In December 2022, the federal government launched the Canada Growth Fund (CGF), a $15 billion arm’s length public fund designed to accelerate the deployment of innovative emission reduction technologies in Canada. The Public Sector Pension Investment Board, a federal Crown corporation first established in 2000, is responsible for managing the CGF. The 2023 Fall Economic Statement announced that the CGF will be the principal federal entity to issue carbon contracts for difference (CCfDs), which are designed to backstop the future price of carbon and provide certainty to businesses for the purposes of de-risking emission reduction projects. The CGF will allocate up to $7 billion of its current $15 billion in capital to issue all forms of CCfDs and carbon credit offtake agreements.
On December 20, 2023, the CGF announced a $200 million strategic investment in Entropy Inc. (Entropy), an Alberta-based carbon capture, utilization and sequestration (CCUS) project developer. In addition to the investment, the CGF and Entropy entered into a fixed-price carbon credit purchase commitment whereby the CGF will purchase up to 185,000 tonnes per year of carbon credits for 15 years, at an initial price of $86.50 per tonne. The scale, length and fixed-price nature of this commitment renders it a one-of-a-kind transaction in the global compliance carbon market.
The federal government further affirmed its commitment towards the promotion of CCfDs in Canada’s 2024 federal budget (2024 Federal Budget). In the 2024 Federal Budget, the federal government announced its intentions to strengthen the CGF’s role as the federal issuer of CCfDs through a number of initiatives. First, the CGF will develop an expanded offering of CCfDs that can better service a wider breadth of industries and markets. Second, the CGF is assisting provinces “contributing significantly to greenhouse gas emissions reductions” by curating and offering tailored CCfD offerings and carbon credit offtake agreements. Of note, one such approach that the CGF may take in expanding its role as the federal issuer of CCfDs is to develop off-the-shelf CCfDs for certain jurisdictions. Third, the CGF’s increased capacity to offer CCfDs may include the implementation of a government backstop of the CGF’s CCfD liabilities.
CCfDs are seen not only as a useful tool for governments seeking to mobilize capital for clean growth projects, but also for project proponents looking for revenue certainty and to share project risk. In new modeling released by Clean Prosperity and Navius Research in February 2024, researchers found that Canada could miss out on up to 33 megatonnes of emission reductions per year by 2030 unless governments expand the use of CCfDs. This article will take a closer look at CCfDs, including (i) an overview of CCfDs and their utility, (ii) current CCfD programs, and (iii) key legal considerations in CCfDs.
I. What are carbon contracts for difference and how do they work?
CCfDs find their origins in the financial markets, where contracts for difference are used to hedge against price volatility in shares or commodities. According to the Canadian Energy Centre, CCfDs allow emission offset project developers to secure a stable and predictable carbon price for the duration of the contract and for the lifespan of the project. In essence, CCfDs work to hedge against changes in carbon pricing policies or against carbon market risks. Depending on the issue being addressed, there is flexibility in designing CCfDs. For example, the arrangement between the CGF and Entropy addresses the potential policy risk associated with the benchmark federal carbon price – if the benchmark federal carbon price does not rise to $170 per tonne by 2030 as planned, Entropy can move forward with the project knowing that the CGF is committed to purchasing the contracted carbon credits at a certain price. CCfDs can also be tailored to the pricing of carbon credits in provincial markets, or on other commodities such as clean electricity.
Under the federal program, the agreed upon carbon price – often referred to as the strike price – effectively acts as the floor price on carbon, meaning that the CGF will pay the price difference to the proponent in the event the federal carbon price falls below the strike price. Since the price of carbon is guaranteed, this insulates the project developer from policy-related risks and allows them to continue with the project. This does not mean that the CGF alone must bear all the risk. In circumstances where the federal price of carbon exceeds the strike price, the contract may require the project proponent to pay to the CGF the price difference between the federal carbon price and the strike price.
Aside from policy-related risks, CCfDs may also insulate parties from market volatility, such as changes in provincial carbon credit markets. In this case, the parties will agree to a strike price for carbon credits based on the market price (as opposed to the benchmark federal price). Such a fixed pricing mechanism may help alleviate common challenges with regulated carbon markets, such as oversupply and low prices for carbon credits.
II. Current CCfD programs
To date, a number of countries have committed significant funds to CCfDs for both carbon credits and clean-technology related commodities. As noted above, Canada announced in its 2023 Fall Economic Statement that up to $7 billion of the $15 billion in the CGF will be dedicated to CCfDs. Acknowledging that CCfDs can provide insurance for corporations looking to de-risk emission reduction projects, the Canadian government believes that this investment can encourage decarbonization efforts across industries, as well as help stimulate the development and growth of a low-carbon economy. In Europe, both Denmark and the Netherlands have CCfD programs, and France has plans to introduce CCfDs.
In 2014, the United Kingdom (UK) introduced one of the earliest CCfD schemes. The UK scheme focuses on supporting large-scale renewable energy projects (as opposed to carbon) and is the UK government’s main vehicle for incentivizing low-carbon electricity generation. Under the scheme, a government-owned company (the Low Carbon Contracts Company) enters into agreements with low-carbon electricity generators. The CCfDs backstop the price of electricity by ensuring that the electricity generator will be paid out in the event the price of electricity is so low that the electricity generator suffers a business loss. In other words, the UK government will pay out the price difference between the price the electricity generator must receive in order for the clean electricity investment to be commercially feasible and the market price for electricity. This price certainty enables project proponents to help drive down electricity costs through borrowing at lower interest rates and attracting new entrants that increase market competition.
More recently, Germany committed to increasing investment through CCfDs. In June 2023, the Government of Germany announced that it would be investing $50 billion Euros over a 15-year period to support decarbonization efforts across energy-intensive industries including steel, paper, chemical and cement production. Through CCfDs, the German government will pay out to companies any additional costs incurred during the course of constructing and operating facilities that are more climate friendly. If the operation of the climate-friendly facility imposes lower costs on the company than the operation of the original facility did, the company may instead be required to pay back to the government the subsidies it received. The first round of bidding was launched on March 12, 2024, which will be followed by a second round of bidding towards the end of 2024.
III. Key legal considerations in CCfDs
There are a number of legal considerations that parties entering into CCfDs should take into account, including:
- Contract term: CCfDs tend to have longer time-horizons to provide sufficient leeway for project development and operation, as well to minimize political risk from changes in governments. The Canadian, German and Dutch CCfDs have terms of 15 years, while the UK CCfD is for 10 years with an option for a 5-year extension.
- Technology types: CCfDs may be well suited to hard-to-abate sectors, or for mature technologies with strong market competition, in order to drive meaningful emission reductions. In addition, focusing on projects where the cost of carbon is a key consideration can help to maximize risk reduction. For example, Denmark and the UK each have a specific CCfD program for CCUS projects.
- Pricing: Determination of the appropriate strike or bid price will need to take into consideration issues such as the level of technology support needed (including the risk of technology failure), carbon market prices, carbon pricing forecasts, capital costs, financing costs, and inflation rates, among others.
- Risk-sharing mechanism: Under a CCfD, risk can be shared between parties. Where the market price for carbon exceeds the agreed strike price, the buyer or investor may wish to include provisions requiring the project proponent to pay out the price difference in those circumstances.
- Regulatory changes: Parties may wish to include provisions dealing with the interplay between federal and provincial compliance regimes. For example, the parties may include a price adjustment mechanism in the event a provincial carbon pricing system replaces the federal backstop carbon pricing system, or vice versa.
- Performance criteria: Parties may wish to make CCfD payments subject to an established set of performance criteria for the facility, or include penalties for failure to deliver the contracted emission reductions.
There is flexibility in designing CCfDs, which makes it an important policy tool to achieve emission reductions across a range of industrial sectors, while spurring investment in lower-carbon technologies and efficiently allocating both project and political risk between parties.
Concluding thoughts
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