Bloomberg News

New Life for North Sea Oil Hinges on Coal Gas

July 02, 2012

Dun-Colored Mine Tailings Loom Over the Village of Stainforth

A carbon capture and storage project at Hatfield Colliery in northeast England could bring new life to old oil wells in the North Sea. Photographer: 2co / Bloomberg Markets via Bloomberg.

The mud, shin deep and soot gray, squelches and tugs at John Murray’s work boots, holding them fast.

It’s as though the earth wants to snatch something back, to exact some small payment for the black rock that miners have gouged and blasted from mineral veins half a mile beneath the surface for almost a century now.

One of Murray’s boots is ripped from his foot, sucked down into a hole quickly filling with muddy water. He curses, then chuckles, Bloomberg Markets magazine reports in its August issue.

“As you can see, there’s a lot of work to do before we can even start construction,” he says.

Murray is the facilities general manager for 2Co Energy Ltd.’s Don Valley Power Project located on a 110-acre (45- hectare) site next to the tiny village of Stainforth in northeast England.

Since 1916, the Hatfield Colliery has dumped its mine tailings here, building piles of mud and rock that rise to heights of 130 feet (40 meters) and loom over Stainforth’s houses.

This is where 2Co plans to build a coal-fired power station unlike any other in the U.K.

Among the First

If all goes according to plan, when 2Co’s power station begins operation in 2016, it will be one of the first in Europe -- and one of only a handful of projects worldwide -- to demonstrate carbon capture and storage, or CCS, technology on an industrial scale.

In June, BOC Ltd., a division of German gas and engineering company Linde AG (LIN), agreed to buy 15 percent of 2Co’s Don Valley power project.

2Co’s 650-megawatt plant will turn coal into a gas, remove more than 90 percent of the carbon dioxide and then use the remaining gas to run electricity turbines.

So far, carbon capture technology has been tried in pilot projects that store less than 1 million tons of CO2 a year. 2Co says it will capture five times that amount.

The International Energy Agency is counting on carbon capture to provide 20 percent of the reductions in greenhouse gas emissions by 2050 if the world is to avoid catastrophic climate change.

More than any other country in Europe, the U.K. has staked its future on carbon capture. Without it, the U.K. is unlikely to meet its 2050 target of cutting greenhouse gas emissions by 80 percent from 1990 levels.

Facing a Shortfall

Britain also faces a shortfall in electricity-generating capacity unless new power stations come online within the next decade.

“The U.K. must champion carbon capture and storage on all new coal-fired power plants to clean up our national power infrastructure and drive new jobs and growth in the low-carbon industries of the future,” says Ed Miliband, leader of the opposition Labour Party.

“The Don Valley Power Project in my constituency is not only one of the most ambitious infrastructure projects in Yorkshire but in the whole of Europe.”

Making money from carbon capture, however, has proved difficult.

2Co Chief Executive Officer Lewis Gillies says his company has found a path to profits: Rather than pumping captured CO2 into saline aquifers or abandoned oil wells, as most such projects do, it will pipe it out to the North Sea and inject it into oil wells to boost their productivity.

Increasing Reserves

While CO2 has been used for what’s known as enhanced oil recovery, or EOR, onshore in the U.S., its use offshore is new. 2Co plans to have an ownership stake in the wells, allowing it to make money from oil sales as well as electricity generation.

EOR can increase recoverable reserves by 20 percent on average, according to a 2010 U.S. Department of Energy study. In the U.S., EOR produced 281,000 barrels a day last year, or 6 percent of domestic oil production.

If 2Co’s idea works and others follow, carbon capture and EOR could extend by more than 20 years the life of Britain’s North Sea oil industry, where production has been in decline since 1999, says Jon Gluyas, a professor of geoenergy and carbon capture and storage at Durham University in Durham, England.

That could mean at least 3 billion additional barrels of oil -- plus the jobs and tax revenue that come with continued production.

Tantalizing Benefits

Enhanced oil recovery would also defer the decommissioning of those fields at a cost of as much as 30 billion pounds ($47 billion), according to a Lloyds TSB Bank Plc estimate.

The 2Co project offers tantalizing benefits to a U.K. government struggling with a floundering economy.

It would bring jobs to one of England’s most economically depressed corners, according to Peter Davies, the mayor of Doncaster, which is the nearest city to Stainforth. And it could help spawn a new energy industry worth billions of pounds, according to London-based energy and environmental consulting firm AEA.

Some environmentalists oppose carbon capture linked to enhanced oil recovery because it doesn’t help wean the world off fossil fuels.

“We see carbon capture and storage as part of the shift to a low-carbon economy, not as a crutch for maintaining the carbon economy,” says Mike Childs, head of science policy and research at Friend of the Earth U.K. “CCS for enhanced oil recovery seems perverse.”

Major Hurdles

Even with oil money to help, the estimated cost of 2Co’s venture -- as much as 5 billion pounds -- is a major hurdle. National Grid Plc (NG/), a publicly traded utility, says it will spend up to 1 billion pounds to build the pipeline to carry CO2 from Stainforth to the North Sea, assuming it can reach a deal with either 2Co or the U.K. government over costs.

2Co will need to find up to 4 billion pounds more.

“Don Valley is one of the front-runners in the pack of European CCS projects,” says Kieron Stopforth, an analyst at Bloomberg New Energy Finance. “But there are still a couple of big question marks over cost and financing.”

With this in mind, 2Co has been pursuing investors. U.S. private-equity giant TPG Capital invested an undisclosed sum when 2Co launched in 2010.

This year, in addition to BOC, Samsung C&T Corp. (000830), the South Korean construction company, agreed to purchase 15 percent of the power project for an undisclosed amount.

Samsung Invesment

Gillies says he’s hopeful that with Samsung’s investment, one of Korea’s export credit agencies will also extend financing to 2Co.

He says 2Co has spent about 40 million pounds so far and plans to spend another 50 million pounds to 60 million pounds before it makes its final investment decision on the Don Valley project in mid-2013.

2Co is also counting on government subsidies.

In April, the British government announced a contest to award 1 billion pounds to carbon capture projects by October. 2Co says it will enter, and 15 other companies have also expressed interest.

The company is also competing for a share of dwindling European Union funding. The European Commission is selling carbon emissions credits to raise a pool of money to award to carbon capture and renewable energy projects.

With the price of those credits plummeting from a high of 28.59 euros in July 2008 to 7.13 euros on June 11, the potential pot of available money fell to an estimated 2 billion euros ($2.5 billion) from about 10 billion euros.

‘Make or Break’

As difficult as fundraising is, Gillies says what keeps him up at night is the question of a government-guaranteed electricity price.

Electricity from carbon capture-equipped power plants is likely to cost from 120 pounds to 160 pounds per megawatt-hour by 2020 compared with about 80 pounds without carbon capture, according to estimates from the U.K. Department of Energy and Climate Change.

By 2013, Gillies says, he needs a government-backed contract covering the difference between 2Co’s generation costs and the average wholesale price.

“That is the single thing that will make or break this project,” he says.

The British government plans to implement these guarantees as part of electricity market reforms this year, although it hasn’t determined the level of price support.

Without subsidies, the financial risk becomes untenable.

‘Massive Projects’

“These are massive projects, and in the current investment climate, it is difficult to see how you can borrow large amounts of money without having a tight grip on risk, and that’s difficult with a new technology,” says Jim Ward, head of carbon capture at National Grid.

Ward is a veteran of an earlier U.K. carbon capture competition that collapsed last year after the winner, Scottish Power, a subsidiary of Spanish energy company Iberdrola SA (IBE), decided that proceeding at its then-41-year-old Longannet coal- fired power station in Fife, Scotland, would be too expensive.

Ward points out that Longannet failed even though it involved three established companies, an existing pipeline and an operating North Sea gas platform.

In June, General Electric Co. and Norway’s Sargas AS announced they were launching a new technology to capture CO2 from gas-fired power stations for enhanced oil recovery with no need for subsidies.

Gillies’s partner -- Gareth Roberts, 2Co’s co-founder and chairman -- has a knack for wringing new oil from old wells.

Extinct Volcano

Though Roberts was born in Bradford, West Yorkshire, about 30 miles (48 kilometers) northwest of Stainforth, and studied geology at the University of Oxford, he made his name across the pond.

Denbury Resources Inc. (DNR:US), the Plano, Texas-based company he founded in 1990, pioneered EOR using naturally occurring CO2 from an extinct volcano buried 2,900 feet beneath Jackson, Mississippi.

Today, Denbury produces about 31,000 barrels of oil a day using CO2 injection, a figure that has grown at a compound rate of 30 percent a year since 1999.

When Roberts retired from Denbury in 2009, he called Gillies.

Born in the remote Outer Hebrides, Scotland, Gillies had spent most of his career working at BP Plc (BP/), where he had once tried unsuccessfully to sell to Denbury CO2 from a hydrogen energy project.

First Fund

In July 2010, the duo created 2Co. The name is a semantic play on what the company does -- reversing the damage caused by CO2 -- and what it seeks to be: two companies in one, both a power generator and an oil producer.

Roberts convinced TPG to invest. The private-equity shop had put $40 million from its first fund into Denbury in 1995 and then gave the company another $100 million in 1998 to help it move into CO2-based EOR. TPG declined to comment.

Rather than start from scratch, Roberts and Gillies set out to graft EOR onto an existing carbon capture project.

In May 2011, they bought Powerfuel Power Ltd., a bankrupt company that had planned to build a coal-fired carbon capture power station in Stainforth. 2Co renamed the project after the surrounding Don Valley.

Roberts is confident of 2Co’s business model.

“Somebody once told me this can’t be done,” he says, sitting with his sleeves rolled up in the company’s design and engineering offices in the London suburb of Guildford.

“Well, you don’t tell a Yorkshireman he can’t do something. And you certainly don’t tell a Yorkshireman and a Scot that they can’t do something.”

In Contention

The majority of large carbon capture projects that have gotten past the PowerPoint stage have EOR at their core.

These include two U.S. projects that have already broken ground -- one a project run by Air Products & Chemicals Inc. (APD:US) at a refinery owned by Valero Energy Corp. (VLO:US) in Port Arthur, Texas, and another at Mississippi Power Co.’s Kemper County power plant.

They are in contention to be the first operational industrial-scale carbon capture projects on the planet. Roberts’s old company, Denbury, is taking CO2 from both projects, meaning that, if 2Co succeeds, Roberts will have helped midwife carbon capture on two continents.

The U.K. has a stake in the technology’s success.

To meet its carbon reduction targets, it has decreed that all coal-fired power stations must use the technology by 2025.

Aging Facilities

In the face of new environmental rules, six of 16 existing coal-fired power plants will cease operation by 2016 and all of the U.K.’s aging nuclear facilities are due to be retired by 2035.

That leaves the country facing a potential shortfall of 24 gigawatts, or more than a third of current peak demand.

The government had hoped to fill the gap with offshore wind farms and a new generation of nuclear reactors. Offshore wind farms are expensive and weather dependent, however, and investors have been skittish about nuclear power.

“It’s risky, therefore, to rely entirely on those two proven sources of low-carbon power,” Adam Dawson, the U.K. official in charge of carbon capture policy, told an industry conference in February. “So CCS, in a sense, is something you do to buy yourself an option.”

For Britain, the big payoff will come if 2Co’s venture and other carbon capture projects give rise to an industry exporting a new generation of carbon capture-enabled power stations. That could mean 100,000 jobs and a 6.5 billion-pounds-a-year boost to the British economy by 2030, according to AEA.

Deep Underground

2Co’s immediate impact, however, will be felt in the Don Valley. Coal mined here once powered the British Empire, and generations of Yorkshiremen made their living deep underground.

Today, unemployment hovers stubbornly above 9 percent. 2Co says its project would employ 3,000 workers during the construction phase and about 300 permanently.

It will also help keep alive Hatfield Colliery, which will supply half the Don Valley Power Project’s fuel.

First, though, 2Co must find 4 billion pounds -- and, no doubt, rescue a few boots from the mire.

To contact the reporter on this story: Jeremy Kahn in London at jkahn21@bloomberg.net.

To contact the editor responsible for this story: Laura Colby at lcolby@bloomberg.net.


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Companies Mentioned

  • DNR
    (Denbury Resources Inc)
    • $8.32 USD
    • 1.00
    • 12.02%
  • APD
    (Air Products & Chemicals Inc)
    • $147.04 USD
    • 2.59
    • 1.76%
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