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TMX POV - Canadian oil & gas companies must adapt to the new realization of de-carbonization or face capital constraints

December 20, 2019

The exploration, production and use of hydrocarbons is fundamentally at odds with the Paris Climate Agreement. The Paris Agreement, signed in 2016, is an agreement within the United Nations Framework Convention on Climate Change (UNFCCC), whereby member countries have agreed to reduce global greenhouse-gas-emissions in an effort to reduce the harmful effects of climate change. As of November 2019, 195 UNFCCC members (including Canada) have signed the agreement.

In order to achieve this goal, scientists have stated that global manmade CO2 production must fall to zero by 2050. Failure to reach this goal, they predict, will result in adverse environmental and economic consequences on a global scale. The Intergovernmental Panel on Climate Change (IPCC), a UN-backed body of climate scientists, have gone even further and are calling not only for the abolishment of all hydrocarbon based fuels but also for an immediate transition to 100% renewable energy.

A noble goal to say the least, but it's not completely realistic. Global demand for fossil fuels is not declining anytime soon. In fact, the International Energy Agency has forecast in its World Energy Outlook 2019 Report under its Stated Policies Scenario (which incorporates today's policy intentions and targets) that global oil demand will climb from 96.9 million barrels a day (2018) to 105.4 million a day in 2030, to finally plateau at 106.4 million barrels a day in 2040 (concentrated mostly in the aviation, shipping and plastics sectors).

What does this mean for the Canadian Oil and Gas Industry going forward? How does the Canadian Oil and Gas Industry reconcile these two diametrically opposed realities – reducing Greenhouse Gas (GHG) emissions (such as carbon dioxide (CO2), methane, nitrous oxide and ozone) whilst taking advantage of increasing global demand for oil and gas? There are many schools of thought around this, but I think one of the keys will be being an active participant in the global movement towards de-carbonization and seeking out solutions to reduce the industry's CO2 output.

Canadian E&P Companies can adopt renewable energy technologies that fit closest with their core competencies of drilling wells and interpreting subsurface geology – think geothermal power. They can also utilize emissions reducing solar, wind and other clean energy technologies to power their field operations. Finally and most importantly, Canadian E&P companies must continue their role as world leading environmentally responsible operators (i.e. reduction of water use, reduction of spills, management of fugitive emissions, reduction in emissions intensity per barrel of production, etc.) all the while finding newer and more innovative ways to reduce fossil fuels used in their production processes.

In short, Canadian E&P companies must transition from pure oil and gas exploration and production companies to ones with renewable energy or clean energy assets as part of their operations. This is evidenced, in part, by the fact that the S&P/TSX Renewable Energy and Clean Technology Index (TXCT) is up 38% over the last five years while the S&P/TSX Capped Energy Index (TTEN) is down 35%*.

Why am I pointing out the sharp contrast in returns between the Oil & Gas Sector and the Renewable Energy Sector? Quite simply, to demonstrate the fact that investors are rewarding those energy companies with low carbon intensity output. Is it fair to compare the returns of the Oil and Gas Industry with the Renewable Energy Industry and say the differences are due solely to de-carbonization. No, not entirely. But the reality lies somewhere in the middle.

The Canadian Oil and Gas Sector is currently capital constrained (both from a public and private equity perspective). When institutional capital does return to the Canadian Oil and Gas Sector one of their key investment criteria will be to focus on those E&P companies with a diminishing carbon footprint and / or have a renewable energy component built into their operations. This is currently evidenced by a recent RBC Global Asset Management survey which highlighted that global institutional investors are shifting more of their assets based on environmental, social and governance (ESG) criteria. Thus, those E&P Companies that do not transition to lower carbon intensive operations via renewable energy or some other form of clean energy will find raising capital in the future very challenging.

 

This article is provided for information purposes only, is not intended to provide any type of advice. This article is not an endorsement or recommendation of any securities or industry referenced herein. Views, comments or opinions expressed in this article are those of their respective contributors only, and are not necessarily endorsed by TMX Group Limited, any of its affiliates or their respective management or employees.

*Source: S&P Capital IQ, as at December 17, 2019.