Financing Greener Growth: The fall economic statement needs to accelerate green investment

Case study: carbon capture

Technology risk: Carbon capture is a proven technology, but has been less effective with non-concentrated emissions sources. There can also be risks of carbon leakage in sequestration. Most of the capital costs relate to point source capture where there is integration risk with existing systems.

Carbon price uncertainty: Future carbon credit prices can form a significant component of the revenue stream needed to underwrite a major capture project.

Demand risk: Carbon capture could be used in industrial applications like steelmaking or cement, where a high share of the product is exported and differentiated pricing for low-emissions products is niche.

Regulatory risk: Pour space availability, liability for potential escape of sequestered emissions, and environmental assessment or right of way for carbon pipelines are sources of regulatory uncertainty.

• Address carbon pricing uncertainty through carbon contracts for differences

Canada should make carbon contracts for differences (CCfD) a focus of the Canada Growth Fund. In these bilateral contracts, the government would compensate project sponsor counterparties when carbon prices deviate from those announced. This would help commit the government to taking the actions necessary to uphold carbon prices that support projects. The Netherlands leads the world in employing CCfDs, with a budget of €13 billion in 2022.

CCfDs are not without challenges. Some elements of carbon pricing are easier for the government to control, like raising the fuel charge rate at which heavy emitters can purchase carbon credits from the government. Others may involve greater tradeoffs. Raising the market-set carbon credit price for heavy emitters for instance, could involve imposing stronger performance standards across sectors—including those less prepared to meet them. If governments can’t follow through on actions to raise carbon prices, fiscal liability of CCfDs could be significant. These risks can be limited by focusing on the fuel charge risk the government controls, partial coverage of carbon credit prices, providing greater support to strategic projects or more uneconomic technologies, or providing shorter term contracts until 2030 to bridge to the development of better carbon markets. As sophisticated financial contracts to structure and price, the government will need to move quickly to be able to execute contracts in time for private investment to flow into emissions reductions for 2030.

The federal government can further boost the regulatory system by finalizing regulations like the Clean Electricity Standard, methane regulations, the oil and gas cap, and the heavy emitters’ system review. There should also be concerted efforts to address permitting and other regulatory hurdles to project development, in conjunction with provinces.

• New tools to address technology and market risks

Technology risk is deterring investors from taking on large-scale projects involving technologies like carbon capture, direct air capture, or hydrogen. What’s needed is an entity to provide guarantees that the engineering, procurement, and construction of these technologies work as planned. This is a common feature in project finance, where the risk allocation helps to both draw in debt investors and improve project returns. The Canada Growth Fund should address this risk, which is too large for most entities to self-insure against. In the U.S., the Department of Energy’s Loan Programs Office provides this type of commercialization support through loans and guarantees, and was given an expanded funding envelope in IRA.

Market risk can be dealt with through offtake agreements, where a customer agrees to take a certain amount of product at a set price for a period of time. Major corporate entities are looking to secure stable supplies of critical minerals, clean hydrogen, or other materials, but may be challenged to fully bear the risks or they may have insufficient regulatory incentive to do so. Government is needed to help bridge the gap and speed the development of enabling infrastructure and technologies enabling critical minerals supply and clean hydrogen production to further decarbonize a range of sectors.

• More tax-based support for maturing technologies

Major investment is needed now to promote innovation post-2030 to improve technologies and commercial models for decarbonizing hard-to-abate sectors. The government should make it an explicit focus for the Canada Growth Fund (CGF) and Canada Infrastructure Bank (CIB) to support innovative or first-of-their-kind projects in strategic sectors.

Tax-based incentives like the cleantech investment tax credit are equally important. When proven technologies are at an earlier commercialization phase and winning models are unknown, the tax system engages as many private actors and approaches as possible. They’ll be faster and broader-based compared to concessionary finance tools like CGF or CIB, which can complement tax incentives by covering additional project risks in strategic sectors. Concessionary finance tools should emphasize transparency so they can operate like tax tools in firming market expectations, such as around future prevailing carbon prices or market development.

• Encouraging the provinces to step up

The provinces have an equally important role to play as taxing authorities and direct beneficiaries of their competitive industrial sectors. Yet provinces have been looking to the federal taxpayer to take the lead in decarbonization or for green industrial policy. For instance, the federal taxpayer is being called upon by Nova Scotia and New Brunswick to meet regulations ending coal use in the power sector, Alberta for carbon capture incentives to meet the oil and gas emissions cap, Ontario for development of a battery supply chain, or Newfoundland and Labrador to encourage east coast green hydrogen production. Federal incentives should smooth disparate decarbonization burdens, but provinces need to step up with their own incentives or revenue models and play a larger role in supporting industrial policy projects.

Federal incentives should encourage explicit provincial matching funds and get further traction for advancing regional economic tables. An overarching federal-provincial dialogue should advance discussions around coordinated and politically-saleable approaches to consumer and industry-pay models for decarbonization investment.

• Strategic prioritization

With so many areas for investment, the federal government will need to prioritize. A key choice is between decarbonizing existing production and pursuing production opportunities in the new energy systems. The first could run the risk of spending too much money to decarbonize early in sectors that could have a diminished role in the future, such as fossil-fuel based industries. The second is a bet on an uncertain energy future: investments in an export-driven sector that may facilitate decarbonization globally at the cost of the Canadian taxpayer, or that doesn’t result in direct cuts in Canadian emissions or long-term economic benefits.

The federal government will need to support the private sector in decarbonizing the current energy system while also building a new one. But it will need to be clear-eyed in pursuing focused industrial policy opportunities, while supporting broad-based decarbonization strategies. Decarbonization investment can advance economic opportunities and Canada’s primary objective: to meet the emissions targets necessary to avoid climate catastrophe. The government should articulate an overarching strategy, with more specific policy objectives across the suite of government policy tools, including programs, procurement, and regulation.