Canada’s Budget 2023: Compromise and Competition – Climate, Carbon and CCfDs

Canada’s Budget 2023: Compromise and Competition – Climate, Carbon and CCfDs

The Federal Government’s Budget 2023 (“Budget 2023”) promises many investments and financial incentives to address issues of climate and energy security. One of these areas of focus is contracts for differences (“CfDs”), which were identified as an investment tool of the Canada Growth Fund (the “Growth Fund”) that will be used to support clean growth projects.[1] While the particulars are limited, Budget 2023 announced that the Federal Government will undertake consultations on “the development of a broad-based approach to carbon contracts for difference”, with the aim of making carbon pricing predictable and providing financial assurances to those developing and implementing new technologies. Budget 2023 provided that the contracts would be complementary to those offered by the Growth Fund.[2]

Carbon Contracts for Differences (“CCfDs”) are a subset of CfDs. This bulletin provides an overview of what CCfDs are, what role they will play in Canada’s industrial decarbonisation efforts, and what Canadian business organizations need to know based on Budget 2023 and looking forward.

The announcement to promote the use of CCfDs flows from Canada’s commitment to achieve net-zero greenhouse gas (“GHG”) emissions by 2050 (the “Canada Target”). As Canadian industry looks to reduce GHG emissions to meet the Canada Target, decarbonisation efforts will face many challenges. For example, investments will be needed to foster technological innovation to support industry and new technologies will require additional investments in order to scale up to meet demand. In most cases, business organizations face uncertainty in terms of the revenue they would be able to obtain by selling carbon reductions or excess allowances since future carbon prices are difficult to predict. This is particularly true because the technological advancements are occurring in parallel and carbon markets, investments and tax incentives remain at an early stage of development.

What are CCfDs?

CCfDs are intended to address this uncertainty by bridging financial and regulatory gaps to encourage low carbon technologies and renewable energy projects. CCfDs are contracts by which a government agrees with the counterparty on a fixed carbon price over a fixed period of time. During this period, the counterparty is permitted to sell any carbon emission reductions or excess allowances generated by the project at the stipulated contract price. The price is formulated as a strike price over a carbon market price. If the carbon market price is higher, the counterparty returns the additional revenue to the government whereas if the carbon market price is lower, the counterparty receives the difference. The below graphic provides a visual representation of this concept, with the government paying the difference during the times when the strike price is higher, and the counterparty paying the difference between the carbon price and strike price when the carbon price is higher.

There are other types of carbon contracts and CfDs that parties may enter into, but if a strike price methodology is not used, typically this would not be considered a CCfD.

Although new to Canadian markets, CCfD are commonly used in Europe.  In Canada, CCfDs offer opportunities in the renewable energy industry, such as for hydrogen, wind and solar energy projects.  The CCfD is favourable for generators and other interested parties because it guarantees a set revenue for the carbon credits (whether carbon emission reductions or excess allowances) that are generated by the project.

Why are CCfDs helpful?

In addition to acting as a hedging tool for future carbon prices and to stabilize revenues for renewable energy projects, they also provide regulatory credibility to fledgling industries. This is because governments are incentivized to help keep carbon market prices high so that the financial cost of the underlying CCfD will be lower. This then provides assurances to those developing and utilizing new innovations – both in terms of government support but also that markets will exist for their energy, products and technology.

As discussed above, in an effort to maintain pace with decarbonisation initiatives around the globe, Budget 2023 adds CCfDs as an additional layer to the Growth Fund. CCfDs will be used to work toward establishing the Growth Fund’s mandate of “attracting private capital to invest in Canada’s clean economy”.[3] It is hoped that CCfDs will function as a medium for encouraging investment in the Canadian clean economy while simultaneously reducing associated risks. That being said, how will CCfDs operate in unison with varying Canadian business organizations?

In short, if a private investor successfully contributes and/or reduces pollution output, they may obtain tradeable carbon credits.[4] Due to this increase in pricing certainty, the intent is to attract an influx of large scale investment to and within Canada over the next twelve to twenty-four months. Through the Growth Fund and CCfDs, Canada is putting itself in-step with the United States’ incentives set out in the Inflation Reduction Act. Accordingly, Canada is attempting to position itself to be a competitive global leader and a clean economy powerhouse.[5]

In response to Budget 2023, the President of the Canadian Climate Institute, Rick Smith, endorsed CCfDs – reiterating that lower upfront investment costs will assist in securing the long-term success of clean technology projects.[6] Importantly, it is noteworthy that CCfDs are available for small-scale projects as well; such as combining the entirety of several small projects to be eligible for a CCfD.[7]

What are the limitations of CCfDs?

• CCfDs are likely to be awarded to specific renewable energy projects – not for specific sources of renewable energy as a whole.
• CCfDs may need to be tailored for particular industries or geographies to reflect regional differences. Moreover, some CCfDs could reflect collaboration between the federal and provincial levels of government, particularly if the governments are jointly providing funding and sharing risks.
• CCfDs guarantee the price of the credit, but not the volume of credits. Thus exposure to regulatory changes could detract from the volume of credits generated, even though the price is secured.
• CCfDs may have restrictions on trading or other conditions.
• CCfDs only capture the carbon revenue stream. All other revenues of a project would need to be considered and documented and associated risks would also need to be considered and mitigated as part of the project’s contract portfolio.
• The regulatory details regarding a competitive procurement or tendering process will need to be determined. The process may focus on certain specific technologies, or more broadly. In addition, the process may take into account different technologies used at different stages of the energy lifecycle (such as exploration and production, midstream, downstream, and end-of-life or reclamation (i.e. circular economy) considerations).
• CCfDs can be administratively burdensome, particularly at the early stages.
• CCfDs will need to be used by the Federal Government in coordination with other contractual and financial tools in order to provide for financial competitiveness.

Conclusion

With an increase in investment pricing certainty, Canada may grow its clean economy at an exponential rate. Budget 2023 offers a foundational investment framework which will allow Canadian industry to compete in the ever competitive decarbonising world. However, CCfDs are only one component of the more fulsome framework provided by Budget 2023. One must bear in mind that CCfDs alone will not support Canadian decarbonisation; yet, when combined with the totality of Budget 2023 and additional federal, provincial, and municipal policies, Canadian business organizations should welcome the opportunities that are at their disposal.

How can McMillan help you navigate these changes?

With offices in Canada’s major energy centres across the country, McMillan offers a wealth of experience in all aspects of renewable energy projects, including commodity CfDs, carbon reduction, environment and energy projects, and financing and tax. Our firm is well-positioned to answer your questions and concerns about CCfDs, Budget 2023, and its impact on your business. McMillan Vantage is happy to help you engage in the consultation process once it is formally announced.  Do not hesitate to contact us for more information.

[1] See Budget 2023: A Made-In-Canada Plan: Strong Middle Class Affordable Economy Health Future, at 87.
[2] The Canada Growth Fund Inc. is a subsidiary of Canadian Development Investment Corporation (CDEV), a Federal crown corporation reporting to the Minister of Finance. It acquires, holds and manages strategic assets and provides various financing solutions. More information is available at the Canada Growth Fund Inc. website.
[3] “A Made-in-Canada Plan: Affordable Energy, Good Jobs, and a Growing Clean Economy” (28 March 2023), online: Government of Canada.
[4] Steve Scherer, “Exclusive: Canada budget sees contracts for difference for large clean-tech project – source” (27 March 2023), online: Reuters.
[5] Ibid.
[6] See Budget 2023 is a strong gameplan to keep Canada competitive (28 March 2023).
[7] See What are contracts for difference? (23 March 2023).

by Julia Loney, Mike Richmond and Ryan Johnson (Student-at-Law)

A Cautionary Note

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.