Low-Carbon Projects: What Have We Learned from the First Wave?
While some important decarbonization sectors and technologies have succeeded in the marketplace (including onshore wind, solar, electric vehicles, and more recently battery storage), other important sectors—biofuels, CCS, green and blue hydrogen, and decarbonization of steel and cement—are nowhere near self-sustaining at this time. These sectors rely on chemical process technology and are implemented through large, complex engineering projects. In this article, I will refer to this set of technologies as low-carbon projects.
It is old news that companies are slowing investment in low-carbon projects. IPA’s numbers bear out the trend. IPA evaluated several low-carbon projects that were sanctioned in 2022. The number of sanctioned projects dropped by half in 2023. In 2024, there was only one. Moreover, the slowdown was underway well before the results of the recent US election.
Problems with the market and with industrial and regulatory policy across the globe needed to support these projects mean there is too much uncertainty to justify the investment in low-carbon projects. However, development of low-carbon projects is not completely dead. For example, Japan’s hydrogen subsidy program is driving multiple companies to work on low-carbon hydrogen projects. But, for many companies, projects have been abandoned in front-end loading (FEL) or put on a slow simmer waiting for conditions to improve.
The benefit of this slowdown is that it gives us a chance to study how industry performed on the low-carbon projects that were sanctioned. The lessons learned can then be adopted for the next phase of capital investment once conditions are in place to drive investment.
Low Carbon Project Failure
From a project cost and schedule perspective, the results of the first phase of low-carbon projects have been terrible. The low-carbon projects reviewed by IPA that were sanctioned and completed had massive amounts of cost growth and schedule slip. Of the 12 completed projects that we evaluated, the projects averaged 31 percent cost growth and almost 50 percent schedule slip from their sanction estimates.
These projects were sanctioned between 2017 and 2022. During this period, of course, the project supply chain was buffeted by the pandemic and made worse by trade and physical wars. In fact, project supply chain problems continue today with no signs of ending.
However, the pandemic and subsequent issues were not the cause of failure for these projects—they vaporized large amounts of shareholder capital on their own merits. The 31 percent cost growth is in real terms because IPA removes the effect of post-COVID project price increases from actual costs. We also adjust project schedules to account for pandemic delays and supply chain disruptions while projects were in execution.
Figure 1 demonstrates that the project failures were not caused by the pandemic or supply chain disruption. I compared the outcomes of the low-carbon carbon projects to a set of non-low-carbon projects with similar levels of technical complexity that were started and finished during the same period. The table shows that the 436 contemporary projects averaged no cost growth and had 25 percent schedule slip, better results than the similar low-carbon projects.
Project size and technical innovation also did not cause failure for this first wave of projects.
These projects were not that big. The average project cost at authorization was approximately $100 million. There is only one megaproject in the sample.
This set of 12 projects used commercially proven technology as part of their scope. Eventually, new technologies for biofuels, carbon capture, and electrolysis will emerge to significantly reduce costs, but these first phase projects used proven technologies. Half the projects did use technology that was new to the company, but the project histories show that the cost growth and schedule slip was not caused by technical problems.
Why Did the Low-Carbon Projects Fail?
If not the pandemic and continuing subsequent supply chain issues or project complexity, what caused these projects to fail? The answer appears to lie in the use of government subsidies. Governments are using multiple types of climate policy to drive decarbonization. Market-based climate strategy takes the form of carbon taxes or cap and trade systems. Industrial policy aims to provide incentives in the form of grants, low-cost loans, tax credits, and price support mechanisms to offset the higher operating and capital costs needed to build the facility.
The low-carbon projects in this sample targeted a stack of subsidies that included grants, low-cost loans, and tax credits. Some of these subsidies came with schedule requirements. For example, some have statutory deadlines for completion to show progress against government decarbonization goals. For other subsidy schemes, governments have a limited pool of money to be disbursed on a first come, first-served basis. Some incentive stacks had both elements. These incentives caused the projects to be schedule driven.
The evidence that these projects were schedule driven is obvious when we compare two key project drivers of the low-carbon and non-low-carbon projects. Figure 2 shows that the low-carbon projects were planned to finish execution 14 percent faster than average and were authorized with Poor FEL, lagging not only the industry average of Fair but also the Best Practical level of definition (see Figure 3 for more information on IPA’s FEL Index).
Let’s say the industry average execution time for a particular project is 30 months. At 14 percent faster than average, the low-carbon project would expect to finish in 26 months. A similar non low-carbon project would expect to finish in the usual amount of time of 30 months. As mentioned earlier, these projects did not meet their schedule targets—the 46 percent schedule slip made them 7-8 months longer than industry average and about 1 year later than planned!
Planning to go 4 months faster may not seem like a lot, but the low-carbon projects were also less ready to start execution when they were sanctioned. The average low-carbon project was sanctioned with a Poor level of FEL while the comparison set had Fair FEL. These projects had cost and schedule estimates with higher levels of uncertainty, putting project teams in a weak position to identify and mitigate project risk. The typical path to failure was the discovery that the project scope was underestimated as engineering design progressed. The additional engineering and procurement work cascaded into construction delays and lower productivity made worse by the project team’s inability to control the project.
What to Do?
All this leads to a catch-22 situation. Low-carbon projects are only viable with government support. Yet, government support often causes us to adopt a project strategy of taking on risk and hoping for the best. One option is to walk away, and many companies have done that by canceling or putting their projects on hold. Yet, many businesses cannot entirely walk away. The European Union and other countries have climate and circularity targets backed by legislation. While these deadlines may be delayed, businesses must continue to develop projects to maintain their social license to operate.
Also, it is hard for businesses to walk away when they perceive an opportunity to create shareholder value. A constant over my 30 years of studying projects is that businesses really want to do projects. They should. Their job is to identify investment opportunities that involve risk but with sufficient potential to create value.
Often the problem is that the plug is not pulled until every option has been explored, negotiating leverage has been lost, and there is no path to a viable business case. Large sunk costs are incurred when this happens during the FEL 3 phase. The cost of completing the FEL 2 and FEL 3 phases is between 5 and 10 percent of the eventual total installed cost or somewhere between $50 million to $100 million for a billion-dollar project, a significant chunk of change even for a big company with billions in profits.
As the analysis shows, the sunk cost fallacy also creates pressure to move forward with projects that should be killed and that eventually end up in disaster.
Managing Sunk Cost Risk With Shaping Strategy
One way to manage the risk of sunk costs is with a robust shaping strategy. Ed Merrow describes shaping “as the project sponsor’s work that takes an opportunity and fashions it into a business venture and asset.”1 A key element of managing sunk cost risk is developing hold points based on condition precedents.2 The condition precedents are to ensure work across the commercial, project, and engineering work streams does not get out of sequence or proceed past a point where the chances of success are too low to justify additional spending. The hold points allow the sponsor to pivot strategies or to cut their losses before too much money is spent and you are stuck in a forward-looking economic trap.
Roger Miller and Donald Lessard put the goals of shaping succinctly: “Successful sponsors start with project ideas that have the possibility of becoming viable. They then embark on shaping efforts that are most likely to unleash this value during a long front-end process. Successful firms, however, cut their losses quickly when they recognize that a project has little possibility of becoming viable.3
Here is one example from a low-carbon project IPA evaluated. At the end of FEL 1, the project team developed condition precedents for a number of workstreams including the basis of offtake agreements, GHG storage license, land purchase agreements, environmental permit submission, and technology license. A roadmap of activities, decisions, and approvals necessary to meet the requirements was developed for each condition precedent. The roadmaps also identified the uncertainties and risks that had to be transformed to achieve the requirements for each workstream. Each workstream was not allowed to proceed past a certain point unless all the conditions precedent for all workstreams were met.
The bad news is that this project never made it past the first hold point. There was too much uncertainty in the offtake agreements and regulatory and permitting requirements to justify additional work on the project. The good news is that the shaping strategy worked, and the project was killed before too much time and money was wasted.
Climate Policy and Capital Projects
We need climate policy that creates markets in which firms can find a way to assemble a profitable low-carbon project.
The authors of Making Climate Policy Work say that a combination of reforms to existing market-based carbon pricing policies and to industrial policy is necessary to overcome the industrial challenges to transition to near-zero emissions. Carbon markets alone will not produce carbon prices high enough to incentivize the R&D and deployment programs needed to develop the new chemical processing technologies that slash the costs of decarbonization. Industrial policy in multiple forms will also be needed for deep decarbonization.4
Climate policy will always be tied to political goals, but political goals can clash with the realities of capital project development and create levels of uncertainty and risk that make assembling a profitable project impossible.
To achieve their goals, policymakers and lobby groups cannot ignore the drivers of capital project success as they design climate policy. We have already seen that tying project completion to unrealistic milestones will not work. Another example of how policy requirements create project risk is that the applications for government subsidies that are submitted during a project’s FEL 2 phase may require an FEL 3 level of engineering design. As a result, project developers are forced to do engineering design with incomplete technical and site information data. It also does little good to create incentives to build projects without the comprehensive regulatory and permitting reform necessary to make it possible to get construction and operating permits in a reasonable timeframe.
These are just some examples of what governments need to do to create markets and incentives to get these sectors to be self-sustaining.
Project Developers Focus on Comparative Advantage
As climate policy evolves, project developers also need to understand their comparative advantage that will enable them to create value.
Biofuels, CCS, low-carbon hydrogen, steel, and cement plants are heavy industrial facilities with hazardous operations. IPA has consulted on a number of these projects where the developer had a very limited understanding of how to design and operate the facility safely and efficiently. There was no chance they could get their project to sanction.
Until deep product markets exist, companies with the capability to shape and execute these complex projects will have an advantage over less-capitalized project developers. Smaller players will find profitable niches based on their ability to contribute to a value chain without adding cross-organizational risk.
Even now, before markets exist, companies are competing on price. Bidders in the Japanese contract for different schemes must submit a breakdown of their operating and capital costs to justify their blue ammonia cost bids. IPA has evaluated five planned blue ammonia projects located across the world over the past 2 years. Each was designed to produce ammonia at similar carbon intensity levels. Blue ammonia is already a commodity and, in commodities, the low-cost producers win. Comparative advantage can be derived in many ways using combinations of the cost advantages from location, access to low-cost renewable power, and manufacturing technology to keep a company on the low side of the industry cash curve.
Looking Forward
It is easy to be discouraged about the current state of decarbonization. There is so much work to be done to reach near-zero emissions.
I am no expert in climate policy, but there is ample data available to policymakers, regulators, NGOs, and investors on what has worked and not worked to direct investment to low-carbon projects. Capital projects are a means to an end, but deep cuts in global emissions will not occur until the climate policy solutions also enable successful capital projects.
- Edward W. Merrow, Industrial Megaprojects, 2nd Edition, 2024, Wiley and Sons, Inc.
- A condition precedent is a stipulation that defines certain conditions that must either occur or be met by either party to ensure progress or execution of a contract.
- Roger Miller and Donald R. Lessard, The Strategic Management of Large Engineering Projects, 2000, Massachusetts Institute of Technology
- Danny Cullenward and David G. Victor, Making Climate Policy Work, 2001, Polity Press.