Policy Insight: Will Budget 2023 Spark A Green Investment Wave?

Budget 2023’s new green measures are mostly about bolstering the upstream supply chain for a low-carbon economy with new refundable investment tax credits (ITC) for clean electricity, clean-technology manufacturing, and hydrogen.

Combined with carbon capture and cleantech adoption ITCs announced over the past year, the Feds expect to spend about $80 billion over 10 years on green investment tax credits.

That’s a significant response to the U.S.’s US$369-billion+ climate program–we estimate Canada would need to spend up to $120 billion to match IRA’s 10% estimated emissions cuts, but required new spending is lower given existing program spending and regulatory incentives.

Cost Of Net Zero: Canada’s Investment Tax Credit Bill

* FES 2022; B23 addition of geothermal and extension to 2034
** Budget 2022; limited new enhancements in B23

Large corporates the biggest direct beneficiaries

The new measures will be advantageous for large corporates given the capital-intensive nature of the related investments.  Consumers and other businesses are supposed to benefit indirectly through lower costs for clean energy and products that federal tax credits support.

Other businesses will probably find greater direct benefit from the Fall 2022 updates’ Clean Technology Investment Tax Credit (Clean Tech ITC), which became effective on budget day and saw some enhancements. The budget’s expanded focus for the Canada Infrastructure Bank on clean electricity, more funding for existing programs to update the grid, and additional funding for the Strategic Innovation Fund could also benefit mid-sized businesses.

Aside from the power sector, oil and gas, agriculture, and buildings–sectors that make up a sizeable chunk of Canada’s carbon emissions—received no new direct support for decarbonization, with only minor enhancements to the existing carbon capture tax credit.

New measures target mostly future emissions reductions

The clean electricity credit may encourage some near-term emissions reductions. It is being made available to non-taxable entities such as public utilities, which may help provincial planners increasingly opt for renewables over unabated natural gas for new power generation.

But the measures are largely about facilitating future emissions cuts. Federal subsidies are meant to lower the costs households and industrial end consumers would otherwise face for important energy inputs, thereby paving the way for investments in low-carbon technologies. There is a strong case for this approach but there are risks. Budget 2023 offers no estimates on expected emissions reductions.

Along with electricity and hydrogen, technologies like electric vehicles, batteries, heat pumps, electrolyzers, and non-emitting power equipment are covered by the new measures. These mostly correspond to abatement pathways for sectors where Canada’s 2030 climate plan seeks significant emissions reductions, suggesting the budget can play a role in achieving ambitious climate targets.

Provinces must play ball on electricity

The budget’s $25.7 billion spend on electricity over 10 years will help provinces implement the proposed Clean Electricity Standard (CES), but it requires them to get on board. The CES is Ottawa’s key regulatory tool to achieve a Net Zero emissions electricity system by 2035.  Access to the new clean electricity ITC in each province/territory will depend on provinces committing to a Net Zero electricity sector by 2035 and that federal funding will lower electricity bills.

The Feds’ clean electricity intervention does more than aim for an affordable Net Zero grid. It throws its weight behind inter-provincial transmission corridors as an important pathway to lower the cost of a clean grid, and clean electricity underpinning Canada’s ability to compete for electricity-intensive, low-carbon industries such as battery manufacturing or green hydrogen.

Provinces are also key to both these objectives, but it’s unclear how system planners will embrace cross-jurisdictional cooperation or precautionary capacity buildout. Without the provinces driving greater and faster investment, the new credit would just shift transition costs from provinces to the federal government.

Canada’s tax credits compare favourably to IRA on first review

Canada does not have production tax credits (PTCs) that are common in IRA and offer tax incentives for each unit produced versus capital invested as in an ITC. However, credit rates for the clean electricity and clean technology ITCs are generally on par with IRA. Canada’s clean hydrogen ITC carries a higher maximum credit rate of 40% (vs 30% in the IRA).

Like IRA, Canada’s ITCs apply into the early 2030s, are generally technology neutral, and carry both wage and apprenticeship requirements. Unlike IRA, Canada’s measures do not phase out earlier if climate targets are reached, and the value of refundable tax credits in some cases could be greater than IRA’s direct pay provisions for unprofitable business.

Feds are sticking with ITCs, carbon pricing

The Budget emphasized that tax-based support is only one of four tools in Canada’s strategy for a clean economy. Pollution pricing and regulation is at the core, with strategic financing through the newly created Canada Growth Fund and Canada Infrastructure Bank and programmatic spending driving more targeted interventions.

As such, Finance officials emphasized the deliberate choice of ITCs for tax-based support, instead of incorporating production tax credits. Upfront payment in capital intensive sectors is seen as providing significant value, and the best way for federal dollars to influence clean technology improvement. Avoided carbon tax or the sale of carbon credits is supposed to provide complementary revenue streams needed to underwrite decarbonization projects.

To firm carbon pricing, carbon contracts for differences are mentioned as part of the toolkit for the Canada Growth Fund, which should start doing deals this spring. The government will also consult on a “broad-based approach” to carbon contracts for differences. It’s not clear what is intended here, and there are numerous complicated issues to resolve. For now, we see these contracts available only in a limited way, so carbon (credit) price uncertainty may continue to challenge investment decisions.

What’s missing in the budget?

Canada has not clarified how it will clear the way for major clean energy projects—which is emerging as an obstacle in securing new investments. Despite last year’s $1.3 billion allotted to federal agencies to improve their project approval process, Budget 2023 still only reiterates a plan to have a plan with concrete actions committed only by the end of the year.  Regulatory issues like permitting may be just as important as tax credits to a project’s feasibility.

Budget 2023 enables the Canada Infrastructure Bank to support Indigenous communities to purchase equity in major projects in which it participates. It’s a step in the right direction, but we were looking for a broader and more transparent program to speed up the process, such as government guarantees. Many clean energy projects will be on Indigenous lands, and with both communities and project sponsors increasingly interested in Indigenous equity participation, communities’ challenges in accessing capital needs to be addressed.

Cynthia is Assistant Chief Economist, Thought Leadership, a role in which she helps shape the narratives and research agenda around the RBC Economics and Thought Leadership team’s forward-looking economic and policy analysis. She joined the team in 2020.

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