* Canadian pulp producers to get money for "black liquor"
* Money must be used for energy, environment upgrades
* Parliament must still approve the program
* U.S. lumber group says plan may violate trade agreement (Adds finance minister's comment)
By Louise Egan
OTTAWA, June 17 (Reuters) - The Canadian government on Wednesday tossed a C$1 billion ($880 million) lifeline to its pulp and paper producers, which complain they are drowning financially because of a tax windfall enjoyed by U.S. rivals.
The government will pay pulp companies 16 Canadian cents a liter of "black liquor" produced this year. Black liquor is a byproduct of the pulp-making process that is used as a fuel by mills to produce energy.
The temporary funding, which must be approved by Parliament this fall, aims to offset a U.S. biofuel tax credit that has allowed some American pulp mills to make money by producing and using "black liquor" in their own facilities.
Canadian pulp producers say the credit has allowed U.S. mills to overproduce pulp at a time when the market is already glutted and has provided them with income to upgrade facilities as mills in Canada are forced to shut down.
Ottawa will require producers that receive the new funding to invest it within three years in projects that will make their Canadian mills more energy efficient and environmentally friendly. An estimated 27 mills could qualify.
Finance Minister Jim Flaherty said the measure would not affect his fiscal outlook because it was already built into the government's budget and is spread out over time.
The "Pulp and Paper Green Transformation Program" will cap funding at C$1 billion. The government said it will provide an additional C$170 million to help forest-sector companies develop new products.
Ottawa promised last month it would help the pulp industry, but it struggled to develop an aid package that does not violate the U.S.-Canada Softwood Lumber Trade Agreement that prohibits subsidies to lumber producers.
"Everything in this program falls within the Softwood Lumber Agreement, both in spirit, in intent and in language," Natural Resources Minister Lisa Raitt said.
But the U.S. Coalition for Fair Lumber Imports warned the plan may violate the trade agreement by indirectly subsidizing Canadian lumber mills owned by pulp makers.
CANADA SAYS ITS CREDIT DIFFERENT
The U.S. tax credit is set to expire at the end of the year, but there have been some calls in Washington to stop the credit sooner because it has become such a financial boon to U.S pulp producers.
Some analysts have projected they could earn US$8 billion from the credit this year.
Canadian officials said that unlike the U.S. credit, which critics say has been misused by industry, their plan caps on the total amount of money, and companies must spend it on environmental and energy improvements -- not use it to reduce debt or increase short-term profits .
"This is government getting it right," said Avrim Lazar, chief executive of the Forest Products Association of Canada.
But the pulp and paper industry's largest union said the government is not doing enough to offset the U.S. measure, which it estimated has already resulted in more than 5,000 layoffs in Canada.
"The Americans will continue to subsidize the production of pulp and paper .... mills will continue to close and none will reopen because they must still compete into a market that is being subsidized by cash," said David Coles, president of the Communications, Energy and Paperworkers Union.
($1=$1.14 Canadian) (Reporting by Louise Egan, writing by Allan Dowd; editing by Frank McGurty)