A massive bipartisan infrastructure act that became law last November authorizes tax-exempt “private activity bonds” to be used to finance carbon capture projects.

Tax-exempt private activity bonds are bonds issued by state and local governments to finance projects that are privately owned or used. The interest payments on the bonds are excluded from taxable income of the bondholders. Therefore, bondholders are willing to accept a lower rate of interest than if the interest were taxable.

The new carbon capture bonds, like most tax-exempt private activity bonds, are subject to the alternative minimum tax if held by individuals. AMT bonds bear interest at a rate higher than other tax-exempt bonds but lower than taxable bonds.

Spreads between tax-exempt and taxable rates vary. Tax-exempt AMT rates are currently around 120 basis points lower than taxable rates for 10-year bonds.

Three types of carbon capture facilities are eligible for this new category of tax-exempt financing. It can be used for carbon capture, transportation and storage equipment installed in certain power plants and other industrial facilities. It can be used for gasification facilities. It can also be used for direct air capture (DAC) facilities.

For industrial or gasification facilities, this new financing is available only if the carbon dioxide (CO2) captured from the facility is injected into geologic storage or used for enhanced oil or gas recovery (EOR) followed by geologic storage.

If at least 65% of a qualifying facility’s CO2 emissions are injected into geologic storage (or used for EOR followed by geologic storage), then tax-exempt financing is available for 100% of the eligible component costs. If less than 65% of the CO2 emissions are so injected or used, then only that lesser percentage of the eligible component costs may be funded with tax-exempt debt.

The infrastructure act does not specify the permissible uses of CO2 captured by DAC facilities, which capture CO2 directly from the atmosphere. Additional guidance from the US Treasury will be needed to identify the permissible uses (though, at a minimum, geologic storage should qualify).

Tax-exempt financing is generally available only for schools, roads, municipal utility systems and other state or local government projects that benefit the general public. The new carbon capture bonds are one of a limited number of tax-exempt private activity bonds that the US government has authorized for the benefit of private entities.

Carbon capture bonds must be issued by a state or local government or an entity authorized to issue bonds on behalf of a state or local government. In a typical structure, the issuer of carbon capture bonds will make the bond proceeds available to the facility owner through a loan or similar agreement.

Like most tax-exempt private activity bonds, carbon capture bonds are subject to annual, per-state volume caps. For 2022, the volume cap for each state is $110 multiplied by the state population (or $335,115,000, if greater). An issuer of carbon capture bonds must receive a volume cap allocation equal to 25% of the bond issue amount. By contrast, most tax-exempt private activity bonds (including bonds for privately-owned solid waste disposal facilities) require volume cap for 100% of the issue.

Equipment financed with tax-exempt debt must be depreciated on a straight-line basis over a longer period. Thus, for carbon capture bonds to be economical, the interest savings must exceed the reduction in tax savings from slower depreciation. However, there is no trade-off to the extent the capture equipment qualifies as a pollution control facility eligible for 60- or 84-month amortization under section 169 of the US tax code.

If proceeds of carbon capture bonds are used to finance equipment for a project for which tax credits for carbon capture are available under section 45Q of the US tax code, the section 45Q credits will be reduced by the percentage of the project costs financed with carbon capture bonds, up to a maximum reduction of 50%. Given the value of section 45Q credits, it generally would not be economic to finance any costs of a section 45Q project with carbon capture bonds. The tradeoff is too great.

Treasury guidance will be needed to clarify the scope of a section 45Q project. For example, transportation and storage facilities might not be part of a section 45Q project if they are owned by persons other than the owner of the capture equipment and no election is made to transfer the tax credits to the party sequestering the CO2 underground. If the transportation and storage facilities are not part of the section 45Q project, then the financing of those facilities with carbon capture bonds will not cause a reduction in section 45Q credits.

Eligible Equipment

Carbon capture bonds are authorized to finance “eligible components” of “industrial carbon dioxide facilities.”

Eligible components include equipment used to capture, treat and purify, compress, transport or store permanently underground CO2 produced by an industrial carbon dioxide facility.

An “industrial carbon dioxide facility” is a facility that emits CO2 (including from any fugitive emissions source) created as a result of any of five processes. The five are fuel combustion, gasification, bio-industrial production, fermentation or any process in eight types of manufacturing. The eight are chemicals, fertilizers, glass, steel, petroleum residues (consisting of the carbonized product of high-boiling hydrocarbon fractions obtained in petroleum processing), forest products, agriculture (including feedlots and dairy operations) and transportation-grade liquid fuels.

The first four processes (fuel combustion, gasification, bio-industrial and fermentation) are not limited to any specific industry. Thus, carbon capture bonds should be available not only for the above-listed industries (chemicals, fertilizers, glass, steel, petroleum residues, forest products, agriculture, and transportation grade liquid fuels) but also for any other industry using one of the four processes.

For example, fuel combustion should include the burning of fossil fuels or biomass at power plants or other industrial facilities. Accordingly, equipment (such as an absorber or regenerator) installed in such a facility to capture CO2 from the flue gas or other emissions stream should be an “eligible component.”

Similarly, equipment installed in an ethanol plant to capture CO2 emitted from both the fermentation process and the burning of fossil fuels should be an eligible component. As another example, equipment that captures CO2 from blast furnace gas emitted in steel production should be eligible for this tax-exempt financing.

In addition to post-combustion capture, carbon capture bond financing is available for equipment that captures CO2 from a gasification process.

Gasification generally involves combining a carbon-based material with oxygen or air and steam in a gasifier. Gasification produces a synthesis gas consisting primarily of hydrogen and carbon monoxide. With the use of a shift reactor, the syngas can be converted into a gas consisting of hydrogen and CO2. If the gasification process meets certain requirements described below, the gasification facilities themselves (including, for example, the gasifier and an air separation unit) are eligible for financing with carbon capture bonds.

Carbon capture bonds are also available for equipment that captures CO2 from an emissions stream resulting from an oxy-fuel combustion process.

Oxy-fuel combustion is an emerging technology that uses nearly pure oxygen instead of air for fuel combustion and produces a flue gas consisting mostly of CO2 and water. This technology generally requires an air separation unit to produce oxygen for combustion. US Treasury guidance may be needed to clarify whether an air separation unit used for oxy-fuel combustion (as distinguished from downstream equipment used to capture and process CO2 emissions) is itself eligible for tax-exempt financing.

An air separation unit that is not a necessary component of an oxy-fuel combustion process (or does not qualify as gasification equipment) is not part of an “industrial carbon dioxide facility” in which eligible components can be installed using carbon capture bonds.

Three other types of property are also excluded from the definition of “industrial carbon dioxide facility” and thus cannot contain equipment financed with carbon capture bonds. They are property that produces a raw product consisting of gas or mixed gas and liquid from a geological formation, property that transports or removes impurities from the product, and property that separates the product into its constituent parts.

Accordingly, absent Treasury guidance to the contrary, facilities used to extract from a natural underground reservoir a raw gas comprised of CO2 and another gas (such as methane or helium) and to separate CO2 from the other gas would not qualify as industrial carbon dioxide facilities even if the extraction of the other gas were itself economically viable.

Similarly, properties used for oil or natural gas extraction, transportation and refining are not industrial carbon dioxide facilities.

On the other hand, petroleum residues that are a byproduct of crude oil distillation can be used as a feedstock in a gasification facility financed with carbon capture bonds. Moreover, the injection of CO2 into an oil and gas reservoir for EOR (followed by geologic storage) is a permissible use of CO2 captured with bond-financed equipment.

Property eligible for financing with carbon capture bonds includes not only equipment used to capture, treat, purify and compress CO2, but also equipment used for transportation or on-site storage of CO2. The precise scope of transportation and storage facilities is not entirely clear, given that eligible components are required to be installed “in” the industrial carbon dioxide facility and storage facilities are required to be “on-site.” US Treasury guidance will be needed to clarify these terms.

Carbon capture bond financing is available only if the captured CO2 is injected into geologic storage, or used for EOR followed by geologic storage. The statute does not define, or identify standards for, geologic storage or EOR. By contrast, section 45Q has detailed requirements for EOR and geologic storage, and the Treasury has issued extensive regulations implementing those provisions. The Treasury can be expected to follow similar principles for carbon capture bonds, taking into account differences in the two statutes. In any event, geologic storage generally should include permanent storage at deep saline formations, oil and gas reservoirs or unminable coal seams. EOR involves the injection of CO2 into oil and gas reservoirs to boost production.

In many cases, the owner of the carbon capture equipment may not also own the pipeline and wells needed to move the CO2 and bury it underground. In those situations, the capture equipment owner will need to contract with third parties to ensure that the captured CO2 is disposed of in a manner consistent with tax-exempt financing requirements.

Gasification Facilities

Certain gasification facilities are eligible for carbon capture bond financing.

Specifically, “eligible components” include equipment installed in an industrial carbon dioxide facility that is integral or functionally related and subordinate to a process that converts a solid or liquid product from coal, petroleum residue, biomass or other materials that are recovered for their energy or feedstock value into a syngas composed primarily of CO2 and hydrogen for direct use or subsequent chemical or physical conversion.

“Coal” for this purpose means anthracite, bituminous coal, subbituminous coal, lignite and peat.

“Biomass” means any agricultural or plant waste, byproduct of wood or paper mill operations, including lignin in spent pulping liquors (but not paper that is commonly recycled) and other products of forestry maintenance.

The statutory language regarding the use of carbon capture bonds for gasification facilities is nearly identical to language in section 48B of the US tax code, which authorized an investment tax credit for gasification facilities.

A key difference is that, for carbon capture bonds, the resulting syngas must be composed primarily of “carbon dioxide” and hydrogen, whereas the ITC requires that the syngas be composed primarily of “carbon monoxide” and hydrogen. The reference to “carbon dioxide” should permit the financing with carbon capture bonds of facilities (such as a shift reactor) that convert carbon monoxide in syngas into CO2. Facilities that capture and remove CO2 from the syngas also would be eligible for carbon capture bond financing. Once the CO2 is removed, the remaining hydrogen stream could be burned to generate electricity (for example, in an integrated gasification combined-cycle power plant) or used for another industrial or commercial purpose.

“Coal” that can be used as a feedstock in a qualifying gasification facility should include waste coal that is a byproduct of previous processing of anthracite, bituminous coal, subbituminous coal, lignite or peat.

Municipal solid waste also should be an eligible feedstock.

In addition to carbon capture bond financing, gasification facilities used to convert waste coal or municipal solid waste to syngas generally are already eligible for financing with tax-exempt solid waste disposal bonds. Solid waste bonds do not require capture or storage of CO2. However, a solid waste bond issue for privately-owned facilities requires volume cap for 100% of the issue as compared to 25% for a carbon capture bond issue.

The use of solid waste bonds to finance a gasification facility would not cause a loss of section 45Q credits even if the facility were considered to be part of the same project with the carbon capture equipment.

Direct Air Capture

A DAC facility that uses carbon capture equipment to capture CO2 directly from the ambient air is eligible for financing with carbon capture bonds.

A DAC facility does not include property that captures CO2 deliberately released from naturally occurring subsurface springs. It also does not include property (such as a tree) that captures CO2 using natural photosynthesis.

The statute does not specify the permissible uses of CO2 captured by DAC facilities. Additional guidance from the US Treasury will be needed to identify the permissible uses, although, at a minimum, geologic storage should qualify.

Absent Treasury guidance to the contrary, facilities used to transport or store CO2 captured from a DAC facility do not qualify for carbon capture bond financing.

Eligible Costs

The amount of costs of the eligible components that qualify for funding with carbon capture bonds depends on the facility’s capture and storage percentage.

The “capture and storage percentage” is the total metric tons of CO2 designed to be captured, transported and injected into geologic storage (or used for EOR followed by geologic storage) each year, divided by the total metric tons of CO2 that otherwise would be released into the atmosphere each year if the eligible components were not installed.

If the capture and storage percentage is at least 65%, then 100% of the eligible component costs qualify for tax-exempt financing.

If the percentage is less than 65%, then only that lesser percentage of the eligible component costs qualifies.

If eligible components are designed to capture CO2 solely from specific emissions sources within a facility, then only those specific emissions sources are considered when calculating the capture and storage percentage.