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Currently, one cannot run Powershell script open in the VSC editor directly in the Azure Cloud Shell since both Cloud Shell and Powershell run in separate workspaces in VSC, this is why a ps1 script will try to open a Powershell terminal, it doesn’t see the Cloud Shell as a Powershell process.
The only option is to 'Run selected text' in the Cloud Shell terminal. This limitation shouldn't be there. Please enhance the extension to get rid of this limitation.