Government as catalyst: Strategic financing paths for scaling carbon dioxide removal

Carbon dioxide removal - CDR for short - is essential to achieve net-zero and avert the worst effects of climate change. While drastic emission reductions remain the core focus, we will require between 5 and 10 gigatonnes of CDR per year by 2050. To make the sheer size more tangible: The combined production of the oil and gas industry is 5.1 gigatonnes per year according to the IEA. Experts estimate that we might need to scale CDR up to 5,000x in just 26 years, a compound annual growth rate of almost 39%.

Even assuming considerable drops in prices to below $100/tonne of CDR (currently at $488/t), 10Gt per year will require financing of about a trillion dollars per year by 2050. At present, financing of durable CDR occurs primarily through the voluntary carbon market (VCM), which logged just over $1.8b in 2023. So where will the rest come from?

While the VCM is expected to grow significantly - up to $80b by 2030 according to McKinsey and up to $135b by 2040 according to BCG - the large majority of this financing will have to come from the government. In this article, I present the main policy options available to finance and scale CDR and propose a framework to compare them. There is no silver bullet here: smart policy will utilize a number of policies, tailored to the needs of each country’s economy, experience, and geology.

What policy options exist?

‍We do not need to reinvent the wheel to scale CDR. Instead, we can draw on decades of experience of using industrial policy to support critical, nascent sectors. The tremendous success story of renewable energy and photovoltaics in particular serves as a strong reminder of just how impactful such policies can be.

Funding policy for CDR can be broadly categorized into three main buckets: compliance markets, public procurement, and fiscal incentives. Each of these categories encompasses specific mechanisms designed to support the development and deployment of CDR technologies by leveraging different aspects of market and governmental forces.

Compliance markets

A carbon compliance market is a regulatory system that establishes a cap on admitted carbon dioxide emissions, requiring specific companies to either reduce their emissions to meet these caps, buy emissions allowances, or receive a limited number of free allowances to comply with the regulations. There are two main approaches:

• Emission Trading System (ETS) Integration foresees the integration of CDR within an ETS, allowing for the direct inclusion of removal credits within an existing carbon market. This enables entities to offset their emissions by purchasing CDR credits, thus providing a financial incentive for carbon removal. Example: the European Emission Trading System (EU ETS).
• Removal Trading System (RTS) involves creating a dedicated compliance market where removal credits can be traded. It imposes an obligation on certain sectors to achieve a specific level of CO2 removal, thereby incentivising the development and use of CDR technologies through market dynamics. Example: doesn’t exist yet.

Public procurement

Public procurement refers to the purchase by governments and state-owned enterprises of goods, services and works. It accounts for approximately 13% of GDP in OECD countries, representing a key tool for the green transition. These are three prominent options for CDR:

• Direct Procurement: The government directly purchases carbon removal credits to meet its climate targets or other policy objectives, providing a direct revenue stream for CDR projects. Example: the United States’ Department of Energy CDR Purchase Pilot Prize.
• Feed-in Tariffs: Similar to their application in renewable energy, feed-in tariffs for CDR guarantee a fixed price for carbon removed over a set time frame, ensuring a stable income for operators of CDR projects. Example: Luxembourg’s L-Net.
• Contract for Difference: This mechanism locks in a specific price for carbon removal. If the market price is lower, the government pays the difference to the project operator, reducing financial risk and encouraging investment in CDR technologies. Example: the United Kingdom’s Carbon Contracts for Difference.

Note: Within the three options above, governments have many main ways to determine prices. Two of the most popular are:

• Reverse Auction: CDR projects bid to offer carbon removal at the lowest price, with the government selecting the most cost-effective bids. This approach promotes competition and efficiency.
• Administratively Set Prices: The government sets removal prices based on technology costs and policy objectives, providing price certainty but requiring detailed market analysis.

Fiscal Incentives

Fiscal incentives are a powerful industrial policy tool governments can use to support the creation/scale-up of a specific industry. They can be directed towards specific projects after a tender or provided under the form of tax credits.

• Subsidies support CDR projects directly by reducing the initial investment burden, encouraging research, development, and deployment of new technologies. Example: the European Union’s Horizon Europe.
• Tax Credits provide a rebate or reduction in taxes for each unit of carbon dioxide removed or for specific parts of the CDR infrastructure investment, directly improving the financial viability of CDR projects by decreasing their operational costs. Example: Canada’s CCUS ITC.

It is important to note that these seven policy options do not operate in isolation. Often, they can be combined to target different industry needs. For example, subsidies can be used to facilitate the set-up of a CDR facility, and direct procurement then to purchase credits from said facility to facilitate scale-up. The ideal policy framework will always include a combination of these options.

How can we compare these policies?‍

In order to evaluate and prioritize these different policies, we need to be able to compare them alongside set criteria. The suggested five variables are:

• Financing Type: This variable categorizes mechanisms into Market-based, Public Procurement, or Fiscal Incentives. Each type represents a different approach to mobilizing financial resources for CDR, from leveraging market forces to direct government action and tax-related incentives.
• Implementation Complexity: This evaluates how straightforward it is to set up and run a particular financing mechanism. For instance, subsidies may be relatively easy to implement, requiring only a call for projects and a selection process. In contrast, a Removal Trading System (RTS) demands the establishment of a more complex construct, including defining obligations and sectors.
• Regulatory Complexity: This variable looks at the legal and regulatory challenges associated with each mechanism. It reflects the degree of regulatory innovation and adaptation needed to facilitate the mechanism's integration into the existing policy landscape.
• Allocation Risk: This assesses the financing mechanism's effectiveness in ensuring that funds are directed towards the sectors that require CDR most, e.g. hard-to-abate emissions. Some mechanisms, like tax credits, might not be as effective in allocating credits to the most suitable industries, thereby impacting the overall effectiveness of CDR financing.
• Innovation Stimulus: This evaluates how well a financing mechanism encourages technological innovation within the CDR space. Market-based systems may prioritize cost efficiency, potentially sidelining emerging technologies that are not yet cost-competitive. In contrast, fiscal incentives like subsidies can target specific, promising technologies, fostering innovation.

How governments are pioneering CDR policies today

‍It is important to note that some pioneering countries around the world have already implemented some of these policies or are well underway in planning to do so. Here are some of the most prominent examples:

Accounting for 87% of global carbon markets, the EU ETS is by far the largest compliance market in the world. Integration of CDR into the EU ETS is a real possibility, providing a potential game changer in demand for the CDR industry. The European Commission is currently working on what an integration could look like - including the creation of a dedicated Removal Trading System - and will develop a proposal by 2026 which would come into effect in 2031 at the earliest. The UK and Japan are both exploring integrations with their respective ETS, which could happen within this decade. Finally, California is currently reviewing SB308, a bill that would create a state-wide compliance market specifically for CDR.

Several examples of tax credit incentives exist under two forms. First, a tax credit based on a ratio of $/tonne sequestered. The 45Q tax credit, increased by the Inflation Reduction Act, serves as a key component of the United States' strategy to encourage CDR projects. It provides $85/t for CO2 stored permanently through Bionenergy with Carbon Capture and Storage (BECCS) and $180/t via Direct Air Capture (DAC). Tax credits can also be used to directly finance CAPEX of CDR installation such as the Canadian ICT which covers up to 60% of CAPEX equipment costs for DAC projects.

Subsidies can take many shapes. In Europe, Horizon Europe will provide up to €15m grants for technologies such as DACCS and BECCS. In the U.S. the DoE will award $100m in CAPEX support over the next 12 months to up to 20 CDR projects across different technological approaches. In Germany, €1.37b have been earmarked until 2030 for, among others, DAC installations. Also in the US, $3.5b are being awarded to scale DAC Hubs with the goal of creating four hubs that can remove 1Mt of CO2 per year by 2030.

It is worth noting that subsidies can also target other segments of the CDR supply chain: The United States Department for Agriculture (USDA), for example, provides a payment to farmers who deploy biochar (NRCS Code 336: $800/acre) and lime (NRCS Code 805: $40/acre). This can have a significant impact on the economics of Biochar Carbon Removal (BCR) and Enhanced Weathering (EW), both of which require end users such as farmers to make changes to their practices to scale carbon removal.

The United States is also leading globally on public procurement. The Department of Energy’s CDR Public Procurement Prize is arguably the first time a government will be directly purchasing high-quality CDR credits. For FY2024 it has a budget of $35m with winners announced in the coming months. For FY2025, we are expecting an additional $20m. Its tech-neutral, criteria-based approach makes this program a particularly appealing choice.

For Feed-in Tariffs (FiT), Luxembourg has proposed the Luxembourg Negative Emissions Tariff (L-NET), adapting the FiT model to encourage the development and scaling of negative emissions technologies. By providing five-year contracts with subsidies based on the amount of CO2 removed or sequestered, the L-NET aims to leverage Luxembourg’s financial resources to foster innovation and scale in the CDR sector, including supporting projects from abroad.

Finally, the United Kingdom is envisioning building on its experience in renewable energy deployment and use Carbon Contracts for Difference (CCfDs) to scale CDR: For 15 years, the UK government would de facto cover the difference between carbon credit prices and production costs (plus a markup) providing revenue support for negative emissions and attract private investments.

The road ahead

‍Policy makers across the world are looking into how they can scale CDR and exploring options to do so. The challenge ahead is huge and will require significant efforts from both the public and private sector. Government policy can act as a real multiplier for private investment and demand, providing the certainty and market signals the private sector needs to invest. As can be seen above, plenty of successful examples already exist with billions of public capital allocated to CDR.

Still, this is just the beginning. Over the coming years, we will see CDR policy being developed by many more countries as they rush to achieve their net-zero targets. This article has taken a first stab at providing a comparison of the options available to governments alongside specific examples that we can observe and learn from.

We are building the aircraft as we are flying it. Thankfully, we have gathered plenty of experience over the last decades, particularly in the scale-up of renewables, that can help guide us. We know what we need to do. It’s time to move from theory to action and deploy significant public resources into the scale-up of CDR.