One can hardly blame oil sands investors for discounting the carbon rhetoric that politicians have so liberally splashed around. The history of carbon policy in Canada and abroad is one of pledge and backslide, where aspirational commitments to reduce deep greenhouse-gas emissions have not been matched with policy action.
Federal oil-and-gas regulations are the poster child for this. Industry, the provinces and the federal government negotiated through 2013 on a deal that would have seen carbon costs imposed in the order of 15 cents a barrel, only to have political will evaporate. The resulting low expectations on the future carbon price have meant that carbon costs are heavily discounted in project design. The so-called shadow price on carbon built into new oil sands projects to assess project feasibility remains just that, a shadow.
But with seemingly renewed political will at home and abroad on the road to Paris – where the post-2020 global mitigation architecture will be set at the Conference of the Parties in December – is it still business as usual? Or has political will shifted, allowing us to expect carbon costs to start to bind and affect project returns?
Looking within Canada, it remains easy to be a skeptic. In the past six months, the federal government has committed $300-million for global carbon finance, announced a significant greenhouse-gas emissions target for 2030 and pledged with other Group of Seven members to eliminate fossil fuels by 2100. But none of these actions impose real short-term costs; they merely kick the can down the road on action. Canada’s recently announced 2030 target and associated plan do not explicitly target oil-sands production.
Look beyond Canada, though, and one can see a different story. Common to all of Canada’s recent moves are external pressures imposed through increasingly hawkish climate geopolitics. The price to pay at the G7 table now includes climate co-operation. Both Canada’s climate finance pledge in late 2014 and the recent 2100 decarbonization commitment flowed directly from the G7. And you know things may be moving when the Pope issues an encyclical on the need for transformational action on climate change.
Adding to this rise in global political will is the continued ground war over market access. While Keystone XL and Northern Gateway are the most obvious casualties, the divestment movement is moving risk upstream to finance. And border carbon tariffs and fuel quality standards are not going away. California, for example, is looking to impose carbon tariffs on commodities to shelter domestic producers from misaligned carbon costs under their cap-and-trade system. The domino effect on other jurisdictions imposing trade barriers could be real and swift.
So which view dominates? Should oil sands investment continue to ignore carbon costs and discount political rhetoric, or should it expect a decarbonized future, where oil prices and carbon policy both drive investment returns?
The answer actually lies in the sector’s ability to respond to changing market conditions – its resiliency. As we have seen recently, sector returns and new investment are highly susceptible to oil price shocks, which implies low resiliency. Fast forward to a decarbonizing energy future, and oil prices are likely to be at current levels or lower, with a requirement to implement advanced technology to control emissions.
Decreased market demand, lower oil prices and carbon costs all conspire to affect project feasibility and returns. Add to this a limited suite of low-cost and effective abatement technologies, and the sector’s ability to rapidly shift in a decarbonizing world looks uncertain.
It is easy to discount this decarbonized energy future, but is that the right bet? A no-regrets strategy to hedge against a million-barrel-a-day future would include three important elements to ensure the sector thrives in a decarbonizing world.
First, a renewed Alberta Specified Gas Emitter Regulation climbing from $30 today rising at least $5 per year to 2030 would set expectations that carbon costs must come out of the shadows and drive reductions and innovation. The price should be extended to all emissions, not just a small portion for compliance. Revenue then needs to target research, development and deployment to help move a considerable range of potential mitigation technologies toward commercialization. Some revenue recycling to reduce corporate income taxes would help defray the carbon cost.
Second, a federal backstop regulation would ensure that other jurisdictions, such as Saskatchewan, implement policy aligned with Alberta, thereby minimizing misaligned carbon costs domestically.
Third would be a significant increase in technology-agnostic R&D spending, sending an innovation signal to increase feasibility and drive down costs. Canada can’t expect global technology spillovers to solve the problem of our oil production’s emission intensity; our sector is just too unique. Solutions need to be primarily made in Canada.
In looking at one possible energy future, the longer term is not so long – it’s entirely possible that within the life span of any given oil sands facility, global demand will remain stalled while carbon costs bind much more than they have in the past. Some in the sector may be betting on an oil price rebound while discounting carbon-price futures. But that is a risky bet.