Michael Bernstein of Clean Prosperity joins CIBC Capital Markets’ Tom Heintzman to discuss the current challenges posed by carbon price uncertainty, the opportunities for a Carbon Contracts for Difference (CCFD) regime in Canada, and what this means for large emitters.
Tom Heintzman: Welcome to The Sustainability Agenda, a podcast series focusing on the evolving complexities of the sustainability landscape. I’m your host, Tom Heintzman. Please join me as we explore today’s most pressing issues with special guests that will give you some new perspectives and help you make sense of what really matters.
Michael Bernstein: There is no time to waste to bring certainty to these markets because there is a race for capital all around the globe for low carbon capital. That is, we know the US has gotten out in front with the Inflation Reduction Act, and carbon contracts for difference are really a key part of Canada’s response to remaining in the game and attracting low carbon capital.
Tom Heintzman: Welcome to our multi-part series, Profiling the Carbon Markets. The purpose of this series is to examine some of the most significant issues facing our clients in both the voluntary and compliance markets. Today, we’re going to discuss one of the central challenges bedevilling the regulated markets, namely price uncertainty. Price uncertainty undermines the ability of emitters to make long term investments in reducing their emissions. In particular, today we’re going to examine the carbon contracts for differences or CFDs, which are one of the leading mechanisms for providing price certainty. We’re super excited today to have on our show Michael Bernstein, the executive director at Clean Prosperity. Clean Prosperity is the leading Canadian NGO working on CFDs. Michael also chairs the advisory board for Carbon Removal Canada. He also sits on Canada’s Net zero advisory Board. Prior to joining Clean Prosperity in 2018, Michael’s career spanned business management, consulting, international development and politics. And I’ve personally had the privilege of intersecting with him in many of those phases. Michael, I’m super excited to welcome you to our show.
Michael Bernstein: It’s great to be with you, Tom. Thanks for having me.
Tom Heintzman: Michael To set the context at a high level, could you explain what carbon contracts for differences are and what purpose they serve?
Michael Bernstein: Yeah. Carbon contracts for difference can be thought of as a form of insurance insurance that really protects businesses and investors against the risk that carbon pricing markets don’t develop in the way that they’re intended. On paper, so many people think of carbon contracts for difference to the extent that they think of such a thing as a way to protect against the headline price of carbon so that businesses are protected if a future government chooses to cancel the program. And in that case, if the program was cancelled, these contracts would actually pay businesses out a specific price. Let’s say, for example, $170 per ton, which is the price that is expected in 2030. And in that way, businesses know by taking action on decarbonising their processes, they are either going to be saving money by not paying the carbon tax and if the carbon tax is cancelled, they will still see an economic return because in that case the contracts will pay them out $170 a ton as well. So they can have certainty that they have the incentives that they need to go ahead and decarbonise. So that is a carbon contract for difference on the headline price, and that is one form of carbon contract for difference and indeed the most well known one. But what I want to add and convey to the listeners here is that there is a second dimension or second potential way in which to do carbon contracts for difference. That arguably is even more important than that first headline price carbon contract for difference, and that is a contract for difference on the credit values that are generated within carbon pricing systems in Canada. To explain that first, need to step back for just one second and explain how carbon pricing works in Canada for industrial emitters, Think about cement kilns, steel mills, refineries. Et cetera. Because there there’s both a carrot and a stick dimension to the program, right? Most people know about the stick. Most people know that you’re going to have to pay a carbon price when you emit. And that’s true. But the way the systems work is that it’s only about 20% of any industrial facilities emissions that actually face a compliance obligation, which is to say pay a price on carbon and the remaining 80% of emissions. If an industrial facility actually decarbonises those, they get a carrot, which is in the form of a credit, a credit that says, okay, you’ve reduced your emissions, now you can use this credit that you’ve earned and sell it to another emitter who might want that so that they don’t have to pay the carbon price. And so the carbon credits that are earned in Canada by industrial emitters is actually. The key driver. The key incentive that those businesses have to decarbonise and carbon contracts for difference need to also give investors and industrial participants in these markets certainty around what value those credits can earn. And that’s what contracts for difference. Do they specify prices that are essentially like a floor price that the government will guarantee emitters so that they know those credits are going to be worth X dollars in Y year? Those are the essential elements of a carbon contract for difference.
Tom Heintzman: Michael That was super helpful. Can you just explain to the listeners what types of projects this would apply to? What types of projects would benefit from CFDs?
Michael Bernstein: Any business or any heavy emitter in Canada who wants to reduce their emissions could see a benefit from carbon contracts for difference. The most obvious example would be related to carbon capture. So if you’re a refinery, let’s say, or if you are a cement kiln, you have emissions that you could capture using carbon capture equipment. And that of course comes with a major cost, often, you know, hundreds of millions of dollars, sometimes billion dollar cost. And you want to know that you’re going to have a business case revenue that you earn to offset that investment. So that would be one example. But there are many others, you know, anybody, any facility that’s looking to to electrify a process, to switch fuels, to, let’s say hydrogen, for example, like a steel mill, might use hydrogen to go to a direct reduction process. That’s still an early technology, but one that shows a lot of promise. Those are all examples. And then you get more standard examples like, you know, wind and solar projects could see benefits from contracts for difference. So many examples and hopefully that paints a bit of a picture.
Tom Heintzman: Got it. Okay. Let’s get into some of the more nuts and bolts of what it takes for a CCFD program to be a success. My understanding is that consultations have begun regarding a Canadian CCFD regime and that they may be ramping up this fall. Could you describe for our listeners what Clean Prosperity considers to be the critical elements for a successful CCFD system in Canada?
Michael Bernstein: Absolutely. So the first thing that is really required in our view is that it needs to be a broad eligibility program. So at minimum, in our view, all of the industrial emitters who are currently registered in industrial pricing systems all around the country, because we have a federal system, we have an Ontario system, an Alberta system, et cetera. So all of those emitters ought to be eligible for a contract for difference. We further think that this program needs to be as simple as possible. Ideally, what we imagine is a kind of template contract, at least for every jurisdiction. So a template contract for the Alberta market, a template contract for the Ontario market that anyone can go on the government website, see what the terms are, understand the basic eligibility requirements, and therefore incorporate in their business case as they’re considering whether to invest in a project, what kind of incentives they’re going to get from that contract and what kind of certainty will be provided by the contract. So I think broad, simple, clear contracts are all critical elements of this. Another element of this is it’s got to be quick. There is no time to waste to bring certainty to these markets because there is a race for capital all around the globe for low carbon capital. That is, we know the US has gotten out in front with the Inflation Reduction Act, and carbon contracts for difference are really a key part of Canada’s response to remaining in the game and attracting low carbon capital. So we’ve got to move quickly. We would really like to see a program announced by the fall economic statement. And then there’s other elements which we can get into that are maybe a little more technical in nature, but there’s various questions around what price do you actually guarantee? Are you guaranteeing the entire program? Are you guaranteeing companies up to $170 a tonne in 2030, or are you perhaps guaranteeing a slightly smaller amount, say 150, $160? And there’s reasons to do that, that we would in fact be in favour of. One last element I’ll mention is there’s a question around whether the government structures these contracts so that they’re topping up the credits that are being transacted among individual emitters. So if Cenovus sells credits to Suncor, for example, and those credits are at a lower value that are in the contract, does the government simply top up to a certain value or as we are actually recommending, would they consider acting as a additional buyer in the market and saying what we’re going to do in our Contract for Difference program is actually agree to buy credits at a floor price such that if the market isn’t trading above that price, those. Holding contracts would have the ability to sell to the government effectively. A put. That’s right. That’s exactly what it would be.
Tom Heintzman: And Michael, can you just explain for our listeners why you would be advocating for a put price that’s less than the legislated carbon price? What advantages would that have?
Michael Bernstein: So the ultimate goal of this program is to make the market work effectively. And if you structure the contract so that the actual strike price, the price that’s included in these contracts is below the headline price of carbon. Let’s just say, for example, in 2030 the contract specifies $150 a ton just to pick a number, a round number. What that will do is it will still provide a significant incentive for those holding the contract. They can now have the assurance that they can get up to $150 a ton for the credits they generate when they go ahead and invest in that CCS project or electrify their activities. But what it will also do is create an incentive for those emitters to want to do better than 150 to say, yes, we have a guarantee of 150, but we want the market to be functioning effectively and we hope to get 160 or $165 a ton for our credits. And in that way you create a vested set of stakeholders in seeing the market work properly. Because remember, one thing I maybe should have specified earlier is the effect of price on carbon. The selling price for these carbon credits are going to be based on a variety of factors, many of which are influenced by government policy. And that’s why it’s so critical for the government, who is a key driver of the risk in this market by policy decisions they make to be the one offering the insurance. And what you want is participants actively lobbying the government to say, Hey, we want you to make this market work. We want you to set the rules to structure this market so it’s going to function effectively. So that’s essentially the conceptual reason why you would advocate for a price below the headline price.
Tom Heintzman: Now, Michael, I’m going to be a little bit of a devil’s advocate here. Just given the budgetary and political realities in Canada, These insurance contracts that the federal government could enter into could create a potentially huge contingent liability for the federal government. Even more so, the issuance of carbon credits are largely determined by provincial regimes. So the federal government could end up on the hook for a lot of money depending upon how the provinces run their programs. Realistically, where do you think this will end up? If there are hearings in the fall and the government decides to come out with a program, what amount of contingent liability will they be able to take on and what do you think the program would look like?
Michael Bernstein: It’s a really important question. And our view is that while those risks absolutely exist and I want to talk about them in a minute, they are all manageable. And moreover, it is not, in our view, an acceptable alternative to do nothing, because what that will mean is not only do we not hit our emissions reduction goals, but we’re unable to attract the kind of capital we need to take advantage of this moment in time where we know low carbon supply chains are forming and where Canada has an opportunity to really generate outsized returns for our economy. But that moment will go away if we are not competitive with other jurisdictions. And I’m principally thinking about the United States with the Inflation Reduction Act. And so while there certainly is a downside risk and potential costs that come with this program, the reality is that those costs are primarily and principally within the control of the federal government. The industrial pricing systems, while yes, they are run by the provinces, are run based on an approval process from the federal government. In other words, the provinces have to go through a procedure with the federal government to have their systems reviewed and to be cleared as equivalent with the federal system. So if provinces do decide to weaken their systems and to either intentionally or unintentionally undermine the program and create the potential for payouts that the federal government will be obligated to disburse, the federal government has recourse. The federal government can take back that program if need be. I think that would ultimately be a last resort. I think the federal government would and should work with the provinces to try to come to some resolution. But there is recourse here. And by the way, just one side point to that. That is another reason why we recommend a couple of design features that could reduce the risk of provinces trying to, as I say, intentionally or unintentionally, undermine the program. One of those design features is having a price in the contracts that is below the headline price so that you do get, as I was saying earlier, market participants who will be unhappy if provinces try to undermine the system. And the last point I would make here is if the federal government wants to incentivise the kind of investments that they have said they want to do, and they have very ambitious targets for 2030, they absolutely are going to need a program like this. And it is the only policy that I’m aware of that can help them achieve their emissions reductions goals that they’ve committed to and potentially allow them to never pay out a dollar. In fact, there’s even a potential to make some money from this program because these contracts are structured BI directionally, whereas if the price is higher than the contract, sometimes the companies even may owe the government money. So yes, there are risks, yes, there’s downside. But our view is this is absolutely manageable and needs to move ahead. The last point here, if the government does say, you know what, we’re not willing to have a very open ended, broad based program, what we’ve been telling them is, look, at minimum, you need to be thinking about a program that if you’re going to constrain it, which we don’t recommend, constrain it at a very high level, something like 50 megatons decarbonisation annually within this program, which gets you to a net downside cost of somewhere in the range of seven and a half to $8.5 billion depending on how you do the math. But again, none of that should be paid out. That’s just the worst case scenario.
Tom Heintzman: And as you point out, it’s really within the control of the government, whether it pays it out, because ultimately it’s insuring against its policy changing. That’s right. When do you think that we’ll see hearings on CFDs and what’s a realistic timeline for having them entered into by the Federal government?
Michael Bernstein: Our hope is that by the fall economic statement, which is likely in the November period, we will get an announcement of a broad based contract for difference program, which would mean if there is a public consultation that is done prior to that announcement. And I think there’s a pretty good chance there will be, but that’s still to be determined. We could see that as early as September this month or perhaps in October. So this is more like weeks away from progress than months away at least, is my hope. I know the federal government is looking at this very seriously. They, of course, announced in the budget in March their intention to do a consultation on a broad based program. So that’s the timelines we are working off of. Of course, it is difficult to say precisely because in politics there’s plenty of uncertainties and things can get derailed for many different reasons, but that would be the timeline we’re looking at.
Tom Heintzman: Great. One last question to wrap it all up. In the end of the day, what does all this mean for large emitters? And if you had to give advice to a CEO of a large emitter, what would your advice be?
Michael Bernstein: My top advice would be get involved in the policy making process. Lend your voice and your company’s voice to why a program like Carbon Contracts for Difference is so necessary. Assuming you see that, and I have to imagine many of these CEOs in fact, I know because we talked to many of these CEOs and many of these firms and many of these industry associations that this is needed. But the government needs to hear from them. They need to understand that the need is acute and that there’s real time sensitivity here and that there’s not time to develop a lot of different options and spend a year or two consulting and thinking about how it would work if this program is going to have the impact that I believe it needs to have, it has to be implemented within months, or really any chance of getting the kinds of decarbonisation projects we need to come anywhere near the 2030 emissions reduction goal will be lost. So I would say to those CEOs, please get involved in the process, reach out to our organisation, reach out to your industry associations, talk to government officials if you already have that direct access. And you ought to be aware, too, and I’m sure many of these companies are, that while carbon contracts for difference are, in our view, a key part of unlocking widespread investment, every project is going to be different. And there are some other financing windows available today that may provide a solution for certain specific kinds of projects. Thinking about the Canada Infrastructure Bank, the Growth fund, there’s a net zero accelerator fund being hosted by, I said industry, science and economic development. So there’s other vehicles too. But in our view, this one is a critical one that we hope will move forward soon.
Tom Heintzman: Fantastic. Thank you so much for your time. It’s always a pleasure to speak with you. I learned something every time we talk, and we’re very fortunate that there are people in our society like you that are devoting themselves to such important topics. So thanks again for coming on the show. I look forward to seeing what next comes out from Clean Prosperity in terms of your leading edge thinking. Take care and have a great day. Michael.
Michael Bernstein: Thanks very much. Tom, it’s really great to talk to you.
Tom Heintzman: If you’d like to learn more about how your business can navigate the carbon markets, join us for CBC’s Carbon Summit on October 26th, 2023, in Toronto. The summit will bring together experts in carbon market structure, project development and policy. To register, please contact your CIBC Relationship manager. Please join us next time as we tackle some of Sustainability’s biggest questions, providing you different perspectives to help you move forward. I’m your host, Tom Heintzman, and this is The Sustainability Agenda.
Disclaimer: The materials disclosed on this podcast are for informational purposes only and subject to our Code of Conduct as well as IIROC rules. The information and data contained herein has been obtained or derived from sources believed to be reliable, without independent verification by CIBC Capital Markets and, to the extent that such information and data is based on sources outside CIBC Capital Markets, we do not represent or warrant that any such information or data is accurate, adequate or complete. Notwithstanding anything to the contrary herein, CIBC World Markets Inc. (and/or any affiliate thereof) shall not assume any responsibility or liability of any nature in connection with any of the contents of this communication. This communication is tailored for a particular audience and accordingly, this message is intended for such specific audience only. Any dissemination, re-distribution or other use of this message or the market commentary contained herein by any recipient is unauthorized. This communication should not be construed as a research report. The services, securities and investments discussed in this report may not be available to, nor suitable for, all investors. Nothing in this communication constitutes a recommendation, offer or solicitation to buy or sell any specific investments discussed herein. Speakers on this podcast do not have any actual, implied or apparent authority to act on behalf of any issuer mentioned in this podcast. The commentary and opinions expressed herein are solely those of the individual speaker(s), except where the author expressly states them to be the opinions of CIBC World Markets Inc. The speaker(s) may provide short-term trading views or ideas on issuers, securities, commodities, currencies or other financial instruments but investors should not expect continuing analysis, views or discussion relating to those instruments discussed herein. Any information provided herein is not intended to represent an adequate basis for investors to make an informed investment decision and is subject to change without notice. CIBC Capital Markets is a trademark brand name under which Canadian Imperial Bank of Commerce (“CIBC”), its subsidiaries and affiliates provide products and services to our customers around the world. For more information about these legal entities, as well as the products and services offered by CIBC Capital Markets, please visit www.cibccm.com.
Featured in this episode
Managing Director and Vice-Chair, Energy Transition & Sustainability
CIBC Capital Markets