I recently attended an energy conference focused on Canada. Oil is a major industry in Canada, and the majority of the country’s production comes from its large resource of oil sands (also known as tar sands), which are deposits of loose sand or partially consolidated sandstone containing bitumen. From an environmental standpoint, oil sands are not viewed favorably, both because the greenhouse gas emissions from oil-sand crude are significantly higher than those from conventional crude oil, and on account of the devastation caused to forest habitats which are cleared as part of the mining process.
In this context, the industry recognizes that it has not done a good job communicating to both the investor community and public the strong efforts that it is making both to reduce emissions and to restore the land after extraction (something that it continues to explore and prioritize); firms also accept that this added scrutiny and responsibility may come at an extra cost. It also seems unlikely that we will see a return to large-scale mining projects, as the trend is moving towards less invasive extraction techniques and brownfield expansions from existing mining sites.
Interestingly, former Canadian Prime Minister Stephen Harper (whose Conservative party was ousted by the current Liberal government led by Justin Trudeau) was the keynote speaker at the conference. He is very pro-energy, pro-fossil fuels, and anti-carbon taxes (and anti-Trudeau). The theme of the speech was the changing political environment, in which large portions of society (not only the working class) are becoming progressively disenfranchised from the traditional political setup of the last few decades.
Feeling the Squeeze
While we have previously highlighted how many people in the developed world on lower or middle incomes are becoming increasingly squeezed on many fronts, Harper pointedly framed this in the context of energy. He warned energy companies against advocating for carbon taxes on the basis that the end consumer will endure that pain disproportionately (at least in the short run). Harper believes that the average person’s view is not aligned with certain media and advocacy groups who promote the beliefs and desires of the ‘green elite’. He cited the recent French ‘gilets jaunes’ protests as an example of an eco-policy that caused unpalatable pain for people. While France is a special situation in itself (and the rise in fuel prices is just one factor which has motivated the protest movement), we think the point has some merit at least: the average person wants to drive from A to B affordably, heat their home, and comfortably pay their energy bill.
While the consequences of high and growing levels of emissions (carbon and other pollutants such as nitrous and sulfur oxides) are a very important consideration – and this angle was entirely omitted from Harper’s speech – it is worth at least considering the risk to affordability through an ill-conceived energy transition.
Tax and Capital Allocation
Beyond carbon taxes, the obvious tactic for governments to make oil companies shoulder more burden would be to reduce incentive structures or raise general upstream taxes. However, if one country was unilaterally to increase taxes or reduce subsidies, it could impair the competitiveness of its resources (as happened in Angola, which recently improved terms to re-attract investment). Ultimately, capital will flow to where it can most efficiently be spent. Again, the current downturn has shown that oil companies are not afraid to exit long-standing positions in countries that do not make economic sense. The capital discipline mantra is alive and strong, something I believe the ‘energy transition’ will only serve to enhance.
Should tax increase, oil prices could be driven higher (to reflect a structural increase in costs), which would at least partially flow through to the end consumer. Furthermore, if such policies are so detrimental to project break-evens that they result in reduced investment, we could see supply shortfalls and price spikes. This could again have knock-on ramifications for end consumers (and indeed sovereigns), at least in the short run.
Innovation for a Greener Future?
Over the longer term, reduced oil consumption and potentially increased substitution with other forms of energy could lead to a slowing of demand which could help rebase pricing, and in turn drive further cost-saving initiatives to make oil more competitive. Indeed, a cost for carbon may be the catalyst for developing better carbon-capture (CC) techniques and investment in large-scale CC facilities to offset these costs. However, in the nearer term, government policies designed to ease an energy transition may have a disproportionate effect on lower-income households, and potentially dampen global growth. This may not be very palatable to the average person (or even affordable for some), which is a risk that deserves some consideration, especially in the current political environment.
From an investment standpoint, we believe those companies that are preparing today for such scenarios are likely to be better placed strategically over the longer term, and should be able to develop more sustainable business models for a future that remains very uncertain.
This is a financial promotion. Material in this publication is for general information only. The opinions expressed in this document are those of Newton and should not be construed as investment advice or recommendations for any purchase or sale of any specific security or commodity. Certain information contained herein is based on outside sources believed to be reliable, but its accuracy is not guaranteed. You should consult your advisor to determine whether any particular investment strategy is appropriate. This material is for institutional investors only. Any reference to a specific security, country or sector should not be construed as a recommendation to buy or sell this security, country or sector. Please note that strategy holdings and positioning are subject to change without notice.
This is a financial promotion. Issued by Newton Investment Management Limited, The Bank of New York Mellon Centre, 160 Queen Victoria Street, London, EC4V 4LA. Newton Investment Management Limited is authorized and regulated by the Financial Conduct Authority, 12 Endeavour Square, London, E20 1JN and is a subsidiary of The Bank of New York Mellon Corporation. 'Newton' and/or 'Newton Investment Management' brand refers to Newton Investment Management Limited. Newton is registered in England No. 01371973. VAT registration number GB: 577 7181 95. Newton is registered with the SEC as an investment adviser under the Investment Advisers Act of 1940. Newton's investment business is described in Form ADV, Part 1 and 2, which can be obtained from the SEC.gov website or obtained upon request. Material in this publication is for general information only. The opinions expressed in this document are those of Newton and should not be construed as investment advice or recommendations for any purchase or sale of any specific security or commodity. Certain information contained herein is based on outside sources believed to be reliable, but its accuracy is not guaranteed. You should consult your advisor to determine whether any particular investment strategy is appropriate. This material is for institutional investors only.
Personnel of certain of our BNY Mellon affiliates may act as: (i) registered representatives of BNY Mellon Securities Corporation (in its capacity as a registered broker-dealer) to offer securities, (ii) officers of the Bank of New York Mellon (a New York chartered bank) to offer bank-maintained collective investment funds, and (iii) Associated Persons of BNY Mellon Securities Corporation (in its capacity as a registered investment adviser) to offer separately managed accounts managed by BNY Mellon Investment Management firms, including Newton and (iv) representatives of Newton Americas, a Division of BNY Mellon Securities Corporation, U.S. Distributor of Newton Investment Management Limited.
Unless you are notified to the contrary, the products and services mentioned are not insured by the FDIC (or by any governmental entity) and are not guaranteed by or obligations of The Bank of New York or any of its affiliates. The Bank of New York assumes no responsibility for the accuracy or completeness of the above data and disclaims all expressed or implied warranties in connection therewith. © 2006 The Bank of New York Company, Inc. All rights reserved.