Creating Carbon Market Certainty

The carbon contract for difference is a long-term contract between the federal government and low-carbon project proponents, tied to the average price of the carbon credits that trade on Canada’s industrial carbon-pricing markets, like Alberta’s TIER system. Firms pay fees on their carbon output over a certain threshold, but they’re also allocated credits to cover a share of their emissions. As they decarbonize, companies end up with unused credits that they can sell to other emitters.

Think of contracts for difference a bit like crop insurance. 

Just as provincial governments protect farmers against crop failure, Canada also needs an insurance product for industrial players in Canada’s low-carbon economy that are undertaking projects like carbon capture and hydrogen production. This is a good deal for the country because it backstops the jobs and growth that low-carbon investment is going to generate in the years ahead.

A program designed around these four principles will serve to maximize the potential of CCfDs, make Canada a global leader in innovative carbon pricing policy, and better position our country to compete internationally in the race to attract investment and decarbonize our economy. 

1. Go as broad as possible: Decarbonizing the Canadian economy must be an all-hands-on-deck effort.
   
   The government should design a CCfD program with broad eligibility. CCfDs should be available, at minimum, to all industrial emitters that are regulated by Canada’s industrial carbon pricing systems.
   
   This would maximize the power of CCfDs to unlock decarbonization investments, and position Canada to meet the targets laid out in the federal government’s Emissions Reduction Plan — while maintaining economic competitiveness in an increasingly carbon-constrained world.
   
   
2. The sooner the better: The United States’ Inflation Reduction Act (IRA) was signed into law in August 2022, offering massive subsidies for low-carbon investment in the US and challenging Canada to deliver competitive incentives.
   
   The federal government has taken some positive steps by offering investment tax credits for a range of low-carbon technologies. But more powerful incentives are urgently needed.
   
   CCfDs are an integral part of Canada’s response to the IRA. They can leverage the strengths of our existing policy framework to help match or beat the incentives available in the US and other jurisdictions.
   
   The government must quickly take the next steps in establishing a broad-based CCfD program. Industry and investors are deciding every day where to allocate capital, and analysts predict supply chain and labour shortages as low-carbon investment ramps up.
   
   Time is needed to design CCfDs that are well-adapted to the Canadian economy. There is significant risk in waiting too long before implementing a CCfD program.
   
   
3. Focus on contracts tied to carbon credit prices: Guaranteeing the benchmark carbon price is valuable, but to maximize the potential power of CCfDs, the government should focus on guaranteeing the value of carbon credits.
   
   Investment decisions for large-scale decarbonization projects often hinge on the projected revenues from selling carbon credits. Firms need confidence that these credits will have value in the future.
   
   Uncertainty about the future value of carbon credits is cited regularly by industry as a barrier to investment in decarbonization projects. It’s often the determining factor as to whether a project can advance to a final investment decision.
   
   
4. Create clear eligibility criteria: Even once the government starts offering broad-based CCfDs tied to carbon-credit prices, industry and investors will need certainty that their projects will qualify for CCfDs.
   
   There should be clear, up-front criteria that determine eligibility to participate in the program. There should be no guesswork or protracted qualification process. This maximizes the bankability of CCfDs for industry and investors.
   
   This is how IRA tax credits work in the United States. Under the 45Q credit for carbon capture, for example, applicants need only submit a single tax form to receive their credits.

In the following examples, the government and Company X sign a CCfD in 2023, guaranteeing the value of a specified quantity of Company X’s carbon credits at $150/tonne in 2030.

CCfD price guarantees will be set below the headline carbon price, to account for the fact that carbon credits trade at a discount to the penalty carbon charges that a buyer would otherwise have to pay for their emissions.

• Example 1: Carbon credits are worth less for the proponent
  
  • In 2030, the average market price of carbon credits is $149/tonne ($1 less per tonne than the price set in the CCfD).
    
  • The government must pay $1/tonne to Company X (multiplied by the quantity of carbon credits specified in the CCfD).
    
• Example 2: Carbon credits are worth more for the proponent
  
  • In 2030, the average market price of carbon credits is $151/tonne ($1 more per tonne than the price set in the CCfD).
    
  • Company X must pay $1/tonne to the government (multiplied by the quantity of carbon credits specified in the CCfD).
    
• Example 3: Carbon credits are worth exactly as agreed 
  
  • In 2030, the average market price of carbon credits is $150/tonne. No payments are made by either party.
    

In this way, a CCfD helps mitigate the carbon-pricing risks faced by proponents of new low-carbon or decarbonization projects that are relying on carbon credit revenue to make their projects economic.