Want to maximize Canada’s future energy economy? Embracing contracts for difference will be key

Contracts for difference are a market-based approach to decarbonization that should resonate with conservatives

Transmission Towers

Originally published by The Hub.

Last month’s federal budget announced the government’s plan to pursue something called “contracts for difference” as part of its effort to catalyse private investment in emissions-reducing technologies. It’s a big idea with the potential to be misunderstood. The upsides for Canada’s environment and economy are significant, however, so it’s important that policymakers and the Canadian public have the basic facts. 

Let’s start with a short primer on Canada’s model of carbon pricing. Between the federal and provincial governments, Canada has a carbon price on consumers and industry. The current price is $65 per tonne and it’s set to rise to $170 by 2030. The gradual increase is designed to protect Canadian competitiveness and minimize the burden on businesses and households. 

Yet one consequence is that the incentive for businesses to invest in emissions-reducing (and in turn cost-reducing) technologies is somewhat blunted. Certain investments may not make sense at $65 per tonne but could be worthwhile if the price ultimately reaches $170 per tonne. The big uncertainty facing firms and investors—and holding back investment—is the risk that a future government might change or even cancel that carbon pricing schedule. This could leave companies holding the bag on major investments that suddenly become uneconomical. 

We’ve been hearing about the problem for a while: firms broadly agree that Canada’s approach to reducing industrial greenhouse gas emissions makes sense—but that hasn’t been enough to get them to make multi-billion dollar investments in decarbonization. Management is reluctant to sign off, and banks won’t commit financing. It’s just too much risk to assume. 

Herein lies the case for contracts for difference. 

Think of contracts for difference a bit like crop insurance. Just as provincial governments protect farmers against crop failure, we also need 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.

In the U.K., the government of Conservative Prime Minister David Cameron introduced contracts for difference in 2015 to help drive the growth of renewable energy. The U.K. program signs deals with renewable producers that guarantee a set price for their power. If the market price of electricity falls below the guarantee, the operators get a top-up. If the price goes higher, they pay the difference back into the program. 

Inspired by the success of the U.K. model, we talked to large industrial emitters, trade associations, investment bankers, and industry experts. Everybody we spoke to agreed that if contracts for difference were done right, they could go a long way to relieving the paralyzing policy uncertainty that’s hamstringing Canadian industrial decarbonization. 

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.

Why tie to the price of carbon credits? Because companies are counting on the revenues from credit sales to make their projects economic. If the carbon-credit market fails—maybe because a glut of credits from new decarbonization projects overwhelms demand—then businesses could be in serious trouble. 

The carbon contract for difference is like an insurance policy on the value of carbon credits. Designed correctly, it shouldn’t cost the taxpayer anything, because if federal and provincial governments administer carbon-pricing systems according to the rules they’ve laid out, then the contracts will stay on the shelf. Put another way, it’s a promise to business that the government won’t change the rules of the game after companies invest, and this cuts both ways. 

It’s a market-based approach to decarbonization that should resonate with conservatives. Former Conservative Party interim leader Rona Ambrose recently stressed that “carbon contracts for difference are really important to the energy sector.” 

Now, it’s important to emphasize here that contracts for difference have no bearing on the consumer-facing component of Canada’s carbon pricing regime. They only apply to Canada’s industrial carbon pricing system. Although the former is the subject of ongoing political debate, the latter is not. Governments across the political spectrum have come to adopt carbon pricing for industry. In fact, some 80 percent of Canada’s industrial emissions are subject to systems designed by conservative provincial governments in Alberta, Ontario, and Saskatchewan. 

In this sense, the contracts for difference model sets aside the part of carbon pricing that’s the subject of political debate and aims to support the part of the system that finds consensus across the political spectrum, between the federal government and provinces, and among businesses. 

But don’t take our word for it. The folks who have to do the actual decarbonizing—Canada’s industrial emitters—have also thrown their support behind this solution. The Business Council of Alberta summed up the consensus in their reaction to Budget 2023: “contracts for difference are a critical remaining component to catalyze major decarbonization projects.”

And for good reason. We think contracts for difference are an idea whose time has come because as a country we’ve run out of time. The United States has thrown down an estimated $1.2 trillion dollars worth of low-carbon investment, and the EU is set to follow. We’re already feeling the impact: just last month Parkland Fuels cancelled plans for a $600 million biodiesel plant in B.C., citing competitive pressures from U.S. subsidies. That means the loss of thousands of jobs.

In 2022, we co-authored a paper that showed precisely how carbon contracts for difference could make Canada competitive against the rich subsidies on offer in the U.S. Inflation Reduction Act. There’s a huge amount of value waiting to be created in Canadian carbon-credit markets. It just needs to be unlocked—and carbon contracts for difference look like a key. 

Canada only gets one shot to grab our slice of the pie, because companies are now in the process of committing to investments that they will develop over decades. 

Staying in the race now requires close cooperation between provinces and the federal government. In signing contracts for difference the federal government will be agreeing to backstop carbon credits in systems designed and run by the provinces. For the plan to work, provinces will need to take enabling measures like publicly disclosing credit transactions. It’s this collaboration imperative that has further motivated us to bring people together around an idea that we think can benefit all of us. 

Canada needs to pick a lane—decide how we’re going to incentivize investment and commit to it. We need to stop being a country that waffles on big decisions and become a country that builds things again. Contracts for difference are a tool to help us build big things today, and create good jobs for Canadians across the country in the process. 

Otherwise, continuing to change lanes could put Canada in the ditch.

Etienne Rainville is the Director of Federal Government Relations for Clean Prosperity, a Canadian climate policy organization

Suggested Reading