Canada-Alberta Carbon Deal: Gradual Price for Durable Climate Policy

The Canada-Alberta carbon pricing deal is a complex balancing act, aiming for durability and investor confidence while potentially compromising on the immediate stringency needed for aggressive decarbonization. The core tension lies in establishing a predictable, long-term carbon price signal that incentivizes investment in emissions reduction technologies, particularly carbon capture, without crippling industry in the near term. This conversation reveals the hidden consequence of political compromise: a slower, more gradual ramp-up of effective carbon costs, which may delay large-scale emissions reductions until the late 2030s. Readers invested in the future of Alberta's oil and gas sector, climate policy, and the practicalities of carbon markets will gain an advantage by understanding the nuanced trade-offs and the critical role of mechanisms like Carbon Contracts for Difference (CCfDs) in bridging the gap between ambition and political reality.

The Gradual Ascent: Why a Slower Carbon Price Might Be the Only Durable Path

The recent Canada-Alberta Memorandum of Understanding (MOU) on industrial carbon pricing presents a fascinating case study in navigating the thorny intersection of climate ambition and economic pragmatism. While the headline figures might suggest a watering down of previous commitments, a closer look reveals a strategic attempt to build long-term durability into Alberta's climate policy. The core insight here is that a system perceived as stable and predictable, even if less stringent initially, can ultimately drive more significant, sustained decarbonization than a more aggressive but politically volatile approach.

Michael Bernstein of Clean Prosperity highlights this trade-off, noting that the agreement lowers and slows the pace of the headline carbon price increase. Previously slated to reach \$170 per tonne by 2030, the new agreement aims for \$140 by 2040. More critically, the price floor for carbon credits, which dictates the actual cost of compliance for many emitters, will rise gradually from \$60 in 2030 to \$110 by 2040. This gradual ramp-up, while potentially moderating the pace of emissions reduction projects in the near to mid-term, is designed to foster a more stable investment environment.

"The bottom line of all that is that it is a really positive signal to the market that the two governments have now agreed on the schedule all the way out into 2040. The concern I have is that there is likely to be a much more modest set of emissions projects that will be made economic through this more modest price schedule..."

-- Michael Bernstein

The immediate implication is that the real cost of compliance, driven by the value of carbon credits, will be significantly lower in the coming years than the headline price. This means that while the system is designed to incentivize reductions, the economic case for large-scale decarbonization projects, particularly those requiring substantial upfront capital, will likely not materialize until the price reaches triple digits, a prospect now pushed into the late 2030s. Conventional wisdom might dictate a faster price increase to force immediate action, but the political reality in Alberta, as this agreement implicitly acknowledges, necessitates a more measured approach to ensure policy longevity.

Unlocking Carbon Capture: The Clean Fuel Regulation's Unsung Role

One of the most compelling, and perhaps underappreciated, aspects of this agreement lies in its interaction with federal regulations, specifically the Clean Fuel Regulation (CFR). Bernstein points out that changes to the CFR, as part of this deal, allow oil and gas companies to generate significant revenue from carbon capture projects by selling credits into the CFR market. When combined with the carbon price floor, this creates a powerful incentive for decarbonization in a sector often seen as resistant to climate action.

"The one important exception to that though and i think it's an underappreciated and under discussed part of the deal so far is that there were some changes announced also to the clean fuel regulation... when you combine that incentive from the clean fuel regulation with the 60 in 2030 from carbon pricing and rising throughout the decade you start to get into a zone where it becomes economic to do carbon capture in the oil sector..."

-- Michael Bernstein

This stacking of incentives--where credits from carbon capture can be sold under both the carbon pricing system and the CFR--could make projects like the Pathways Alliance, aimed at decarbonizing oil sands operations, economically viable much sooner than anticipated. The effective price for carbon capture could reach \$140 per tonne (\$60 from carbon pricing plus \$80 from CFR credits, based on current prices). This creates a business case for decarbonization in the oil sector in the near term, a significant departure from previous expectations. For the rest of industry, however, the business case for comparable decarbonization efforts will likely still require waiting for the carbon price to climb higher, into the 2030s. This highlights a systemic consequence: the agreement creates a bifurcated incentive structure, accelerating decarbonization in the oil and gas sector while maintaining a more gradual approach for other industries.

The Stringency Safeguard: Ensuring the Market Doesn't Collapse

A primary concern for investors in carbon markets is the potential for an oversupply of credits to depress prices, rendering their investments in decarbonization projects uneconomical. The MOU addresses this through two key mechanisms: stringency increases and a legislated price floor for credits. Bernstein explains that stringency, which refers to the percentage of a facility's emissions subject to a carbon charge, will increase gradually, typically by 1-2% per year across sectors. While modest, this steady increase contributes to demand for credits.

However, the more robust safeguard is the minimum price floor for credits, set to rise from \$60 in 2030 to \$110 by 2040. This ensures that even if market forces would drive credit prices lower, emitters will still face a minimum cost of compliance. This provides a baseline level of certainty for investors, as they can rely on a guaranteed minimum incentive for their decarbonization efforts.

The question of what happens if there is a significant surplus of credits, driving market prices below the floor, remains a detail to be worked out. Bernstein suggests that offset developers might see their credits lose priority, with companies holding credits for their own compliance obligations taking precedence. This dynamic underscores the importance of carefully designing market rules to ensure that the intended price signal is maintained, even amidst potential supply gluts. The system's success hinges on its ability to prevent the price collapse that has historically undermined carbon markets.

Carbon Contracts for Difference: The Ultimate Insurance Policy

To further bolster investor confidence and ensure long-term commitment, the agreement introduces Carbon Contracts for Difference (CCfDs). These financial instruments act as a form of insurance, guaranteeing a specific credit price for emitters who enter into these contracts. If the market price for credits falls below the guaranteed price, the governments will compensate the emitter for the difference.

"The carbon contracts for difference are the way at least from a financial perspective that the parties will remain motivated to stick with the deal and so my hope is that... they're going to have to forgo capping their liability at 1 2 billion dollars..."

-- Michael Bernstein

The deal initially contemplates \$600 million in potential liability for each government, totaling \$1.2 billion. However, Bernstein emphasizes that the true value of CCfDs lies in their ability to keep both governments financially motivated to uphold the agreement's terms. The critical unresolved detail is the cap on this liability. If Alberta were to renege on its commitments, such as abolishing the price floor, the costs to compensate emitters could far exceed the \$1.2 billion cap. Therefore, it is crucial that the CCfDs are structured to ensure full compensation in the event of a policy reversal, thereby creating a strong financial disincentive for governments to abandon the agreement. This mechanism is the linchpin for ensuring the deal "sticks for a decade or more," which Bernstein identifies as the key factor that could elevate the agreement from a B/B- to an A.

Key Action Items

• Immediate Actions (Next 1-3 Months):

  • Clarify CCfD Liability Caps: Advocate for governments to finalize CCfD terms that ensure full compensation for emitters in the event of policy reneging, rather than capping liability at \$1.2 billion.
  • Engage with CFR Opportunities: Oil and gas companies should immediately explore how to maximize revenue from carbon capture projects by leveraging the Clean Fuel Regulation credits, in conjunction with the carbon price floor.
  • Understand Sector-Specific Stringency: Businesses in regulated sectors should familiarize themselves with the gradual annual increases in stringency applicable to their operations to forecast future compliance obligations.

• Short-Term Investments (Next 3-12 Months):

  • Develop Carbon Capture Business Cases: Companies in the oil and gas sector should develop detailed financial models for carbon capture projects, incorporating the combined incentives from carbon pricing and the CFR.
  • Monitor Credit Market Dynamics: Track the trading value of carbon credits to understand the actual cost of compliance and identify opportunities for credit generation or purchase.

• Medium-Term Investments (1-3 Years):

  • Plan for Gradual Price Increases: Begin strategic planning for decarbonization investments that become increasingly economical as the carbon price floor rises through the late 2020s and into the 2030s.
  • Build Long-Term Policy Advocacy: Support organizations and initiatives that advocate for the long-term stability and durability of carbon pricing mechanisms, recognizing that sustained policy is key to unlocking larger investments.

• Long-Term Investments (3-10+ Years):

  • Invest in Deep Decarbonization Technologies: As carbon prices approach and exceed \$100/tonne in the late 2030s, companies should be prepared to invest in large-scale decarbonization projects that may not be economical today.
  • Sustain Political Will: Continue to foster public and political support for credible, long-term climate policy, as the success of this agreement hinges on its ability to endure political cycles. This requires demonstrating the economic and environmental benefits over time, even when immediate payoffs are delayed.