Carbon Spotlight: Demystifying Canadian Levies, Markets and Beyond
This week our podcast guest is Rachel Walsh, Environmental Commodities Strategist at BMO Capital Markets.
Here are some of the questions Peter and Jackie asked Rachel: Is the hefty Canadian emitter carbon tax starting to impact competitiveness? Is the carbon levy causing industrial emitters to invest in reducing their emissions? Canada and Alberta have introduced incentives to reduce the capital cost of carbon capture and storage (CCS) projects. Are these incentives enough to kick-start the industry? Are the contracts-for-difference that guarantee a carbon price for industrial emitters over a decade or more required for investment in large decarbonization projects? The Canada Growth Fund has set aside about $7 billion for contracts-for-difference; how much carbon do you think that will mitigate? The voluntary markets have struggled with credibility issues; do you expect this will improve and prices will increase? Could strong voluntary markets reduce the risk of investing in Canadian compliance markets since they offer an alternative way to monetize the carbon credits?
Content referenced on this podcast:
- Clean Prosperity Canada
- ICE has introduced two futures markets for Alberta Carbon Credits: Alberta Emission Offset and Alberta Emission Performance Credits
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Episode 235 transcript
Disclosure:
The information and opinions presented in this ARC Energy Ideas podcast are provided for informational purposes only and are subject to the disclaimer link in the show notes.
Announcer:
This is the ARC Energy Ideas podcast with Peter Tertzakian and Jackie Forrest. Exploring trends that influence the energy business.
Jackie Forrest:
Welcome to the ARC Energy Ideas podcast. I’m Jackie Forrest.
Peter Tertzakian:
And I’m Peter Tertzakian. Welcome back. Well, it’s April 2nd and we have just seen the carbon tax be raised to $80 a ton from 65. There certainly was a lot of political chatter leading up to it and it’s certainly still going on. What do you think, Jackie?
Jackie Forrest:
Well, it is interesting to watch. The premiers are really putting the pressure on, right? We’ve got Premier Mo in Saskatchewan not charging the carbon tax for natural gas, even though it’s illegal. Danielle Smith is regular, if you look at her social media feed, there’s been a lot of activity around retail tax needs to go. And of course, at the federal level we have Pierre Poilievre with the “Axe the Tax’. It’s still not clear actually if when he says, “Axe the Tax”, if it’s just the retail or if it’s the industrial as well. All of this chatter got my husband saying, “Do we even get the rebate?” And I’m like, “Oh, I can’t believe you’re asking me that.” So, I had to get him out and show, I actually got a letter this year, something like $330 every quarter, and it kind of laid out when I was going to get paid and I went and checked and showed him. It showed in my bank the money coming in. But it’s just interesting that he, even living with someone like me, doesn’t seem to know he is getting the rebate. So, I don’t think he’s unique though, and I think that’s been part of the issue.
Peter Tertzakian:
Well, it is I think dominantly retail focused. There’s not a lot of talk on the industrial side. I think though that you are going to start hearing more from industrial emitters because at $50 bucks a ton, which was last year or the year before, it was interesting and there was this knowledge that it was going to go up to 170, but when it actually starts to happen and you actually have to start to pay more is when all of a sudden people wake up and I think the industrial side is going to wake up. The bulk of the focus has been on the retail.
But anyway, that’s us conjecturing. We are necessarily going to have to talk about carbon pricing and who better to have back than Rachel Walsh, Environmental Commodity Strategist at BMO Capital Markets. Rachel is a repeat guest. She joined Jared Dziuba on April 2022 with us to discuss whether the Canadian investment tax credits otherwise known as the ITCs were going to be enough to jumpstart Canada’s CCS industry. But today we’re going to talk to Rachel about carbon markets, how appropriate, given that the price of carbon just went up on April 1st. So welcome, Rachel.
Rachel Walsh:
Yep. Thanks for having me, Peter and Jackie. I’m an avid listener of the show and it’s great to be here again.
Jackie Forrest:
Okay, well, we’ve got lots of topics and Peter stepped into some hot water a few weeks ago on the podcast because he said he wasn’t a big fan of this Contract For Differences. So, we’re going to get to that. But before we do, we want to remind everyone a bit about yourself, and I know you have a new role from when you came last time, your new role as Peter talked about, environmental commodities strategist. So, tell us a bit about that.
Rachel Walsh:
Yeah, thanks. So, Peter, as you were alluding to, we believe the price on carbon is only going to become more relevant for our clients over time. Typically, that price is enforced through a market-based mechanism for heavy emitters, and that’s largely for our large corporate clients. So, my role specifically helps our clients navigate those markets by providing fundamental market analysis on the various environmental commodities markets to help them with risk management and portfolio optimization. These include government run and voluntary carbon markets as well as clean fuels markets. But my role is part of a broader suite of services at BMO. The bank has had a long-standing goal of wanting to be our client’s lead partner in energy transition. And in that spirit, the bank went out and acquired a Calgary based carbon trading and advisory business a little over a year ago, which does give us a unique set of services, especially for a financial institution.
Jackie Forrest:
Right. You bought Radicle, right?
Rachel Walsh:
Yeah.
Jackie Forrest:
I was actually getting my carbon credits from Radicle.
Rachel Walsh:
Oh, really?
Jackie Forrest:
Now they’re not supporting me anymore, so I just signed up to someone new. We can talk about that another time. Well, let’s get into the carbon markets. It sounds like we’ve got the perfect person for our discussion today. Let’s talk about this $80 per ton as Peter alluded to, that large emitters may start to see some pain from this. Just to be accurate, they actually saw that increase at the beginning of the calendar year, and not only did they see going from 65 to $80 per ton, but they also got about a 2% increase in the stringency. So, today they don’t pay on all of their emissions, they pay on a fraction, but every year that increases around 2%. So, are you seeing that starting to be a problem or is it still a fairly low cost for these industrial emitters?
Rachel Walsh:
I would say overall it’s on average a low cost. I would say that some of the older legacy assets are feeling that cost more significantly. The facilities you’ve seen over time that have made retrofits; improved efficiency have been able to keep up with those benchmarks. But certainly, as that price continues to head toward 170 and if you have conviction that it is going to head there, it’s becoming relevant for almost every facility.
Jackie Forrest:
Is that just oil and gas that you’re talking about?
Rachel Walsh:
No. And so maybe it’s helpful to take a step back and talk about these systems and how they operate in Canada overall, just so we can understand the structure. So, there’s two parts to carbon pricing in Canada. We’re talking about this, there’s the fuel charge and then there’s also the system for industry, which is regulated through an Output-Based Pricing System, also known as an OBPS. Provinces are allowed to run their own programs, but they have to meet a federal minimum overall, otherwise a federal backstop will be applied instead. So, Quebec is a little bit of an outlier. They run a cap-and-trade program that’s linked with California, so that regulates facilities on an absolute emissions basis. Every other system in Canada is regulating emissions on an intensity basis.
Peter Tertzakian:
Yeah. Let’s explore that a little bit more for our audience because it’s not obvious and it’s not easy. So, to clarify, the OBPS, which is a suite of targets that become more and more stringent over time. So the carbon intensity of a product that is produced, in other words, the amount of carbon emissions that is associated with producing say a ton of steel or a bushel of wheat or any other product, that intensity has to go down over time and carbon levies, in other words, the amount you have to pay as a carbon tax increases even if the carbon tax is flat. But we’ve got a double dynamic going on here that every year the headline is the carbon tax is going up, say 65 to $80 a ton, but at the same time the stringency is increasing. So, it’s like a double whammy.
Rachel Walsh:
Yeah. And how to think about that stringency. So, every system, every OBPS system in Canada, that emissions intensity benchmark is an average for that product typically in the markets. You’ll see that in the Canadian market, as well as BC. However, in Alberta is specific to the facility. So, it’s based on 2013 to 2015 average emissions intensity for that specific facility. So, in Alberta, when you’re talking about stringency increasing, it’s relative to that facility’s historical emissions over time, whereas other systems in Canada, it’s just an average for the product.
Peter Tertzakian:
So, these are getting really into the nuances, but the point is that we have an economy which has quite a few emitters, and it’s not just heavy emitters that are affected by this all the way down to small businesses that have to comply, that you have a situation where it’s not just the tax increasing, but your performance has to improve, otherwise the impact of the tax is even greater.
Rachel Walsh:
Yeah, absolutely.
Peter Tertzakian:
And so, the question then becomes recognizing this or maybe not recognizing this, I guess the CEO, board of directors of any company that is subject to this, do you see any evidence of them actually mitigating their carbon emissions or are they just sort of, whoa, I’m waking up to this. What’s going on? And actually, I want to talk not just about oil and gas, but I’m thinking of other sectors of the economy like steel, fertilizer, agriculture, aviation, the list goes on and on.
Rachel Walsh:
Yeah, you’re seeing, especially with new builds for facilities, executives are typically deploying lower carbon intensity options at the get-go. Typically, those are relatively cost competitive with higher carbon intensity options. If you’re looking at electrifying certain items, we’re seeing installation of electric arc furnaces in some jurisdictions for steel. They’re being supported with other government subsidies of course as well. But you are seeing investment decisions towards lower carbon intensity options and facilities.
Peter Tertzakian:
But the existing base of capital stock, we’ll call it the existing infrastructure, is more difficult.
Rachel Walsh:
More difficult. Certainly, if an asset isn’t at the end of life, you’re looking at deploying capital on an existing asset earlier than you otherwise would. But with the method of compliance here, there’s an ability for a company to bank tradable units and kind of hedge out their longer-term liability. And so there are ways to mitigate costs earlier in the program overall that don’t include spending on that infrastructure.
Jackie Forrest:
And you’re incented to do it because it means that you pay less carbon tax. Now, one other big thing looming in terms of making an investment decision is the likelihood that the Conservative party may get it in the next election, and they have this “Axe the Tax” that they keep saying, and it’s still not clear if that is just for the retail or if it also includes industry and they’ve never clarified that. Do you think that they may axe the industrial carbon tax or maybe even change the terms if not so that it’s not quite as aggressive?
Rachel Walsh:
Yeah, I think to your point, there’s more unknowns than knowns at this point in time. I think there’s certainly a risk that price escalation schedule to $170 per ton goes away. But I will say the Alberta carbon program has been in place since 2007. It’s actually one of the longest standing compliance carbon markets globally. And so our take is that certainly that price schedule is risk, but we think the carbon market will exist and endure. To your point, Jackie, if they lower the federal requirements for that federal backstop to not be applied, then perhaps the province could loosen stringency on the program. But that would be up to them to do.
Jackie Forrest:
And it’s not just Alberta, right? You’ve got B.C.’s got an existing… Quebec, you talked about that cap-and-trade’s been around pretty much as long as TIER, right? So, you got to think that those, even when the federal government says you don’t need to do it, there’s the potential that those longstanding policies continue on.
Rachel Walsh:
Yeah, absolutely. I think the power simply goes back to the provinces with this, and B.C. has long stated that they will have a more significant price on carbon, at least than the federal price, so that market should exist. I don’t see Quebec going away either.
Peter Tertzakian:
My sense is that it’s quite hard to axe the tax on the corporate side, the non-retail side, because there’s so many entrenched programs. There is entrenched contractual obligations. You just can’t get rid of all that stuff overnight, and the potential for large constituencies to lose lots of money as a consequence is quite great.
Rachel Walsh:
Yeah, absolutely. And you also have some companies coming here building low-carbon facilities hoping to monetize those investments through these tradable carbon markets, like the Dow net-zero ethylene cracker would be an example of that. Air Products hydrogen facility as well.
Peter Tertzakian:
Yeah. But just going back to this comment about, it will go back to the provinces and therefore different provinces will have different levels of stringency, different levels of tax. All of a sudden you create provincial arbitrage for carbon markets, and potentially even a company might say, “Oh, it’s way too expensive to operate in BC. I’m moving to Alberta.”
Rachel Walsh:
Yeah. And I think regardless, you see that anyways. So, for example, I said BC has always had the goal to have something that’s more stringent than the federal requirements. And so, you already see that arbitrage exists. Now, you can’t pick up facilities and move them, but you can choose to spend drilling capital elsewhere. You do already see a bit of that regulatory arbitrage between provinces despite us having a federal framework.
Jackie Forrest:
Okay. Well, let’s talk about CCS projects in Canada. Big news recently with the word that the Pathways folks are going ahead with the regulatory process associated with the big carbon pipeline they’re planning. But I want to go back to early 2022 when you and Jared were on the podcast. And at that point we had learned about this big investment tax credit of 50% of your initial cost to be covered as a tax credit by the federal government. And we asked you, does that mean we’re going to see investment in CCS? And both of you had said, “We still need a carbon price. In itself, the tax credit is not enough to get the carbon capture storage business going here in Alberta.”
Well, I think you’re right because we haven’t seen it get going yet. Now, since that time the government of Alberta has added a 12% grant, which will also cover initial capital costs. So, now we have something like 62%, potentially, the initial capital cost of the projects being covered. So, what’s your view today on the carbon price needed for large scale CCS in the oil sands, or even natural gas power plants with the carbon capture storage on them? Because with this new electricity standard, that’s another topic.
Rachel Walsh:
Yeah. So, the Alberta Carbon Capture Incentive Program is certainly helpful, but it’s not material in moving projects towards final investment decisions on its own, so you still do need that carbon revenue support in the background on our modeling. And I will say we have a generic post-combustion model, so much higher cost than some other technologies that can be deployed for carbon capture. But on our model, we think the ACCIP can lower breakeven costs by about $5 per ton. So again, helpful but not material. We still think that something in the range of $90 to $100 dollars per ton is needed for those more expensive large projects.
Now, that said, you are seeing certain groups realize very compelling capture costs and there are some new technologies being deployed. There’s also pre-combustion opportunities for carbon capture, so that’s not to say that it won’t move ahead. But for those more costly applications, still need very durable carbon pricing in the background to support those overall. And that’s not competing for capital internally in terms of opportunity for spending at the corporate level. That’s simply just breakeven costs.
Jackie Forrest:
Okay. And when you visited last time, you talked about the fact that carbon tax is needed to cover the operating costs. So even though you’re getting quite a deal on the initial cost, there’s a lot of cost in running this every year and energy required and storing the CO2. There’s costs, and that’s why that’s needed.
Rachel Walsh:
Yeah. These facilities are very energy-intensive, both for the carbon capture part of it and then also the compression to get the CO2 into the pipeline. And so, we think operating costs are in excess of half of the total cost of the project over its life. They’re very significant.
Peter Tertzakian:
The oil and gas industry gets a lot of flak for having a large amount of free cash flow, dividending it out, sending it back to investors in favor of spending money on these big CCS projects and abatement of carbon in general. What do you think is going on in terms of the decision making that happens at the corporate boardroom tables?
Rachel Walsh:
I mean it’s challenging. These executives and boardrooms do have a fiduciary duty to protect shareholder capital and to return that to shareholders. I think, at the moment, the incentive structure to spend on these large infrastructure projects really doesn’t exist. At the moment, the benefit for spending on this massive carbon capture project is really limited as a license to operate or potentially a way to get under an incoming oil and gas emissions cap overall.
But if you think about the oil and gas industry specifically, they really don’t have an ability to pass the cost of a project like this onto customers. They’re exporting into a global commodity market. They’re price-takers overall, and so these projects would simply add to cost of supply and could potentially deteriorate international competitiveness. You could see production shift to jurisdictions that don’t have carbon pricing. And certainly, today we can look at long-term crude price and think that they have enough free cash flow to spend on these projects. But if you take a more conservative look, if you think the price of crude will come down over time, that free cash flow deteriorates quite meaningfully
Peter Tertzakian:
And rapidly.
Rachel Walsh:
Yeah.
Peter Tertzakian:
Yeah. I think that this is an important point, is that the Canadian oil and gas industry, the American oil and gas industry, and a handful of regional industries, say the North Sea, are largely free market. And therefore, not only are their products, the oil and gas they sell, going into a global market, but the capital that they access from investors is also global. And there is a choice at the boardroom table as to how to allocate that capital. Say, “Well, I can allocate it in Canada, or I can take my money and I can invest it in the United States or North Sea or wherever.” Less and less in the North Sea, but you know what I mean. There’s choice. And so, the decision or choice to spend on big carbon capture is in the context of being able to spend money and choices elsewhere in the world.
Rachel Walsh:
And I think you have to remember Canada’s actually quite unique for an oil and gas-producing nation. We do a have quite punitive carbon pricing program here.
Peter Tertzakian:
Right.
Rachel Walsh:
You don’t see that another large oil-producing nations overall.
Peter Tertzakian:
This is a good segue into comparing the Canadian system for incentivizing carbon capture versus the American system. And a lot of people say, “Well, the Canadian system is more attractive if you actually run the spreadsheets,” but actually it’s not so clear because the job of people who allocate capital is to assess risk and return or returns and risk. And so, what’s your sense of the difference between the Canadian and the American system? And which is more attractive?
Rachel Walsh:
Yeah. Certainly, to your point, there is potential for higher project returns in Canada, but again, risk. You’re trading or selling those offsets into a carbon market where the price is subject to supply-demand fundamentals. In the US, in contrast, you have price surety over that 12-year claim period under the 45Q program. And that’s at about US $85 per ton and will also be inflation-adjusted over time. So, when you’re calculating risk-reward and you have that surety on one side for a decarbonization program, that seems to be more compelling overall.
We’ve always said that somebody has to pay for these massive infrastructure programs. That’s either going to be the taxpayer or the consumer at the end of the day, and the US has chosen for the taxpayer to completely subsidize these projects overall.
Jackie Forrest:
One thing that’s unique is they get the guaranteed price for 12 years, where we have the potential that the carbon price may not be the stated price because it is a market-based price. And if everyone does carbon capture storage it may oversupply the market and have low prices. We also have the political risk. We just talked about it, where Conservative Party of Canada, if they were to get in, may just get rid of the program altogether. So, let’s move into the solution to that in Canada, is this Contract For Differences. So, Peter, I won’t paraphrase your own words. Tell us your view.
Peter Tertzakian:
Well, I will phrase my own words. I didn’t say I was against it, I said I was skeptical.
Jackie Forrest:
Yeah.
Peter Tertzakian:
And I said, “I don’t even want to talk about Contract For Differences until such time as the carbon markets are made more transparent, liquid, and there is a depth of market that people can trade around.” And this is because the Contract For Difference is effectively a financial instrument, and so financial instruments like derivatives depend upon well-functioning markets, in this case the carbon market.
Jackie Forrest:
All right, and we did have some feedback. So, from our listener email box I picked just one email here. We have Jake Wadland from Clean Prosperity reached out to debate your point. Now, Clean Prosperity is led by executive director Michael Bernstein, and they’ve of course been advocating for Contract For Differences. So, thanks, Jake, for reaching out. I’m just going to outlay his arguments and then I want both Rachel and Peter to get their thoughts on it.
So, first of all, his argument is the liability is quite minimal to the government, and he’s assuming that the provinces manage their carbon markets and that the prices don’t fall. So therefore, there’s not really much risk there. And they do like your idea of inter-provincial trading, and they think that’s necessary, but you don’t need to figure that out first. You can do these things together. You can move forward with this and then figure out the inter-provincial trading.
They disagree the way you described it as a put option. They actually think it more like a swap and that it provides upside to the holder as well as downside. And they talked about the Canada Growth Fund deal actually, where they were taking the ownership. So, they may have paid 86.50, and if the price in the market wasn’t 86.50, they could just hold it until the price is 86.50. So, there’s a little bit of an ability to make money. Now, we did clarify that a few weeks ago. They also would argue that the taxpayer doesn’t need to be a counterparty.
Of course, the first deal was with entity backed by the Canadian government, with the Canadian Growth Fund, but banks or pensions could hold these. Provincial governments should, and they agreed with our point that the Alberta government should. Now I would just put in my little bit. You’d have to have a lot less risk, potentially, in that case, for other people to step up, than there is today. But the bottom line is they think we need to have this. And they actually have done some modeling by Navius, which is a consulting group, that showed that a broad-based Contract For Difference would add 33 megatons of reductions, that’s very significant, versus not having one.
Jackie Forrest:
… megatons of reductions, that’s very significant, versus not having one. So, Peter, what’s your response to the Clean Prosperity counterarguments?
Peter Tertzakian:
Well, the bit about the liability is manageable, the provinces should be able to manage this whole thing, you look at it from the theoretical lens and you say, “Yeah, it makes a lot of sense.” But you look at it from the lens of people making decisions in the boardroom and the financial markets, and it doesn’t make sense because of the lack of clarity, the amount of risk in assuming that the liability is going to be manageable. So, I think there’s a split between theory and reality here. And all I’m arguing is let’s get the pragmatic matter of getting the carbon markets functioning, transparent, liquid, cross-jurisdictional, fungible, and then we will have enough trading and price discovery to be able to handle swaps or puts, or whatever financial derivative. And why we want that is because ultimately there will be investors in the private sphere that may want to take on the liability and the government doesn’t have to. In other words, the government can sell their liabilities.
Rachel Walsh:
Yeah, I’m going to have to agree with Peter on this. I think it is a solution to help accelerate investments in carbon capture, but we can’t ignore the impacts that that could have on these tradable carbon markets. So, taking a step back, when you think about the point of a carbon market, it allows for the efficient transfer of capital between facilities, and it allows capital to flow to the lowest cost opportunities. So what carbon markets are great at? Directing capital to the lowest cost opportunities. What are they not great at? Directing capital towards higher cost opportunities overall. You think of it as a supply cost curve essentially.
And so certainly at some point in time, when the stringency comes down enough and the price is high enough, then the market will signal that it is time to spend money on carbon capture. But if you’re underwriting higher parts of the cost curve today, it’s going to oversupply the market near term potentially, and it’s going to disincentivize spending on the lower end of the cost curve overall.
So, there is a dilemma, however. You have the need to deploy these projects at scale, help them commercialize, help costs come down, and be an industry leader there. I just don’t think we can ignore the impact that that could have on carbon markets overall, especially if they’re deployed at scale.
Jackie Forrest:
Right. So that risk of carbon markets trading low is quite high based on the fact we’re going after these large, large projects that could oversupply the market.
Now, we do have a solution for that too. The Canadian Growth Fund has earmarked about $7 billion for these Contract For Differences. We had the one deal with Entropy, which we’ve talked about a number of times on the podcast, which will back up to a million tons of CO2. Now, that sounds like a huge amount of money, 7 billion, and there is the idea that they’re going to back more projects, but I kind of question how many projects they can really back.
Look at this “Axe the Tax” thing. In reality, they kind of have to think about, they could have the liability for this whole amount for, I don’t know how long these contracts could be, 15 plus years. And so, because of the uncertainty around price, because of the political uncertainty, I think that the parties that back these are going to have to kind of put aside a fair amount of capital to cover off those liabilities. And that’s why I don’t think pension funds or other groups are going to step into this.
Rachel Walsh:
Yeah, I would say certainly if these markets improve, you have further liquidity, de-risking market, banks could step in and provide liquidity, but they also need to be able to offload that risk to other parties in the market. And it seems very one-sided at the moment for these types of contrasts. So, I just don’t think the risk suits banks well to spend capital at the moment.
Peter Tertzakian:
And Jackie, this phrase that you used, uncertainty around price, the role of a financial professional, somebody making big capital investment decisions around a boardroom table, they’re accustomed to uncertainty with price, uncertainty with, say, oil price or gas price, or any other commodity price. That’s not the issue here. The issue is I don’t even know what the price history is.
Jackie Forrest:
And it’s not even transparent. Yeah, yeah.
Peter Tertzakian:
It’s not even transparent. So how can I model the uncertainty of price in my spreadsheet? That’s the issue. The job of financial professionals is to assess risk and return. And if you can’t assess risk, then the return part of the spreadsheet becomes meaningless.
Rachel Walsh:
And Jackie, to your point of the up to $7 billion, assuming that the price on carbon could completely go away, you might have to assume that the entire notional portion of those contracts is at risk. 7 billion in the context of that one carbon offtake contract that we saw, that was 185,000 tons was the firm part of that agreement with Entropy over a 15-year period at 86.50. That would suggest that you could potentially underwrite up to 5 million tons per annum through Contracts For Differences or offtake agreements. And just for context, in terms of the total market in Alberta, average annual demand, or the average annual obligation, is about 20 million tons. So obviously that will be deployed economy wide. That’s not all going to be dedicated to the province of Alberta, but it could be quite significant overall.
Jackie Forrest:
By the way, I think that is a solution. It’s a good solution. It’s going to kickstart the industry. It’s going to get us in the business and get some experience. What do you think, 10 years from now if we were sitting here, would Canada and Alberta have a very big carbon capture storage sector? We’re already leaders. We talked about that last week, Peter, after your trip to the UK. Will we be even bigger world leaders? Will we be one of the biggest places in the world for CCS? What are the chances, do you think, that this will all work out and we will get ourselves into a position where the carbon markets will support these investments?
Peter Tertzakian:
Well, investment in carbon capture depends upon the availability of capital and the propensity for capital allocators to make those investments. But I think what you’re hearing is that there is enough uncertainty in these carbon markets that the capital is not going to flow as expected. That’s what I see. And that 10 years is not the issue. The issue is now. And right now, the carbon markets are not functioning properly. That’s my perception. But Rachel, talk to us about the state of carbon markets in Canada.
Rachel Walsh:
I do think that we will see a large carbon capture industry here in Alberta, but I think it’s largely going to be on pre-combustion applications or lower cost…..
Peter Tertzakian:
So, define that for us.
Rachel Walsh:
So that could be things like blue hydrogen, blue ammonia. You’re creating these products with utility. You have a very concentrated stream of carbon dioxide while you’re creating those products. And so given the concentration of CO2, you can capture it at a much lower cost. Market pricing, right now, the average market price, at the moment, is a few dollars over $50 per ton. With the investment tax credit, things like that supporting that, that does signal potential profit opportunity for those products. And you’re also creating a product with utility that you can sell as well. So, I do think that we will see a CCS industry in Alberta. It’s just going to be in lower cost applications. You already have the Air Products net-zero hydrogen facility going ahead, that’s going to be online in 2025. And then you also have Dow.
Peter Tertzakian:
This is all positive momentum but let me probe this a little bit more. If I’m a company that wants to invest in another hydrogen project, hydrogen projects are dependent upon carbon credits, right?
Rachel Walsh:
Yeah.
Peter Tertzakian:
The ability to sell them.
Rachel Walsh:
Yeah.
Peter Tertzakian:
To finance the project. And again, if those credits are going into some murky, opaque black box, then the person who fills the spreadsheet out for assessing that hydrogen project is confused.
Rachel Walsh:
Certainly. And we do have a lot of market information, being engaged in the Alberta carbon market. I will say Alberta is much closer to a functioning market than any other carbon market in Canada. So, you are able to reasonably assess risk in the province of Alberta. There’s actually a futures contract that just started trading on ICE, as well in the Alberta TIER market. So, we are leading to more price discovery in the market overall.
Peter Tertzakian:
So, in Europe, I was just there, you can pull up your iPhone and get the price of carbon.
Rachel Walsh:
Yeah.
Peter Tertzakian:
Here, I tried to get the price of carbon and it’s like two months lagged, and you’d be lucky to get quarterly data.
Jackie Forrest:
But she’s saying there’s a futures contract. That must be….
Peter Tertzakian:
Yeah, yeah, yeah, but it’s not transparent.
Rachel Walsh:
Yeah. No. And it remains to be seen if that contract will be successful. There isn’t a ton of liquidity on it at the moment. The market is currently digesting it overall, but you would have to call somebody like BMO or somebody that’s constantly in the market and trading these offsets and credits to have any idea what the price on carbon is. It’s certainly not accessible to the average Albertan.
Peter Tertzakian:
Right. And then my argument is you need to have deep markets, as much as we have in oil, gas, electricity, cotton, coffee, you name it, to have a capital markets that is interested in investing or even interested in running some spreadsheets.
Rachel Walsh:
Yeah, I think we’re getting there. The ICE contract is a good start to that more price discovery is obviously great for investment and market efficiency overall. So, we’re heading that direction. But certainly, at the moment, not in a really transparent market.
Peter Tertzakian:
Right. And not also tradable across jurisdictionally from province to province. Can you comment on that?
Rachel Walsh:
Yeah, I think that’s a big challenge with carbon markets and a frustration for me. Larger markets would be more efficient markets. I’m a proponent of linkages. There are some signals that we could have certain linkages between BC and Alberta, but if you look at the contrast between the structures of the program, I don’t think it’s going to be a complete linkage. You certainly don’t have interprovincial trading at the moment. Quebec is one of the only linked markets with California with the cap-and-trade. Washington state looks like they’re going to join that as well. So, there are green shoots on some linkages here. I hope that politicians and bureaucrats can see the benefits of linking markets and we move toward that over time.
Jackie Forrest:
All right. I want to switch topics to the voluntary markets, and we’ve talked about it quite a bit on the podcast already. We had Dirk Forrister, President, CEO of the International Emissions Trading Association come on. And of course, the issue with the voluntary markets is quality. There’s been a lot of news releases around the fact that these credits really aren’t really doing anything, and that it’s kind of business as usual. Whether you had a credit or not, that emission would’ve been avoided. As a result of this, the prices have been quite low this year. I think it’s about $5, according to Bloomberg New Energy Finance, last year for an avoidance credit and $15 for removal. Now, the price is vary quite a bit. An average doesn’t represent everything, there are some higher priced credits. But there are people that say, if the voluntary markets could get figured out, that they could actually be quite high-priced. In fact, Bloomberg New Energy Finance is predicting that under the right conditions, it’s just a scenario, with strict quality and a push that only removal credits would be allowed, the price could increase to over $100 per ton. What’s interesting about that is, if that were to occur, then that could create a backstop for some of these projects. So, if the provincial system disappears or the price is very low, instead of selling into the provincial system, you could sell into the voluntary. And the people that buy the voluntary are people like Microsoft, people that have made voluntary commitments.
Peter Tertzakian:
Can you just elaborate on that for our audience again, or remind the difference between the compliance market and the voluntary market? Give me an example of a compliance market credit versus a voluntary market credit.
Rachel Walsh:
So, compliance market credits, the government regulator would disclose what protocols they would accept and be fungible into their compliance market. So, in Alberta, we have almost 20 offset protocols. It includes things like renewable energy build out as well as carbon capture with enhanced oil recovery. Also, pneumatics or methane abatement are all fungible into the Alberta carbon market.
Peter Tertzakian:
Right. So, I swap a gas actuator valve in a facility with an electric one, I will get a credit and the Alberta government will recognize that as a legitimate transactional instrument in the carbon markets, assuming it follows a certain suite of protocols to get certified as a credit?
Rachel Walsh:
Yep. And you’ll get issuance on the Alberta registry. It’s completely fungible into the Alberta carbon market.
Peter Tertzakian:
Right. So, this is basically like minting legitimately, with strict protocols, a piece of carbon currency.
Rachel Walsh:
Yep. And in the case of methane abatement, you’re able to monetize your investments that you’re going to have to make anyways with the methane regulation. So lowers costs overall.
Peter Tertzakian:
Okay. So voluntary credit?
Rachel Walsh:
You’re doing it on a voluntary basis. It’s outside of the regulated facilities in Alberta, but it’s under the specific protocols within the province.
Peter Tertzakian:
Right. So, a weak protocol would be I go plant a tree, claim it’s a piece of carbon currency that I got, and I try and sell it?
Rachel Walsh:
Yeah. And I won’t use the word weak, but you do see that a lot in the voluntary market. So, for example, Apple has invested in nature-based removals projects. So, they are reforesting certain areas of the world and they’re getting issued carbon credits for that, which they’re then retiring against their own emissions.
Peter Tertzakian:
Right. But there are agencies that certify those as well.
Rachel Walsh:
Yeah. You see there’s four main registries in the voluntary carbon market that will validate and verify that an activity meets their protocols. That said, they’ve been under a lot of scrutiny lately. And you have seen some other registries and standards emerge.
Jackie Forrest:
Okay. So, with that context, one of the big questions I think is, what’s going to happen with the voluntary markets? Because if they do go up to that $100 per ton, it actually will make a lot of these projects less risky because if you can’t sell into the compliance market, there may be this other market which is global and more transparent. It’s not larger today, but eventually it would be larger. Do you think that that is a potential scenario?
Rachel Walsh:
It certainly is. I would caution that there is extreme price variability in the voluntary market, and it all relates to quality of the credit overall. So, when you talk about those flashy prices at north of $100 per ton, you’re talking about things like direct air carbon capture. And so not every project that’s going to get issuance in the voluntary market is going to see that pricing. They’re going to have to prove that it’s a high-quality project overall. So, remains to be seen what a carbon capture and sequestration credit would trade at in the voluntary carbon market, but certainly an opportunity there. The things you need to confirm is that the project is truly financially additional. So, to your point, Jackie, if there’s no funding option through compliance market mechanisms for these projects, then they certainly could issue on the voluntary market.
Peter Tertzakian:
So, accountants, when they do their audits, they account for all these credits on the balance sheet. And do you foresee a possibility that the voluntary credits all of a sudden become worthless as a currency?
Rachel Walsh:
If you’ve watched what’s happened in the voluntary carbon market over the past, call it 18 months, that’s certainly a possibility of that, I will note that those are largely in nature-based avoidance project types, so essentially conservation in certain areas. But another really critical aspect to understand what the voluntary carbon market, you can’t double count the environmental attribute, so you can’t double claim it. So, if I am a facility, I’m installing carbon capture and sequestration and I’m monetizing all of those tons in a market, I can’t also say that I own those reductions. So, if you’re thinking about returns for a facility overall, you do have to keep that in mind. And perhaps if you have a goal to cut emissions in half, you monetize half of those credits and you internalize the other half, but you can’t sell and also claim.
Peter Tertzakian:
I think the highlights that anyone listening to this conversation will go, “I don’t understand half of it and it’s extremely complicated and there’s a lot of uncertainty,” which to me is the fundamental issue even at a boardroom table where most people around the boardroom table don’t understand that the deep nuances of these carbon markets, the uncertainties that layered on top of that with a political risk, “Is a new government going to cancel carbon tax industrial or not?” and so on and so forth, now we get a sense for why stuff isn’t getting built.
Rachel Walsh:
Yeah, it certainly seems like we’re having paralysis by analysis at the moment. It’s really hard to figure out best pathway for monetization. I think the Alberta TIER market will exist. I think it will have a robust price on carbon overall. It just might not get to that $170 per month.
Peter Tertzakian:
Yeah, I mean it’s like someone deciding to swap Canadian dollars for some other currency for which they don’t know what the price is, they don’t know what it’s going to be worth and wondering if that’s a good investment just because it’s at an attractive foreign exchange rate today.
Jackie Forrest:
Yeah, that’s actually a really good way to think about it.
Peter Tertzakian:
I have no idea, like, “Why should I invest in this? People are telling me it’s going to be worth X in the future,” but I’m sitting here thinking about all the complexities and difficulties and uncertainties and going, ‘Well, I don’t know if it’s going to be worth X. It might be only worth half’.”
Rachel Walsh:
And I do think when you see the leaders in the space like the Microsofts of the world, they do have, to your point about this being a very complex market, especially voluntary, they have several PhDs working for them, determining what they think the value of these credits are. And they have enough buyer power to kind of dictate what they pay for it.
Peter Tertzakian:
Yeah. Sure. Well, they have enough financial horsepower to be able to afford all the PhDs. Most industries in the steel fertilizer and other kind of businesses don’t.
Rachel Walsh:
One of our goals as a business is to help our clients navigate these markets overall. And so, we will be helping educate them on how to approach these markets, how to use offsets thoughtfully, how to consider pricing as well. And so, we do think these markets are going to be around. We do believe as companies do strive to reach both their near-term targets and their longer-term targets, they are going to have to access offset markets, whether that be compliance offsets or voluntary offsets to help get them to those emissions’ reduction goals overall. And it is very-
Peter Tertzakian:
Sounds like you’re in the right business.
Jackie Forrest:
Yeah. Hey, I have a story. I went to Ottawa recently and I visited the Canadian Mint. It was really worth doing by the way.
Peter Tertzakian:
Yeah. Yeah, I’ve been there.
Jackie Forrest:
But it was really interesting because they spent a lot of time talking about how these coins of gold that they spent all their time making them exactly whatever the weight was, it was an ounce or something like that, I forget the exact weight, and they forged them, and then they run laser machines just to skim off just the tiniest amount so that they’re exactly the right weight. And every coin is 0.9999 quality of gold, and therefore it’s worth this much. It’s always the same, right?
It got me thinking about the carbon markets. It’s like, that’s kind of what we’re trying to get to. Every ton of carbon should be like at the Mint, right? It’s validated. It’s exactly the same. And whether it came from nature or whether it came from a CCS project, it should be exactly the same. And therefore, people in Europe would pay you a certain amount of money for a Canadian ton. And just like currency, right? That’s where we have to get to. We’re a long ways away from that today, but it just kind of was very good for me to symbolize at some point in the future I think we’ll get there.
Peter Tertzakian:
Well, I think with the protocols you talked about in the compliance market, jurisdictionally saying in Alberta, we have that type of scrutiny, but it’s not tradable with other provinces. It’s not tradable with the Europeans nor anyone else.
Rachel Walsh:
And I think you will see kind of alignment on fungibility. There’s Article 6.4 through the Paris Agreement, which could lead to an international trading carbon market. We’re a ways away from that getting-
Peter Tertzakian:
Well, it’s so sad that we’re a ways away. This is a global problem.
Rachel Walsh:
No, I know. And unfortunately, when we’re talking about carbon offsets, we’re talking about either storing it in natural reservoirs like trees or underground and geological reservoirs. The duration of time that you can store in either of those is quite varied. And so, while I hope we can get to a situation where a ton is a ton is a ton, I don’t know if we can realistically get there just given all of the different nuances with the protocols.
Peter Tertzakian:
A ton is a ton is a ton and the price is discoverable. I mean, I can pick up my iPhone right now and it’ll tell you the price of gold is just over 2,000 bucks US. I know that.
Rachel Walsh:
These markets largely trade OTC. Price discovery is a massive issue, and it needs to improve.
Peter Tertzakian:
Oh, yeah, over the counter.
Rachel Walsh:
Yeah.
Jackie Forrest:
Well, Rachel, thank you so much for joining our podcast. We really enjoyed the discussion. I feel like we just kind of got going with it. There’s such a complex topic.
Peter Tertzakian:
Yeah. There’s so much more. I mean, I wanted to talk also about some of the regulatory initiatives in the financial markets that are also complex. Like we’ve been talking mainly about government directed carbon policy, but there’s now regulation in the financial markets.
Jackie Forrest:
Yeah, like the SEC.
Peter Tertzakian:
We haven’t even talked about that.
Jackie Forrest:
Well, Rachel, maybe we’ll have to get you back.
Rachel Walsh:
Yeah, always happy to join.
Peter Tertzakian:
Thank you so much, Rachel. Rachel Walsh, Environmental Commodities Strategist at BMO Capital Markets.
Rachel Walsh:
Yeah, thanks for having me, Peter and Jackie.
Jackie Forrest:
And thank you to our listeners. If you enjoyed this podcast, please rate us on the app that you listen to and tell someone else about us.
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