On November 22, 2023, Miller Thomson’s National ESG and Carbon Finance Group hosted a webinar discussing the latest legal trends and developments surrounding energy and energy transition in Canada. Hosted by Bruno Caron (Co-Chair, ESG and Carbon Finance and Partner, Miller Thomson LLP) and moderated by Tamara Farber (Partner, Miller Thomson LLP), they were joined by panelists Selina Lee-Andersen (Partner, Miller Thomson LLP), Tyson A. Wagner (Partner, Miller Thomson LLP), and Colleen Ma (Partner, Miller Thomson LLP). Together, the expert panelists engaged in a stimulating discussion on topics including clean energy and federal fuel initiatives, legal considerations in the development of hydrogen markets in Canada, and federal investment tax credits. Below is a summary of key takeaways and highlights.

I. CLEAN ENERGY AND FEDERAL FUEL INITIATIVES

According to Environment and Climate Change Canada (“ECCC”), the transportation sector was the second largest economic sector emitter of greenhouse gas (“GHG”) emissions in 2021.  Against this backdrop, the Clean Fuel Regulations (“CFR”) came into force on July 1, 2023. The CFR replaces the Renewable Fuels Regulations and seeks to incentivize the adoption of lower carbon fuels and new technologies. Specifically, the CFR is a performance-based emissions reduction regime providing for flexible compliance options to both drive innovation and to enable primary suppliers to choose the lowest-cost compliance actions. For each compliance period, a primary supplier will demonstrate compliance with their reduction requirements by creating credits or acquiring credits from other creators in the credit market. Primary suppliers will then use the required amount of credits to meet their annual carbon intensity (“CI”) reduction requirements. In terms of the credit system under the CFR, while surplus credits can be used or sold in later years, credits used to satisfy compliance requirements can no longer be used again. While many of the above regulations pertain to primary suppliers, the CFR also welcomes voluntary participants.

There are a number of legal factors that must be considered when facilitating compliance with the CFR. First, a business subject to obligations under the CFR must understand the CFR’s framework, including but not limited to registration requirements, application processes, CI performance standards, measurement tools, and reporting and record-keeping requirements. Second, a business should also consider how it can integrate emission reduction considerations into its operations. Such considerations include establishing corporate GHG emission reduction targets, identifying emission reduction and efficiency opportunities, deploying emission reduction technology, tracking of abatement activities, and implementing processes to measure performance against targets.

II. LEGAL CONSIDERATIONS IN DEVELOPING HYDROGEN MARKETS IN CANADA

In addition to the economic and technical considerations that must be made by market players in the hydrogen industry, many key legal factors must also be considered. Specifically, hydrogen producers must consider factors including land acquisition, zoning, permits, regulations, transportation, buyers, offtake agreements, ancillary contracts, and risk allocation.

Due to the nature of a hydrogen project, the physical land is of paramount importance. Considerations that must be made at the land acquisition stage include assessing the land’s suitability and implementing certain contractual clauses in the acquisition agreement. Such clauses should afford a developer with time and access to the land to conduct due diligence, as well as the ability to exercise an option to lease the land. One main consideration during the due diligence stage is whether there are zoning issues relating to the land that will need to be resolved. Moreover, even where the land is zoned appropriately, additional jurisdiction-specific permits will be required from governmental bodies. The permitting process itself may also trigger regulatory hurdles relating to pipeline systems, safety associations, and utility commissions.

At the commercial stage, a hydrogen producer will need to consider factors including how to transport the hydrogen, the current market landscape, and any necessary agreements and contracts that will need to be drafted. In terms of transporting hydrogen, common methods include transportation through vehicles, pipeline, train, or ship. Each transportation method will require additional considerations. There are a number of emerging buyers under the current landscape of the hydrogen market. They include industries that partake in oil refining, steel production, and industrial heating. Once a potential buyer has been identified, a hydrogen producer must consider the appropriate offtake agreement and other ancillary documents that the transaction will require. Potential contractual factors to consider include risk allocation, which party is to be responsible for paying for the inputs and outputs (e.g., electricity and water), and potential requirements from lenders.

III. FEDERAL INVESTMENT TAX CREDITS: CLEAN HYDROGEN AND OTHER INCENTIVES

There are a number of federal tax incentives available to support investment in green energy.

One such incentive is the investment tax credit for clean hydrogen (the “CH Tax Credit”). This refundable credit will vary between 15% and 40% of eligible project costs. The credit rate for a particular project is based on the assessed CI of the hydrogen that is produced (kilogram (kg) of carbon dioxide equivalent (CO2e) per kg of hydrogen), with the highest credit rate available where the CI is less than 0.75k. The CH Tax Credit will not be available if the CI is 4kg or greater. There is also a 15% tax credit for equipment that is needed to convert hydrogen into ammonia for transportation purposes provided certain conditions are met. If certain labour requirements are not met, the credit rate is reduced by 10%.

Additional details about the CH Tax Credit were announced in the 2023 Fall Economic Statement (the “2023 FES”), released on November 21, 2023. This included more details about eligible clean ammonia production equipment, power purchase agreements and other similar instruments, a proposal that the use of renewable natural gas would be eligible for the purpose of calculating the project’s CI (subject to some conditions), and additional details about the initial project CI assessment, validation, ongoing compliance, and recovery of the tax if a project fails to achieve the anticipated CI.

The CH Tax Credit is intended to apply to property that is acquired or made available for use on or after March 28, 2023 and will be phased out starting 2034. The federal government is intending to launch public consultations on draft legislation this fall with legislation to be introduced in Parliament in early 2024.

In addition to the CH Tax Credit, there are several other investment tax credits being implemented, such as credits for carbon capture, utilization, and storage, clean technology (targeted at solar, wind, water, geothermal, nuclear, zero-emissions and (as announced in the 2023 FES) waste biomass equipment, clean technology manufacturing, and clean electricity (which the 2023 FES announced will expand to include using waste biomass to generate electricity).

To be eligible for the full investment tax credit for most incentives, certain labour requirements  must be met. Broadly speaking, employers must (1) pay the prevailing wage, including benefits and pension contributions; and (2) create apprenticeship opportunities, such that at least 10% of the labour performed by workers in the Red Seal trades is performed by registered apprentices.

The 2023 FES provides a delivery timeline for the investment tax credits, including when consultation on draft legislation is expected, when legislation will be introduced in Parliament, and when the particular tax credit will be available.

The legislation for the investment tax credits for carbon capture, utilization, and storage and clean technology, as well as for the labour requirements, were included in the Notice of Ways and Means Motion to introduce the Fall Economic Statement Implementation Act, 2023, tabeled on November 28, 2023.