Financial attractiveness of flaring and methane reduction investments

5

Practical Considerations for Implementing Flaring and Methane Reduction Projects

FINANCIAL ATTRACTIVENESS OF FLARING AND METHANE REDUCTION INVESTMENTS

This report aims to create awareness of the business case for reducing gas flaring and methane emissions, the financial attractiveness of flaring and methane reduction (FMR) projects, and the barriers that project developers need to overcome. The study analyzed the financial attractiveness of six FMR solutions at flare volumes of 1 million standard cubic feet per day (mmscf/d), 5 mmscf/d, and 10 mmscf/d: (1) gas-to-power (with electricity used externally), (2) gas-to-power (with electricity used on-site by the oil operator), (3) gas delivery to an existing pipeline network, (4) gas delivery to an existing gas processing plant, (5) compressed natural gas, and (6) small-scale liquefied natural gas. Other solutions exist but were not modeled because of their niche nature (for example, Crusoe Energy’s digital flare mitigation, presented in chapter 4). Financial returns (internal rates of return [IRRs] and net present values) were modeled on the basis of indicative assumptions derived from project experience and feedback from industry experts. Sensitivities were conducted to reflect the variability of assumptions in real-life projects.

The analysis points to a potentially attractive financial opportunity for independent developers to invest in FMR projects tackling flares in the study range. About 2,358 flare sites fall in the 1–10 mmscf/d range, representing 53.8 percent of global flare volumes, offering a very significant emissions reduction opportunity. Oil companies are unlikely to divert capital and engineering resources to small noncore projects that, from a profitability standpoint, are trivial compared to their core activities. Although far from straightforward, FMR projects of this size are less complex than projects involving large and mega flares, which require large infrastructure investment (for instance, in gas or electricity transmission infrastructure), government planning, and large capital injections. At the other end of the spectrum, FMR projects at flares smaller than 1 mmscf/d are unlikely to be economically viable, unless clustered in larger projects.

Financial modeling presented in chapter 3 shows that FMR projects at flare volumes between 5 mmscf/d and 10 mmscf/day are potentially attractive investment opportunities. For a typical 5 mmscf/d flare, the unlevered and pretax IRR ranges from a barely acceptable 7 percent for a gas delivery to gas processing

solution, to an attractive 20 percent for a small-scale liquefied natural gas solution. A single-digit IRR is below the minimum return threshold of 10 percent suggested by industry participants consulted for this study and would result in a negative net present value. For a 10 mmscf/d flare, all FMR solutions modeled in chapter 3 would produce positive net present values and double-digit IRRs, ranging from 12 percent for a gas delivery to gas processing solution to 24 percent for a small-scale liquefied natural gas solution.

On a standalone basis, 1 mmscf/d flares do not offer attractive financial returns, but they can be clustered to reach an aggregate project size closer to 5–10 mmscf/d. None of the FMR solutions analyzed is financially attractive at flare sites of 1 mmscf/d, with the exception perhaps of power generation for on-site use. The relative advantage of this solution is the ability to charge electricity prices above grid levels, displacing more expensive diesel- or oil-fueled generation. Even this solution, however, would yield only a 7 percent IRR under the model’s assumptions. All other solutions are too intensive in terms of capital expenditures (capex) to generate attractive returns at 1 mmscf/d flares. In practice, FMR developers will want to cluster small flares to reach aggregate volumes more in line with the 5 mmscf/d and 10 mmscf/d scenarios. These size considerations apply to the six FMR solutions modeled in chapter 3. Other niche FMR solutions may be financially attractive at smaller flare sites. Crusoe Energy’s digital flare mitigation, for instance, is viable at flare sites as small as 300,000 scf/d.

FMR projects at 5 mmscf/d–10 mmscf/d flare sites (unique flares or clusters) involve a capital investment in the range of US$7 million to US$59 million, depending on the FMR solution adopted and according to the model’s assumptions. In the 5 mmscf/d scenario, capex would range indicatively from US$7 million (gas delivery to existing pipeline) to US$31 million (gas-to-power for external use, with 17 megawatts capacity installed). In the 10 mmscf/d scenario, capex would range indicatively from US$13 million (gas delivery to existing pipeline) to US$59 million (gas-to-power for external use, with 38 megawatts capacity installed). Please refer to chapter 3 for full details.

Projects of these sizes can be financed primarily with equity provided by the developer and co-investors. This is important because many FMR projects do not meet the requirements of traditional nonrecourse project finance, at least in the development phase. Many FMR projects do not meet contractual project finance criteria—for instance, they may not have feedstock supply agreements in place. In addition, tight development timelines may limit the window of opportunity to contractually arrange a debt package. When a project meets the requirement for debt finance, the magnitude and terms of such debt may not be as attractive as in more established project finance sectors. The Thermo Mechero Morro gas-to-power project discussed in chapter 4, for instance, managed to raise debt but only to the tune of 55 percent of the capital structure.

In the operational phase, when development risk is no longer present, FMR projects may be easier to leverage—especially if de-risking tools are available. FMR developers and investors interviewed for this study indicated use of such tools as a potential avenue to recover some of the equity investment before project expiration (see the Hoerbiger case study in chapter 4). However, not all risks disappear in the operational phase: for instance, FMR projects remain exposed to offtaker risk. De-risking tools such as partial credit guarantees or insurance for breach of contract could enhance the bankability of FMR projects, allowing developers to take money off the table and reallocate capital to new FMR projects.