Pricing levels will also have to be sufficiently commercial for both operators and insurers.
Available insurance capacity - Insurers would not be willing to assume an unlimited liability. Insurers are generally reluctant to retain commodity price risk. For example, a typical business interruption policy for oil and gas companies would usually be based on a pre-agreed price per barrel of oil.
Exposures will grow over time as more CO2 is injected into the store. This means that, in the initial stages, less insurance capacity will be required. By the time the CO2 stores get bigger, the insurance industry should have a better understanding of the risk.
Trigger - Leaks may not be identified straight away and could last for years. There are still mixed views on whether policies should be on a claim occurrence basis, or triggered by the timing of the EU demand for EUA repayments.
Risk appetite - Given that insurers would not be able to assume an unlimited liability, any residual risk would fall back to the operator and hence onto the government. The government's willingness to act as the insurer of last resort is a key decision for policymakers.
Timing - CO2 injection would last for approximately 30 years at any given site, and then would require a further 30 years of monitoring. The CCS directive's request to have financial security in place at the outset is clearly at odds with the insurance industry's annually renewable policy cycle.
The use of alternative risk transfer and capital markets was also investigated. Although capital markets may be more comfortable with the commodity price risk involved, the same fundamental hurdles mentioned above would still need to be overcome.
Conclusion
CCS highlights the important role the insurance industry has in combatting climate change and how progress can be made following consultation with wider stakeholders.
For actuaries involved in the energy sector, the whole CCS chain will represent a growing risk that will need to be understood from a pricing, capital and reserving point of view. The scale of investment involved in this growing sub-industry means that the insurance industry will see this as an opportunity for premium growth.
References:
[1] ClimateWise, Managing Liabilities of European Carbon Capture and Storage, 2012 www.climatewise.org.uk
Chris Gingell is a deputy managing director of Willis' Global Solutions Consulting Group. He is a member of ClimateWise.