Time for investors to get tough on oil sands risks

The financial crisis has put a damper on development in Canada’s oil sands, but investors can’t rely on oil price fluctuations to deliver ESG risk mitigation.

During 2008, the environmental and social impacts of developing the oil sands reserves in the Canadian province of Alberta became a focus of concern among responsible investors globally. However, the current financial crisis credit problems seems to have brought about exactly what some investors have been calling for – a de facto moratorium on new oil sands development. Has this eliminated the need for investor action on oil sands ESG risks? Although oil sands development has been underway in Alberta for decades, in recent years the industry has undergone an international boom. Energy security concerns have been a driving force behind this expansion. Facing a future of shrinking conventional oil reserves in unstable regions, it is no surprise that the scale and location of Alberta’s unconventional oil sands reserves caught the attention of the oil majors: 173 billion barrels, second only to Saudi Arabia, in a safe, dependable country next door to the world’s biggest consumer of oil. Most major international oil companies have staked a claim, while existing players are seeking to expand their operations. With more companies involved in more and bigger projects, investor exposure to the oil sands – and to oil sands risks – has been increasing.Oil sands production creates heavy impacts on the environment. Bitumen – solid or semi-solid oil – is extracted either by surface mining of shallow oil sands deposits or by injecting steam into deeper deposits to render it fluid enough to extract through wells “in situ”. It is then either “upgraded” to synthetic crude oil, or diluted for shipment to refineries. Depending on the extraction method, production phase greenhouse gas emissions per barrel may be 3-5 times higher than for conventional crude. Even taking into account recycling, for each barrel of synthetic crude from an oil sands mine, 2-4.5 barrels of fresh water are withdrawn from the Athabasca River. Oil sands mines produce vast quantities of toxic tailings that pose a major reclamation challenge. It is not possible to restore the Boreal forest wetlands that are removed to allow oil sands surface mining: the reclaimed landscape will be a significantly different ecosystem. Although the landscape impact of in situ production is less striking, dispersal of habitat disturbance over a large area may create greater impacts on wildlife. Oil sands production impacts translate into a variety of risks to shareholder value. Rightly, investors have focused on oil sands carbon risk. Present carbon pricing and regulation may

be lax both in Alberta and at Canadian federal level, but given the long investment horizons of oil sands projects – 40 years or more – it would be unwise to assume this situation will persist. Further risk may be posed by regulations targeting high carbon fuels in the US, the primary oil sands market. However, carbon should not be the only concern for investors. For example, initiatives are underway to tighten provincial regulations on water use and tailings management, which could impact significantly on companies that have externalized these costs in the past. There are also doubts about the adequacy of corporate disclosure on liabilities and asset retirement obligations associated with tailings reclamation. A further significant risk – and one that may be unfamiliar to international investors – lies in possible infringements of Aboriginal constitutional rights. Several Alberta First Nations whose traditional territories are impacted by oil sands operations have already launched litigation against the provincial government, claiming lack of consultation in the granting of oil sands development leases, or the negation by cumulative impacts of treaty rights to practice a traditional lifestyle. Given that Aboriginal rights have been upheld by Canada’s highest courts in earlier cases relating to resource extraction, this aspect of litigious risk should not be underestimated. Project-level environmental impacts are compounded by the pace of expansion in the industry, and the lack of a comprehensive regional land use plan setting cumulative limits on development and defining how competing land uses will be accommodated. Technologies are emerging that could mitigate some of the impacts, but implementation lagsbehind industry expansion. Although individual operators have already reduced per barrel impact intensity, growth in total output has wiped out these gains. Meanwhile, the proliferation of new oil sands projects has driven up capital costs – already significantly higher than for conventional production – and created uncertainty about return on investment. Responding to these risks, some investors have called for enhanced disclosure. This is vital, but not sufficient to resolve performance issues. Others are considering divestment from oil sands companies.

“The race to develop the oil sands hasn’t been cancelled – this is just a breather.”

This may be an option for some investors, but presents difficulties in Canada, where the energy sector accounts for around a quarter of the market capitalization of the TSX, and oil sands account for 97% of reserves. Furthermore, divestment means losing the opportunity to engage oil sands companies on their performance. The best results are likely to be achieved when many investors with significant assets under management support engagement of an entire sector. That’s why The Ethical Funds Company has published the questions it will be asking in its shareholder engagement with oil sands companies, and has invited other investors in Canada and internationally to use them with the companies they own. In recent weeks fall-out from the global financial crisis seems to have put the brakes on

oil sands development. Faced with regulatory uncertainty, a changing royalty regime, cost overruns, a credit squeeze, and with the price of oil under US$60 – below the latest estimates for viability of new oil sands projects, companies have announced a series of project delays and cancellations. In these changed circumstances, it might be argued that responsible investors can relax – the financial crisis is taming oil sands risk for us. But this would be a mistake. Established projects are operating as usual, and construction and approval processes for new projects continue, albeit at a slower pace. Investors need to be vigilant to ensure that short-term cost-cutting does not come at expense of necessary measures for ESG riskmitigation. More importantly, the de facto “moratorium” on new development will likely be temporary. Right now new players may be reconsidering entry or expansion in the oil sands, but when the economic situation changes, they’ll be back. With the IEA predicting a post-crisis oil price rebound to $100, climbing to $230 by 2030, we can’t afford to leave oil sands ESG risk mitigation to short-term market fluctuations.
The race to develop the oil sands hasn’t been cancelled – this is just a breather. Rather than forgetting about the oil sands, responsible investors should be making good use of this opportunity to ask hard questions about the risks involved.
Michelle de Cordova is manager of sustainability research at The Ethical Funds Company, Canada.
Copies of Ethical Funds’ Sustainability Perspectives report “Unconventional Risks: An investor response to Canada’s Oil Sands” are available for download at: Link to report