De-risking clean tech investments with CFDs

Investing in low-carbon technology doesn’t come cheap – and the cost may not be recovered easily when the future of carbon pricing isn’t guaranteed. Contracts for difference (CFD) can incentivize investments in clean technology by helping to remove this uncertainty.

CFDs help de-risk investments in low-carbon technology by guaranteeing project proponents will be compensated if carbon prices don’t rise as expected. For example, if the price of excess carbon emissions is scheduled to be $100 in a given year but only reaches $90, a CFD can make up the difference, paying a project proponent $10 for every tonne of emissions reduced by their project.

Currently, the federal government’s price on excess carbon emissions is $65 per tonne of greenhouse gas (GHG) emissions. That price is set to rise to $170 per tonne by the year 2030 (noting that the federal environment minister recently mentioned the updating of the federal government’s estimate of the “social cost of carbon” to $261 per tonne). But political and market uncertainty could mean the price never actually rises to $170 – and investments made today to avoid paying a price on carbon pollution in the future might not pay off as expected.

That’s where CFDs come in. If, for example, the price of carbon doesn’t actually rise to $170 by 2030, a CFD can make up the difference for companies that make cleantech investments.

Agreements similar to CFDs are already in use in the Netherlands, where the Stimulation of Sustainable Energy Production and Climate Transition Subsidy pays clean energy project developers based on the prevailing price of carbon credits. A carbon capture and storage project in Rotterdam, for example, is currently using the program to be paid the difference if the price of carbon credits falls below €80. Last year, Germany announced its own CFD program – and CFDs have already been put to use in Canada.

CFDs have had success in Alberta

In Alberta, CFDs are often used by independent power producers selling electricity to the grid by way of a power purchase agreement.

Typically, the price for energy produced by a wind or solar project is linked to market prices in the Alberta power pool. CFDs provide pricing certainty for clean power producers. If the pool price is below the strike price, the power purchaser makes up the difference to the power producer, and vice versa.

Many believe the elimination of the developer’s market price risk has contributed to the boom in wind and solar projects Alberta has seen in recent years.

Federal budget promises CFDs

In its latest budget, the federal government announced that the Canada Growth Fund (CGF), a subsidiary of the Canada Development Investment Corporation, would offer CFDs to help make clean energy projects more cost-effective than carbon-intensive projects.

How exactly these contracts will work in this government-backed context remains to be seen, but a technical backgrounder on the CGF noted two possibilities:

  • Two-way contracts. If the future market price of carbon is lower than the “strike price” stipulated in the contract, the CGF will make up the difference to the company investing in clean technology. Conversely, if the future market price exceeds the strike price, the company would make up the difference to the CGF.
  • One-way contracts. Under these contracts, the CGF would make up the difference if the future market price is lower than the strike price, but companies would not have to make up the difference if the market price exceeds the strike price. The CGF may participate in the upside of successful projects through warrants.

In addition to the CFDs offered by the CGF, the federal government said it would consult on the development of a broad-based approach to carbon CFDs to make carbon pricing more predictable.

Government-backed CFDs could have a significant impact on investments in the clean energy space, both for existing players and new entrants. Existing players may want to re-evaluate their margins and recalibrate as necessary, while companies who have avoided renewable investments may want to have another look given the changing risk profile.

If you have questions about launching a clean energy project, the lawyers in our Energy practice group have wide-ranging experience advising innovators across Western Canada. Contact us to learn more.

Note: This article is of a general nature only and is not exhaustive of all possible legal rights or remedies. In addition, laws may change over time and should be interpreted only in the context of particular circumstances such that these materials are not intended to be relied upon or taken as legal advice or opinion. Readers should consult a legal professional for specific advice in any particular situation.