The government gives carbon credit permits to companies to emit carbon and certain other greenhouse gases. The carbon credit tax credit program is designed to incentivize the reduction of greenhouse emissions by companies that emit carbon and other pollutants. Essentially, a company can purchase a carbon tax credit, also known as a carbon offset, to offset their carbon dioxide emissions produced by industrial production (manufacturing), travel and/or delivery of goods. 

How do carbon credits work?

Each credit represents one ton of carbon dioxide removed from the atmosphere. Individuals or private companies can purchase these credits and sometimes sell them from one party to another. 

Carbon credits can have many benefits for the environment and the companies that have them. Internal Revenue Code Section 45Q provides a tax credit of up to $50 per metric ton of carbon "captured" and stored in a "qualified facility" instead of being released into the atmosphere. 

This process can get pretty technical, but it means that the companies are securely disposing of carbon. This is often in deep, underground facilities such as:

• Salt deposits,
• Oil reservoirs, and
• Unminable coal seams

These carbon credits also comply with all other local and global regulations, of course (the Environmental Protection Agency (EPA) and the International Organization for Standardization (ISO) both have rules about this).  

Why are carbon credits important?

For decades, governments worldwide have struggled to control the level of pollutants companies emit. As the realities of climate change become more tangible and immediate, many feel incentivization to pollute less through tax credits is a critical feature of humanity's survival over the next century. These credits can be a powerful tool to combat global warming and promote increased awareness of environmental issues and social responsibility in this respect. 

The concept of carbon markets was created in the 1997 Kyoto Protocol, an international agreement developed by the United Nations' Intergovernmental Panel on Climate Change, and came into force in 2005. However, the United States had already dropped out of the agreement by 2001. Nonetheless, the US has been regulating airborne emissions since the passage of the Clean Air Act of 1990, another cap-and-trade carbon credit program.

What is the 1997 Kyoto Protocol, and how does it affect carbon credits?

Essentially, the Protocol set a per-country cap on carbon emissions, which opened the door for countries to "trade" carbon emission allowances. This meant that companies planning to emit less carbon than allowed would sell their allowances to other companies who needed or planned to emit more. 

Although this probably sounds like a great plan overall, not every country was a signatory to this agreement. Some had no actual obligations under it, and the signatories with obligations only accounted for approximately one-fifth of global carbon emissions. Fast forward to today, and carbon tax credits and credit trading have become all the more popular as a supplement to the Kyoto Protocol.

How do carbon markets work?

The way the carbon market works is that each company gets a set number of credits that allow them a certain amount of emissions per year, and this cap decreases over time. If a company exceeds its cap, they get fined by the government in the form of having to purchase extra credits. 

Alternatively, companies can make money by reducing their emissions and selling off unused credits to other companies who need them. Thus, companies are doubly incentivized to reduce their carbon output, as operating over the carbon allotment comes with a high financial cost. In addition, the tax incentive is there to encourage companies to reduce their carbon emissions and dispose of the carbon appropriately. 

Carbon credits have a range of values depending on many variables, but the typical value of a single credit is anywhere from $5 to $50 per metric ton of carbon dioxide. The World Bank compiles annual reports on carbon credit pricing. 

Pros and Cons of a Cap-and-Trade System

Proponents of the cap-and-trade system say that it encourages companies to invest in cleaner technologies to avoid purchasing carbon permits that will increase in cost annually. On the flip side, environmental advocates against allowing companies to sell their excess carbon permits might argue that this market system enables the overall global carbon levels to remain high. This argument stems from the fact that carbon emissions aren't being reduced in the aggregate and instead are simply being passed around. 

Carbon Credits and Oil and Gas Wells

The EPA estimates that there are over 3 million abandoned oil and gas wells in the United States, and these are only the known ones. These are wells that were used for oil or gas extraction, now deemed to be at the end of their useful life. These inactive wells are supposed to be properly “plugged and abandoned,” (P&A), but this process is extensive and can be hazardous.

Additionally, if not done correctly or at all, these sites can emit methane into the environment, and the EPA estimates that this occurs in concerning amounts. The well site must be prepped, precautions taken, and assessed before plugging work can begin. Sometimes there are materials or resources from within the well that can be salvaged and must be removed carefully. 

Then, once the site is ready, cement plugs are placed in the well site's hole, called the borehole, and the site must then be tested for leaks or movement. Many state and federal regulations must be followed in this process, varying from state to state. The project overall can take a long time and is quite costly.

Unplugging P&A Wells and Carbon Credits

In some states with lax regulations on P&A wells, these sites can be left unplugged for many years, if not indefinitely, if an argument can be made for possible future use. Sometimes, the fines associated with leaving these sites unplugged are negligible, and the penalties tend to be cheaper than paying to plug and abandon them, so there is often minimal incentive to handle this responsibly. 

A potential solution could be offering carbon credits to companies willing to undertake P&A of these unused sites. By the end of 2022, the American Carbon Registry (ACR) will finalize and publish a peer-reviewed methodology for implementing a program that offers carbon offset credits by reducing methane emissions by plugging unused wells.

Since the process for this activity is so expensive, the idea is that offering valuable carbon credits that would have otherwise had to be purchased will help finance and incentivize P&A and therefore reduce the current methane leaks from existing unplugged sites.    

A project developer interested in earning the carbon credit for P&A activity can register their project to be deemed eligible for receiving the carbon credits. Credits received as part of this program can then be used (sold) in the general carbon market. 

Factors to Qualify for Carbon Credits for a P&A Well Project

If your company is interested in receiving carbon credits for the P&A of a well project, you must first determine if you meet the eligibility requirements.

The ACR provides an 'Eligibility Decision Tree' in their Peer Review of the Methodology for Quantification, Monitoring, Reporting, and Verification of Greenhouse Gas Emissions Reductions From Plugging Abandoned and Orphaned Oil and Gas Wells. To summarize the 'tree,' you have to ask:

1. Is the well located in the US or Canada?
   1. If the answer is no, then the well is not eligible.
   2. If yes, proceed to question #2.
2. Does the well meet this methodology orphan well description?
   1. If yes, then the well is eligible.
   2. If no, then proceed to question #3.
3. Does the well meet this methodology abandoned well description?
   1. If the answer is no, then the well is not eligible.
   2. If yes, then proceed to question #4.
4. Was the well first drilled before 1950?
   1. If the answer is no, then the well is not eligible.
   2. If the answer is yes, then proceed to question #5.
5. Does the well show for reported production for the last six consecutive months?
   1. If yes, then the well is eligible.
   2. If no, then proceed to question #6.
6. Does the well show proof of regulatory compliance?
   1. If no, then the well is not eligible.
   2. If yes, then the well is eligible.

For question #2, a methodology orphan well is referred to as a well “without a solvent operator, and that are not plugged or have been poorly plugged and require additional plugging measures to prevent emissions.”

Find the whole peer review report here: AOOG v1.0 Peer Review Draft

Financial Value of Carbon Credits

Before determining if you will invest in this type of venture, you must determine if the value of the carbon credits is financially worth it for the cost of plugging the inactive well. Again, since carbon markets can vary, it is important to calculate the costs versus the value of the credits.

This value will also change depending on various factors of the well itself, such as:

• Where the well is located
• How deep is the well
• How old is the well

Questions?

If you have any questions regarding carbon credits and the P&A of wells, contact our experienced energy lawyers today for a free consultation.