In this paper, I look at the contract entered into by the Norwegian government and Statoil on the establishment of the world's largest full-scale CO2 capture and storage (CCS) project in conjunction with the projected combined heat and power plant at Mongstad. I use the theory of incentives to indicate potential problems with the contract as a result of information asymmetry between the two agents.
I first explain why the government is involved in this project. The potential for CCS as a climate mitigation strategy is significant, but very costly and uncertain, as it is a quite new technology with limited deployment. Today, it will take a very high quota price to make this profitable, but the costs of CCS will probably fall as the technology matures. I show that it is especially costly to implement CCS on gas-fired power plants like the one at Mongstad. In addition, CCS would require new infrastructure and the cooperation between many independent economic actors. This, and the fact that the profitability will depend on how strict future climate policy is, weakens the incentives to invest. Hence, there is a potential role for the government to help CCS to the market.
I then use the theory of incentives to discuss how a contract should be designed, and compare this idealized version to the actual contract. I will show that when such asymmetry exists, the government is forced to give up costly rents to Statoil, and to mitigate these costs, allocations are distorted away from first-best allocations. Finally, I will show that the actual contract is not optimal, even though it gives Statoil some incentives to minimize the costs.