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ESG is now a top priority and Canada oil and gas companies must adapt

INSIGHT ARTICLE  | 

Nearly two years after production quotas went into place for the oil and gas industry in Alberta, the provincial government announced on October 23 that oil curtailments will end in December, returning some sense of normalcy to the industry.

Those quotas were instated to limit supply and protect oil prices from selling at large discounts. Canadian oil supply for October still remains approximately 270,000 barrels per day below 2019 levels, according to the Canada Energy Regulator; global demand currently remains approximately seven million barrels per day lower than last year. No one could have predicted the demand destruction the market has experienced throughout 2020 as a result of global travel restrictions and a supply glut.

A more obvious change on the horizon, however, is the increasing importance of environmental, social and governance (ESG) principles within the oil and gas industry. External factors affecting the viability of middle market oil and gas companies—such as global supply and demand volatility due to the pandemic—are typically out of a company’s control and require reactionary measures; thus, organizations must adapt as best they can. But preparing to exit the pandemic in a position of strength, namely through a proactive ESG strategy, is very much within a company’s control.

Access to capital

Recent industry shifts have made clear that companies must adapt to ESG requirements and expectations if they want to survive into the future. Access to capital has become tougher as institutional investors have committed to reducing investments in the industry that do not meet their own ESG criteria: In January, for instance, BlackRock declared that it would divest coal-related assets and create funds that avoid fossil fuel stocks. In March, UBS announced it would not finance new oil sands projects. In May, Norges Bank stated that its trillion-dollar national wealth fund would no longer include interests in several Canadian oil sands producers; also in May, Mitsubishi UFJ Financial Group added oil sands extraction to its restricted transaction list.

This globally recognized shift is causing oil and gas companies to adapt in response. Saudi Aramco intends to boost oil production and use the revenue to research and invest in technologies that further reduce its relatively low greenhouse gas emissions and carbon intensity per barrel. The company’s strategy is to outlast laggards in the industry as governments escalate carbon regulations.

The industry will continue to see ESG principles become increasingly regulated and codified into law, which will add to the challenges in accessing capital for companies that do not adhere to these principles. In Canada, the federal government has stated that it will publish proposed regulations for the Clean Fuel Standard during fall 2020, which will further tax carbon emissions related to fuel. This change is expected to substantially increase costs for the oil and gas industry as well as end consumers of products such as gasoline and natural gas heating, with the objective of encouraging the adoption of alternative energy.

These new regulations are supplemented by the federal government’s ban on single-use plastics by 2021, announced in October, which affects the petrochemical industry in particular. Emergency funding for the oil and gas industry from the Business Development Bank of Canada (BDC) and Export Development Canada (EDC) requires the disclosure of environmental plans and a climate change report from companies. In January of this year, the federal government added the requirement to disclose board diversity for publicly traded corporations to the Canada Business Corporations Act. This is a key example of the governance aspect of ESG being recently codified into federal law.

Industry consolidation

The need to comply with rising government regulations and satisfy institutional investors in order to access capital are not the only reasons to conform to ESG principles. Recent major consolidations in Canada and the United States have indicated that ensuring the parties’ ESG strategies are compatible is at the forefront when making merger and acquisition decisions and receiving board and shareholder approval.

On October 19, ConocoPhillips acquired Concho Resources in a USD $9.7 billion all-stock transaction and said in the official press release that the transaction “elevated commitment to environmental, social and governance excellence with a newly adopted Paris-aligned climate risk strategy.” The following day, Pioneer Natural Resources acquired Parsley Energy in an all-stock transaction valued at approximately USD $4.5 billion, stating in its official release that, among the strategic benefits of the acquisition, “Pioneer and Parsley have demonstrated strong commitments to best-in-class environmental, social and governance practices.”

Within the same week, Cenovus Energy announced on October 25 its CAD $3.8 billion all-stock acquisition of Husky Energy, and said in a statement that “the commitments both Cenovus and Husky have made to world-class safety performance and environmental, social and governance (ESG) leadership will remain core to the combined company.” Oil and gas companies seeking strategic alternatives may find their options limited if they do not demonstrate a satisfactory commitment to ESG principles and sustainability.

ESG: Canada vs. United States

While the aforementioned oil and gas companies in both Canada and the United States have expressed similar ESG priorities in their deal announcements, there is a contrast between the two countries’ overall sentiment regarding ESG as indicated by RBC Global Asset Management’s annual survey on responsible investing, released in October. Over 800 institutional investors were surveyed globally, and while Canada has increased its ESG adoption rate to 89% from 80% the prior year, which is in line with Europe, the United States has dropped its ESG adoption rate to 65% from 66% the prior year. Additionally, 26% of U.S. institutional investors (up from 22% in 2019) believe that an ESG-integrated portfolio performs worse than a non-ESG-integrated portfolio, while only 2% of Canadian respondents believe an ESG-integrated portfolio will underperform.

This contrast is due in large part to differing administrations between the two countries. Under President Donald Trump, the U.S. Department of Labor proposed in June that Employee Retirement Income Security Act plan fiduciaries “may not invest in ESG vehicles when they understand an underlying investment strategy of the vehicle is to subordinate return or increase risk for the purpose of non-financial objectives.”

U.S. election implications

The outcome of the U.S. election on November 3 will engender vastly differing implications to the oil and gas industry both in the United States and Canada. Democratic candidate Joe Biden acknowledged during the final presidential debate on October 22 that he would “transition from the oil industry,” eliminate subsidies for fossil fuels and ban fracking on federal lands. He has also previously stated that, if elected, he would rescind the Keystone XL pipeline’s presidential permit due to environmental concerns, potentially halting again the project that has remained in limbo over the past decade under both Trump and former U.S. President Barack Obama.

In March, Alberta Premier Jason Kenney committed an investment of CAD $1.5 billion to the Keystone project and pledged to back TC Energy’s CAD $6 billion credit facility to complete the Alberta-to-Nebraska pipeline. While Premier Kenney has expressed confidence that the project will potentially continue under a Biden presidency, recently reelected Saskatchewan Premier Scott Moe has expressed doubt regarding the pipeline’s Canadian leg if there is a change in the U.S. administration, and has urged Prime Minister Justin Trudeau to advocate for the project’s completion should Biden win.

In contrast to Biden’s focus on clean energy, Trump has committed to continuing his focus on expanding oil and gas production. In September, he announced that he would issue a presidential permit for the proposed USD $17 billion Alaska-Alberta Railway Development Corporation (A2A Rail) project that would transport crude oil—up to two million barrels per day—and other exports (including minerals, ore, potash, sulphur, and grain) from Alberta to the Alaska coast.

Government incentives and programs

To assist with the transition to an increasingly ESG-focused oil and gas industry, the Canadian federal and provincial governments have made several incentives and programs available. In October, the Alberta government released a summary of its Natural Gas Vision and Strategy, which includes supporting the creation of a clean hydrogen industry by 2040 (hydrogen as a fuel source produces only water and no carbon emissions). The strategy also includes support for large-scale liquefied natural gas (LNG) projects to displace coal as an energy source in Asia and reduce global greenhouse gas emissions. Specific details on the Natural Gas Vision and Strategy are forthcoming, but support for hydrogen and LNG from the provincial government aims to ensure that Canada’s natural gas industry remains strong for years to come, as the nation is among the world’s top five natural gas producers.

The federal government also announced in October its aid of CAD $100 million to the Clean Resource Innovation Network over four years to allow businesses to apply for research funds focused on reducing the oil and gas industry’s greenhouse gas emissions by 100 megatons by 2033.  This is in addition to the federal government’s commitment of CAD $1.7 billion in April to assist with well reclamation and remediation for orphan wells. The Alberta government similarly intends to assist with reducing asset retirement obligations: It announced a new Liability Management Framework in July to replace the Licensee Liability Rating program with the new Licensee Capability Assessment System, which looks beyond a company’s assets and reclamation liabilities.

Adapting to ESG

Survey findings released by oil and gas data analytics firm Evaluate Energy in July indicated that less than 50% of middle market energy companies categorize themselves as having a high understanding of ESG principles.

RSM is familiar with the changing ESG landscape for the oil and gas industry. We can assist with:

  • Applying for various government incentives and programs
  • Consulting and advising on ESG initiatives
  • Providing attestation services for sustainability metrics and reporting
  • Reducing asset retirement obligations with a review
  • Improving governance with digital transformation and blockchain

Oil and gas companies that lean into developing a strong ESG strategy and recognize it as a way to remain competitive, versus as a burden, are the ones that will survive as the industry changes. But let us unite in the hope that the changes we’ve seen throughout 2020 are once in a lifetime.

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