More O&G Energy Transition Deals – Oxy Acquires Carbon Engineering

Building off the prior mentions of acquisitions by O&G companies in the energy transition (ex: BP-Archaea, Exxon-Denbury), yesterday Occidental (NYSE: OXY)’s wholly owned subsidiary, 1PointFive, announced it has entered into a definitive purchase agreement to acquire Carbon Engineering Ltd. for ~$1.1 billion, to be made in three approximately equivalent annual payments, with the first at closing (expected by YE23). Oxy and Carbon Engineering have been working together on Direct Air Capture (“DAC”) deployment since 2019. It’s no coincidence this comes on the heels of the DOE announcing $1.2 billion to advance the development of two commercial-scale DAC plants including one of the plants Oxy and Carbon Engineering were working on.

The post is split into:

1. Background on DAC vs. CCUS
2. Why we need DAC?
3. Oxy’s DAC Ambitions
4. Current State of DAC Capacity
5. Marketplace for DAC
6. Transaction Rationale, Context, and Impacts

Background on DAC vs. CCUS: As a reminder: CCS vs. DAC: Direct air capture removes CO₂ directly from ambient air (think facilities/giant fans pulling in air directly from the environment), resulting in negative emissions. In contrast, carbon capture and storage (CCS) captures CO₂ from point sources of carbon dioxide (think machinery hooked up to facility to capture the flue gas), resulting in avoided emissions.

 

Why do we need removal in addition to avoided emissions?

• Even in the most optimistic cases around emissions reduction, in order to keep warming to below 2C or 1.5C, we will need 5+ gigatons of carbon removal annually from 2050 onwards. 5 gigatons is 5 billion metric tons of CO2. We currently emit 40 billion metric tons of CO2 annually.
  • Why can’t we just remove all the CO2? Costs range from $600-$1,100+ for a single ton of removal, implying trillions of dollars and not to mention the significant energy and land use required that makes it untenable. While early days, many hope we can eventually get carbon removal costs <50-$100 ton, but even at those levels, capital outlays will still be meaningful.
• This is a stark reminder that while CCUS and DAC have roles to play in mitigating residual/hard to abate emissions, the vast majority of mitigating climate change will need to come from reducing the use of CO2 and other GHGs altogether.
  • Given we continue to move slower on abating emissions than climate models anticipate, our dependence on future removals continues to grow

 

Oxy’s DAC Ambitions: Back in Mar-22, Oxy held a low carbon ventures day, which was outlined in detail in this post. Some key takeaways repasted below:

• The Levelized Cost of Capture (LCOC) from the first DAC plant (DAC1) is expected to be $300-425/ton, declining to $250-350/t in 2025-30, and ultimately reaching <$150/t longer-term.
• Oxy expects revenue to come primarily from carbon removal credits, policy support, and higher priced oil (relative to peers). Based on their estimates, they think up to ~5 gigatons (billion tons CO2e) of emissions from the hardest-to-abate industries would be economical at $250/ton per credit.
  • They also only plan to only build the plants in areas where policy is support. [In the US, the 45Q tax credit is $130/ton for used CO2 and $180 per ton for permanently stored CO2 – updated for IRA] and you can also stack it with other tax credits.
  • They also expect to sell premium priced ‘Net Zero Oil’ and have already struck one deal with SK trading which gave the South Korean refiner an option of buying up to 200,000 barrels a year (also see: Transcript Zero Episode 7: Would You Buy “Net-Zero Oil”?)
• OXY plans to have 70 DAC facilities with 1 MTPA capture potential each by 2035 (~1.5% of addressable market) with the potential for up to 135 plants (~2.5% of addressable market). They use the aforementioned 5 gigatons segment as their refence addressable market in this case.
• DAC1 is expected to be $.8-$1.0 billion+ for the first 500,000 ton per annum train with a construction build-time of less than 3 years and an operating life of 25 years. The plant is expected to commence operations in 2H24 and commercially operational in mid-2025. Through 2024, projects will be funded primarily through internal capital, government grants/loans, and strategic equity. From 2025-2030, the funding will transition towards financing through project debt and equity as opposed to deploying internal capital.

Current State of DAC Capacity: The DAC market is extremely nascent given 1) how expensive it is ($600-$1,000+/ton with current technologies), 2) long lead times & complexity building nth of kind facilities, 3) very limited track record and scale to date given aforementioned challenges. In order to meet Net Zero-aligned pathways, we’ll need orders of magnitude more removal.

• IEA Direct Air Capture Report – June 2023:
  • Capturing CO2 from the air is the most expensive application of carbon capture. The CO2 in the atmosphere is much more dilute than in, for example, flue gas from a power station or a cement plant. This contributes to DAC’s higher energy needs and costs relative to these applications.
  • Twenty-seven DAC plants have been commissioned to date worldwide, capturing almost 0.01 Mt CO2/year. Plans for at least 130 DAC facilities are now at various stages of development. If all were to advance (even those only at the concept stage), DAC deployment would reach the level required in 2030 under the Net Zero Emissions by 2050 (NZE) Scenario, or around 75 MtCO2/year.
  • Lead times for DAC plants range from two to six years, suggesting that deployment in line with the NZE Scenario could be achieved with adequate policy support. However, most of the facilities announced to date are at very early stages of development, and cannot be expected to reach final investment decision (FID) and operational status without continued development of market mechanisms and policies to create demand for the CO2 removal service they would provide.
• BNEF Direct Air Capture: Market and Cost Outlook Report – August 2023:
  • Based on announced projects, capture capacity will grow 1,200-times to 12 MtCO2/yr by 2030. Still, there will be a 200 MtCO2/yr gap between supply and potential demand in 2030.
  • Despite being a nascent technology, investors have already spent over $2.8 billion on direct air capture. Bigger players with deeper pockets are entering the market to turn start-ups’ technologies into commercial projects (incl. the $1.1 billion Oxy-Carbon Engineering).
• If I show announced DAC capacity expansions against the Net Zero roadmap side-by-side, you can see the wide gap.
  • If I compare these figures to the number required by 2050, we have a lot of work to do… orders of magnitude large: 12 MT (12,000,000 tons CO2) announced capacity expansions (75 MT assuming everything announced and in development is built) compared to 5 Gigatons (5,000,000,000 tons CO2) required by 2050 and beyond.
    • To give an idea of how small the scale is today, Climeworks’ Orca plant is the largest DAC plant today and removes 4,000 tons/year
    • When Oxy/Carbon Engineering’s plant goes up, it will remove 500,000 tons CO2/year, so a huge jump but a lot that needs to be proved out in order to achieve that

Marketplace for DAC:

• Prices vary drastically between voluntary carbon markets and compliance markets. Removal credits are the most expensive given the lack of availability of high quality, permanent, quantifiable carbon removal options. Historically, nature-based carbon removal was sought out the most and is cheaper than the nascent mechanical/technology-based removal options. If corporations/governments intend to meet Net Zero goals, there will need to be a lot more supply of permanent carbon removal and many are hoping the mechanical/technology-based removal options will be the ones to scale up and meet the challenge.

• The biggest catalyst to the market today in terms of purchasing is Frontier: an advance market commitment to buy an initial $1B+ of permanent carbon removal between 2022 and 2030, founded by Stripe, Alphabet, Shopify, Meta, McKinsey and tens of thousands of businesses using Stripe Climate.
  • Companies like Microsoft & Stripe have also open-sourced their approach to carbon removal purchases, in an effort to accelerate the development of these markets
  • Of note, the $1B+ commitment is not timebound and specifics around when the purchases will be made are TBD
• The current state of the market is quite small, a live dashboard of the carbon removal market & some snapshots below can be found here
  • As you can see, 1PointFive (Oxy subsidiary) is already the largest supplier to the DAC offset market and Carbon Engineering also rounds out the top 5
  • Demand is currently driven entirely by voluntary purchases. Buyers can typically consist of high-profit, high-margin, private corporations, such as Microsoft and Shopify, looking to diversify their sustainability portfolios and willing to pay the premium price tag or other companies where their industry may face existential risk without removal solutions.
  • Not all purchase announcements openly disclose prices making total corporate expenditure difficult to calculate so while the theoretical spend on something like Airbus’ purchase could’ve been in the hundreds of millions, it realistically was transacted at a much smaller price per ton value.

Transaction Rationale, Context, and Impacts:

• Consistent with what is happening in CCUS, scale seems to be the differentiating factor between who can invest and vertically integrate these new energy transition markets
• To be clear, Oxy is only spending ~$367M per year (assuming 3 payments split over 3 years) on this transaction, which on $6 billion of capex is ~6% of capex – as a result, don’t expect much to meaningfully move at all relative to the news
  • In return for that investment, they continue to cement technology/deployment leadership in DAC, a technology/market required for the future of carbon removal
  • Longer-term, this also will be a litmus test to see customer appetite to purchase ‘Net Zero Oil’ (regardless if net positive or negative for emissions abatement at large) at a premium
• The big question marks in my eyes are whether Oxy meaningfully continues to invest into these businesses or eventually shutters them if DAC traction fails to build momentum
  • At a capital cost of $1 billion per DAC plant and plans to build 70-135 over the next few decades, capex spend does become meaningful to the company (although that will be supplemented with government money, third party-financing, etc.)
  • There will need to clear signals that Oxy can achieve meaningful learning curves on new plant builds to lower costs, secure removal commitments/purchases above & beyond cost of removal, and get premium pricing for their oil barrels if ‘Net Zero Oil’ catches on in order to generate any meaningful returns on invested capital
• ​Relevant excerpt from Cowen note: “Prior to the acquisition, OXY would’ve been required to pay a licensing fee to use Carbon Engineering’s technology at both of their planned DAC facilities that would have been an underlying opex. In turn, this licensing fee along with other royalty payments generates another source of revenue for XY. On the R&D side, Carbon Engineering’s small stature and lack of liquidity prolonged technological advancements that came at much higher costs. With the backing of OXY’s organizational resources, the team can accelerate developments needed to commercialize the DAC technology. The reduced costs should appear much more attractive to potential capital partners.”