The Economics of CO2 Sequestration through Enhanced Oil Recovery

Professor Charles Mason, University of Wyoming

The process of injecting CO2 into mature oil fields to increase oil production, enhanced oil recovery (EOR), contributes a significant and growing portion of overall world oil production.  This is an important development for climate-change policy, because most of the injected CO2 remains underground after fields are decommissioned. Provided therefore that the CO2 comes from anthropogenic sources, EOR constitutes a form of carbon capture and sequestration (CCS).  Moreover, whereas projects that inject CO2 into saline aquifers incur only costs, EOR projects generate revenues from the incremental oil that they recover. Accordingly, EOR may form a “bridge” to widespread CCS in aquifers, by helping pay for required infrastructure.

In this paper, we discuss the economics of CO2 sequestration through EOR.  We first consider how climate-change policy may influence optimal management of EOR projects. Currently, these projects treat CO2 as a costly input. In the context of climate-change policy, however, operators may receive carbon credits or other types of subsidies for any CO2 they sequester.  Because these subsidies become a new source of revenues, the question arises how operators should “co-optimize” oil recovery and CO2 sequestration. We show first that, paradoxically, cumulative CO2 sequestration is much more responsive to the oil price than to the sequestration subsidy. At realistic price and subsidy levels, discounted oil revenues make up a far larger share of a project’s NPV than discounted sequestration revenues.  As a result, the operator will optimally manage the project to maximize oil production, potentially injecting large amounts of additional CO2 if this increases oil production even slightly.

We then consider the policy question of how to address the fact that, due to both geological factors and differing management practices, net CO2 emissions by EOR projects can vary widely. Presumably, one would want a policy to discourage projects that sequester far less CO2 per incremental barrel, while promoting projects that sequester more.

We show that a comprehensive tax on CO2 emissions (or an equivalent cap-and-trade scheme) will accomplish both objectives.  It does so indirectly, through induced adjustments in the oil and CO2 markets that reduce both the oil price that EOR projects receive and the CO2 price that they pay.