Last week saw Western Texas Intermediary (WTI) dip to nearly negative -$40.00. Little can be said with confidence these days, but it seems safe to claim that we are witnessing a disruption to our global energy system that has changed our world. Not surprisingly, some environmental critics have embraced the demand destruction from COVID-19 measures and Canada’s struggling oil and gas sector as the catalyst to drive Canada’s renewable energy transition.
They are investing in a false flag, however. In the case of Canada’s economy and our climate policy regime, we are conflating breakdown with transition. Without efforts from the federal government to improve liquidity for Canada’s oil and gas sector, the fact remains that climate policy goals will be hampered, not improved. Canadians will soon come to learn that a disorderly transition to the low carbon economy will hurt everyone.
First, let us survey the carnage of the oil price meltdown. The US shale industry is clearly in dire shape. Only five of 100 are profitable at a WTI price point of $31.00 a barrel. Many firms are heavily levered in the capital-intensive extraction process of fracking. As of March 2020, the low prices threaten to make 300 billion in US bank loans delinquent. For context, the US subprime mortgage debt was 1.3 billion.
However, much to the chagrin of those who have used COVID-19 as an excuse to shutter the oil and gas industry, Canadian producers are not in the same position as their US counterparts. In fact, many are weathering this storm by cutting capital costs. Few have liabilities similar to the US shale market, a product of strong management and that Canada’s regulatory system has kept many away from starting projects that would expose them to further liabilities.
Still, many Canadian firms will need liquidity to cover immediate costs. Investors in Canada and globally are watching closely for the federal government to signal that it will help guide the sector out of a global energy system turned upside down. With global storage capacity full and COVID-19 lockdowns likely to continue into the summer, if not longer, many companies will cut production and for some this is creating a short-term crunch in servicing liabilities.
Without more fulsome liquidity measures we are on course to see a significant contraction in Canada’s oil and gas sector, a sector that drives 6% of Canada’s GDP and directly and indirectly employs nearly a million Canadians. While many refuse to acknowledge the sector’s economic contribution to Canada, they may be more receptive to the knock on impacts this contraction will have on Canada’s shift to a lower carbon economy.
Real-time pricing of WTI
Those citing that lower oil prices will hurt renewable companies as oil and gas become more competitive are right in the immediate term, but the premise relies on these washed out prices continuing indefinitely. Enter the false flag. Neither a sudden maturity in renewable energy sources nor the ubiquity of zero-emission vehicles is driving the collapse in oil demand. It is a unique set of circumstances: a third of the world’s population is under some form of lockdown. Those who envision a world with no fossil fuels should remember that these prices are not the result of a non-emitting energy system displacing demand.
The reality of this scenario is an accruing increase in the price of oil. It is plausible that we will end up witnessing the lowest and highest oil prices in our lifetime within the next eighteen months. Why? As operations go offline and surviving firms cut production, supply may not be nimble enough to meet a sudden spike in demand as countries leave quarantine. A factor that might temper a demand driven price spike is if quarantine ends unevenly, with some regions lifting restrictions months ahead of others. In either scenario, the price will go higher because the drivers that could push oil demand into the ground are temporary rather than permanent.
While the low oil price as a detriment to renewable energy growth may not be that dire, a significant contraction in Canada’s oil and gas sector does jeopardize the momentum of Canada’s energy transition. The health of Canada’s oil and gas sector is core to Canada’s carbon price system and the economy’s momentum towards a low carbon economy. This takes shape in two ways.
First, the hard truth is that achieving the transition to a lower carbon economy is going to require significant financing. In particular, the infrastructure needed to generate investment in clean technology, build and connect communities to renewable and net-zero power systems, create energy resiliency, and put in place a transportation system for zero-emission vehicles are capital intensive endeavors, to say the least
In fact, the Conference Board of Canada estimated that financing the transition in Canada would cost $100-$150 billion dollars over the next few decades. While these projects should benefit from a low interest rate environment, capital is going to be scarce and the hangover from the COVID-19 response will subdue federal fiscal firepower.
Where will the money come from, then? Carbon pricing revenue is supposed to fill some of these gaps. In particular, the Output Based Pricing System, Clean Fuel Standard and revenues generated by TMX were earmarked for funds like the Low Carbon Economy fund to help drive dollars into these initiatives.
Over the next year, it is likely that a key part of our recovery in Canada will be led by infrastructure investment, projects that improve climate resiliency for Canadian businesses and communities, projects that get Canadians displaced by COVID-19 back to work, and projects over medium term that contribute to this government’s net-zero by 2050 aspirations. Some of these projects lack clear ROI and, as such, are harder to finance than conventional projects.
Though green finance continues to mature, revenue generated from the energy sector as well as other emission intensive industries creates funds that can drive these types of research and infrastructure work. A faltering sector will adversely affect the revenue generated through carbon pricing systems. This is all the more important as the lion’s share of the carbon fuel surcharge has gone to Canadian households and not innovation.
Second, the Canadian government has put in place the architecture for a national carbon credit market. This architecture takes shape under the Output Based Pricing System and the Clean Fuel Standard, both of which operate on the principle that larger emitters will buy offsets and credits to achieve compliance and drive a carbon credit market. Mining, industry, the oil and gas sector are important parts of this ecosystem.
The demand from fossil fuel based energy companies is creating the business opportunities that are drawing in renewable and clean technology companies who intend to sell credits and related technology into Canada’s offset and credit markets. Similarly, oil and gas companies have been both procurers of renewable energy, and have invested heavily into clean technologies.
Rather than being in opposition to one another, renewable energy and oil and gas companies are increasingly in a symbiotic relationship of creating opportunities for one another. A sudden and sharp contraction in the oil and gas sector will disrupt this ecosystem and shrink the opportunities and the sap momentum from the very technologies and energy options that opponents of the oil and gas industry wish to see form the foundations of our energy system.
We must look past the voices of those who are repeatedly trying to use COVID-19 as an excuse to shutter the fossil fuel industry. This approach not only discounts the significant economic importance of this sector to Canada’s economy, but also completely overlooks that Canada’s carbon pricing regime uses our hydrocarbon assets to create momentum for the transition to a lower carbon economy. Those wishing upon the industry its ‘just desserts’ of collapse are advocating for a disorderly transition, one that will leave Western Canada in unprecedented economic distress, and reduce the bulk of our resources for the energy transition.
Instead, the Canadian Chamber of Commerce proposes three alternative measures.
First, it is crucial that in the immediate term we extend further liquidity to the sector to help companies manage short-term crunches from the demand destruction from COVID-19. Our economy dictates its immediate necessity, as do our long term net-zero ambitions for Canada.
Second, government should work closely with the sector to identify infrastructure projects that will put people to work, but also assist government in meeting its long-term priorities of achieving net-zero by 2050. As many firms have made pledges to achieve net-zero oil production by 2050 and other targets, there is significant opportunity to make this happen. Invest in energy companies that will deliver net-zero commitments.
Third, recognize that supporting the industry today amidst this crisis will put Canada apart from other nations when oil demand stabilizes. For instance, were 80% of US shale production to go permanently offline because of this crisis, that would knock about 4.7 million barrels per a day off the US balance sheet. Long term, this would create opportunities for Canadian producers to fill gaps in both the US market and fill gaps in global demand.
If the sector is supported immediately and companies are able to pursue their pathways to net-zero energy production, Canada could not only gain more market share of the world’s energy demand, but it could displace higher or even emitting fuels from the global energy system.
Today’s calls to exploit COVID-19’s impacts on the energy sector misses not only the bigger picture, but fails to understand what is actually happening. Politics, ideology and opportunism are false flags of their own, and they have no place amidst a global pandemic with a depression teetering in the balance. What we need now is clear-eyed, economically sound reasoning that serves the interest of all Canadians as we move toward our net zero goals in an increasingly precipitous time. Liquidity and confidence today will allow Canada to shape tomorrow’s world for the better.
– Aaron Henry
Aaron Henry is the Senior Director of Natural Resources and Sustainable Growth at the Canadian Chamber of Commerce. In this role, he has worked with Canada’s leading resource companies to develop public policy on key climate and resource files, from the regulation of major infrastructure projects, to carbon pricing. Prior to joining the Canadian Chamber, he worked as an academic and later with the federal government both in the Department of Natural Resources and on a joint foresight initiative with Policy Horizons and the Privy Council Office. He holds a doctorate in political economy and sociology and is an adjunct research professor at Carleton University.