UPDATE 2-Canada promises C$1 billion in aid to pulp producers

* Canadian pulp producers to get money for "black liquor"

* Money must be used for energy and environment upgrades

* U.S. tax credit under fire at home (Adds details, quotes)

OTTAWA, June 17 (Reuters) - Canada promised C$1 billion ($880 million) in aid on Wednesday to the country's pulp and paper industry, which has been hit hard by a U.S. tax rule that has benefited its U.S. rivals.

The government will pay pulp companies 16 Canadian cents a litre for "black liquor", which is a byproduct of the pulp-making process and which is often burned to produce energy.

The program aims to offset the impact of 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 American 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.

Canada will require that producers that receive the new funding invest it within three years in projects that will make their mills in Canada more energy efficient and environmentally friendly.

"By making a smart investment today, we are laying the groundwork for a greener, more secure future for the pulp and paper sector and the people who work in it," Natural Resources Minister Lisa Raitt said in a statement.