Capital and climate – a fast-paced race is on

November 2024 | SPOTLIGHT | SECTOR ANALYSIS

Financier Worldwide Magazine

November 2024 Issue

The climate race has shifted up a gear, as governments and industry tackle what Bill Gates has described as “the greatest challenge humanity has ever faced”. The pace of the race is accelerating across a range of areas. This includes electricity grids and carbon capture and storage (CCS) – both of which require large capital allocation.

Following a gold medal haul for the ages at the Paris Olympics in July 2024, China delivered a gold medal performance of a different kind – by achieving its 2030 renewable energy (RE) penetration targets five and a half years’ early. In absolute terms, the scale of this achievement is extraordinary. The world has reaped the cost benefits of China’s investments in this area, critically through lower cost solar panels. The pace of the race in China is not slowing.

China’s RE rollout has been, according to reports, impacted by the state of its electricity grid. In August 2024 the country announced that $800bn has been allocated for grid investment over the next six years. Yet, more of China’s grid is less than 10 years old compared to any other country. While the quantum of this committed capital is noteworthy, so too is the fact that 15 percent of it will be allocated toward software management for smarter grid solutions, including artificial intelligence (AI) functionality for smarter grid management.

This is an area to watch. It is not only Chinese government capital that is following the AI-led path to smarter grids. The Wall Street Journal reported (also in August) that while US-led venture capital (VC) investment in climate tech start-ups has been falling since 2021, VC houses see opportunities in battery efficiency and technologies to improve the efficiency and reliability of the electrical grid. VC houses cannot do all the heavy lifting though.

Ironically, as AI is positioning centre-field for grid management, it is driving exponential growth in required grid capacity and a substantial reappraisal of power plants and grids. The data centres required for AI need very large amounts of electrical energy to function. On average, each ChatGPT query needs nearly 10 times as much electricity to process as a Google search, for example. Goldman Sachs forecast 160 percent growth in global data centre power demand to 2030. Recent Barclays Bank research estimates that data centres account for 3.5 percent of US electricity consumption today, potentially moving to 9 percent by 2030.

Texas provides a great example of what this means in practice. Earlier this year, the operator of the Texas electricity grid (ERCOT) forecast an additional 67 gigawatts of electrical load will be added to its grid by 2030. This was a 78 percent increase over the prior year forecasts to 2030. This is largely (but not exclusively) driven by power-hungry AI and is growth that is hard to comprehend.

The dramatic increase in electrical energy required to service AI computing creates an interesting challenge in the context of the net zero and climate pledges of tech giants that will be large players in the AI space. In recent years, these tech giants have made excellent strides in purchasing RE power and renewable offsets for their operations as part of net-zero commitments they have made. Some have even been committed to netting out their carbon footprint since their incorporation. Due to the pace and scale required, there is a question mark over the ability of RE (alone or in combination) to meet the increased power needs for AI.

There are also suggestions that RE will take a backseat in meeting increased power demand for AI, at least in the US. China is suggesting nuclear will be a pivotal power source for AI in China. Parts of Asia may be able to meet increased demand through RE without impacting power grids. In the US, there is a perspective that RE installations will lag. One tech giant has announced small modular nuclear for new AI data centres but the mainstream view seems to be new gas-fired power generation, with CCS to capture and store the carbon from the gas-fired power station. A gas plus CCS approach removes grid-related impacts of RE from the equation and is capable of attracting financial support from the US government. CCS is an expensive addition to any power generation facility.

However, the US government may provide support for what is needed. The Inflation Reduction Act in the US has established a tax credit that acts as an incentive support structure for CCS projects in the US (provided they meet certain requirements). We are seeing CCS projects (at scale) moving forward in the US with material investment by industry and private capital. To some extent the US has stolen a march on the rest of the world, in terms of attracting private capital into the climate project investment arena generally, due to the Inflation Reduction Act. This is particularly the case for CCS and projects to create climate friendly fuel alternatives such as clean ammonia and hydrogen (which some governments (like Japan and Korea) have recently mandated for use in power generation to lower their country’s carbon emissions).

Globally, CCS has moved up the priority list as a means of addressing climate change and for countries to meet their international commitments to reduce emissions. One of a number of recognised pathways to reduce greenhouse gas, there is now recognition that CCS is not an interim measure but a long-term solution. Looking around the world, Europe, the UK, Japan, South Korea, Malaysia, Indonesia, Singapore and Australia (among others) are all implementing policy or regulatory initiatives to facilitate the implementation of this nascent industry.

The dynamic is particularly interesting in Asia Pacific, which contains some of the world’s largest greenhouse emitting economies and has some world class storage options for carbon (in the form of CO2), but lacks a common legal or economic framework to facilitate cooperation (in contrast to the European Union (EU)). More than this, big emitters like Japan and South Korea are not blessed with the long term storage options of their South East Asian neighbours Indonesia and Malaysia or, further afield, Australia. This paves the way for CCS value chains originating with capture in one country, the development of infrastructure to collect, gather and aggregate CO2 in that country, most likely liquefaction facilities to liquify the CO2 for loading onto ships, for onward transport to a storage site in another country.

CCS may be regarded as an expensive proposition in the cross-border context. Even with a price on carbon under the EU’s Emissions Trading System (a price that is avoided through use of CCS), the few pioneering cross-border CCS projects in Europe that are under development have required material government financial support to move forward, both initial and ongoing. Absent government support, emitters will not absorb the costs, at the risk of being uncompetitive.

There is also a very important role for government. In the EU, the proceeds from the price of carbon are recirculated to provide support for low, lower or no carbon solutions, with the support being shared across member states. The position outside the common framework of the EU is different, and more complex. One government must provide financial support for its emitters to capture and process CO2, but is relying on another government’s storage assets for permanent storage.

It is well known that governments in Asia Pacific are engaged in government to government discussion, as they seek to facilitate their own domestic emission reduction targets and source long term storage solutions. In some cases, new legislation has been passed to lay the regulatory framework for this new industry: Indonesia and Japan are two examples. Malaysia has committed to draft legislation by the end of 2024. Further implementing regulations and policy are, however, required. It is an evolving landscape. Any form of economic or support mechanism may take a little longer to evolve.

Sequestration of CO2 can be onshore or offshore. In the US, the existing network of gas pipelines and available onshore storage sites make onshore storage more prospective. In locations with depleted offshore gas fields, we are seeing offshore storage of CO2, including the North Sea and the gas-exporting countries of Asia Pacific, such as Australia, Indonesia and Malaysia. The early movers in this fast-developing area tend to be those with gas field experience – international energy companies and national oil companies. This is the case for at least some parts of the carbon value chain. However, the carbon value chain comprises different components that must be coherent from point of capture to storage. It is right to focus on this as a ‘service’ chain, as many parts are assets with classic ‘infrastructure’ attributes such as pipelines and port terminal facilities, and processing facilities. Then there are shipping and storage services.

Does CCS technology exist today? Yes, but the real test is the scale. CO2 has been captured and processed by industry for some time. CO2 transport ships exist but larger capacity carriers are needed. For many years, oil & gas operations have enhanced the productiveness of fields by injecting CO2 which (in broad terms) facilitates greater gas and oil extraction. The CO2 remains in field. The chemistry of CO2 and how it reacts with the geology of the field is known. What is and is not a good storage site – from a geological perspective – is known. The challenge is the scale of investment needed and the higher costs of cross-border movement of CO2. These costs are both development and operational. In time, we will see capital recycled as chains mature.

CCS and electricity grids are two specific areas where the pace of change has been rapid over the past year and will continue to accelerate.

Governments are playing a large role in both areas. While the benefits of a centrally planned economy (such as China) are clear to see, government support in different formats is underpinning or will support the deployment of non-government capital – be it the balance sheet of industrials, energy companies or private capital in different forms.

Richard Guit is a partner at Baker Botts LLP. He can be contacted on +65 8882 7149 or by email: richard.guit@bakerbotts.com.

Richard Guit

Baker Botts LLP