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 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. As such, the government should design a CCfD program that has broad eligibility that extends, at minimum, to all industrial emitters that are regulated by Canada’s series of industrial carbon pricing systems. This would ensure Canada maximizes the value of CCfDs to unlock decarbonization investments from coast-to-coast-to-coast and position Canada to meet the targets laid out in the federal government’s Emissions Reduction Plan while maintaining economic competitiveness in a carbon-constrained world.
2. The sooner the better: The United States’ Inflation Reduction Act was signed into law in August 2022, upending the playing field for those seeking to invest in Canada’s low carbon future. While the government has taken some positive steps with investment tax credits, the need for a more robust response remains. CCfDs are an integral part of that response, leveraging the strengths of Canada’s existing policy framework to help match or beat the incentives available in other jurisdictions. There is an imperative to move quickly, as industry and investors are deciding every day where to allocate capital, and as vendor queues develop in industries where project construction gets underway. While time is needed to ensure that CCfDs are well-designed for the Canadian economy, there is significant risk in waiting too long before moving forward with such a program. Therefore, the government must move quickly on next steps in establishing a broad-based CCfDs program.
3. Include contracts around credit price value: There is value to CCfDs that seek to give certainty on the benchmark carbon price schedule, to maximize the value of CCfDs, there should also be a focus on guaranteeing credit price value. Given investment decisions for large-scale decarbonization projects often hinge on the projected revenues associated with carbon credits, certainty on the value over the long-term is essential. Uncertainty about the future value of carbon credits is cited regularly by industry as a barrier to investment in decarbonization projects and is often the determining factor as to whether a project can advance to a final investment decision.
4. Create clear eligibility criteria: In addition to the certainty around credit values provided by the CCfD, and taking into consideration that broad eligibility is essential, industry and investors need certainty about the likelihood of their project qualifying for a CCfD. This can be done through established up-front criteria to determine eligibility. This maximizes the bankability of CCfDs for industry and investors, so there is no guesswork or protracted qualification process, as is the case when applying for 45Q credits in the United States. Under 45Q applicants needs only to submit a single tax form to receive the 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.*

• 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.

* Note: carbon credits will always be valued at less than the government carbon price, as buyers would not buy a carbon credit that costs the same as the penalty carbon price they would have to pay.