Oil’s brief dip into negative values this month was the result of fear that storage space would run out and buyers would have nowhere to put their oil amid the current pandemic. While widely reported, this sudden plunge is a distraction. Prices are now back above zero, but futures contracts (the price of oil delivery in the coming months) are expected to linger at unprecedented levels.
What’s important to take away from this sensational plunge in value is that the COVID-19 crisis has placed the fossil fuel sector in such a precarious state that it may accelerate the arrival of peak demand for all fossil fuels. This provides an opportunity to plan a Canadian transition to a green economy within upcoming recovery initiatives.
Prior to the pandemic, growth of fossil fuel demand stood at 1 per cent. Furthermore, oil and gas had dropped to 5 per cent of the U.S. stock market, down from 15 per cent a decade ago. Oil and gas companies have been underperforming on the Dow Jones for about five years. Projections for peak demand pegged its arrival in 2023, and investors have become increasingly apprehensive.
The plight of coal has shown us that once demand drops, clean tech alternatives fill the vacuum. Afterwards, the fossil fuel sector in question loses much of its money-making potential and is stuck with stranded assets.
In addition to high extraction and production costs for non-conventional fuels, low prices and oversupply have existed in the oil and gas sector since well before COVID-19. And while conventional fuels have fixed costs, clean tech prices continue to decline.
These already precarious market circumstances were exacerbated by the recent Saudi Arabian decision to eliminate competition from non-conventional oil producers by flooding the market with low-priced fuels.
The COVID-19 emergency has combined with these factors to create a perfect storm in the oil and gas industry, presenting an opportunity to make the green transition through economic recovery plans. Critically, for the 80 per cent of the world’s population that relies on imported fossil fuels, there are no incentives to go back to old paradigms. That’s because it’s far better to produce energy needs locally and, if applicable, manufacture clean technologies and export them to external markets. This opens paths to create new jobs, as opposed to having an outflow of regional financial resources to a relatively small number of parts of the globe where fossil fuels are extracted and produced.
The timing couldn’t be better to end fossil fuel subsidies and invest in Canadian clean tech.
COVID-19 and pipeline politics
In the thick of the COVID-19 pandemic, March 31, 2020, brought an oilsands double whammy.
That day, Jason Kenney’s Alberta government announced it would invest US$1.1 billion in equity for the long-delayed completion of the Keystone XL pipeline. This came in addition to a US$4.2-billion loan guarantee from the Alberta government to Keystone’s owner, TC Energy. The oil giant’s response to Alberta’s announcement of assistance was immediate. TC Energy would supposedly buy back the Alberta government equity and refinance the credit facility once the pipeline was in service.
Because financing was difficult, TC Energy had experienced delays in getting permits and, prior to the COVID-19 outbreak, faced numerous public protests. The Alberta leverage funding led TC Energy to issue a $2-billion bond on April 1, 2020, led by the Bank of Montreal, Royal Bank of Canada, Scotiabank, and TD, with CIBC and the National Bank as co-managers, in addition to BlackRock as a bond holder.
The next day, Citibank and JPMorgan Chase divulged their involvement in a US$1.25-billion bond for TC Energy to repay debt and finance long-term investment, in collaboration with Japanese megabanks MUFG, Mizuho, and SMBC. This topped off Liberty Mutual’s US$15.6-billion bond to insure construction risks.
Yet the newfound financial enthusiasm for Keystone XL may be short-lived, since the pipeline project was dealt another judicial blow on May 11. That day a U.S. federal district judge upheld his ruling that cancelled Nationwide Permit 12 which allowed dredging work for pipelines across all U.S. waterways. This also means that many other U.S. oil and gas projects may be delayed pending further environmental reviews.
The other big announcement on March 31 came from the Trudeau government, confirming that, in spite of the pandemic, construction of the Trans Mountain pipeline expansion to deliver tar sands oil to the Pacific coast would continue as scheduled.
Could it be that the pandemic is a strategic time to proceed with construction of these two tar sands pipelines because protestors are stuck in confinement?
The decline of the fossil fuel era
Answering questions about the prospects of the oilsands sector requires looking at the combined impacts of three factors: U.S. shale oil production driving a global oil glut; the Saudi Arabia, Russia, and U.S. oil crisis management agreement; and the economic collapse precipitated by the pandemic response and consequent decline in petroleum demand.
The recent agreement reached between Saudi Arabia, Russia, and the U.S. to limit production to 10 million barrels per day offers some wiggle room for gradual adjustments in how production is curtailed. Nevertheless, the agreement has had little impact on low oil prices because reduced production still means high output without other countries on board. Hence, non-conventional sources such as oilsands, shale oil and offshore petroleum remain as collateral damage.
In early May, heavy oil from Western Canadian Select, Canada’s largest stream of heavy crude, was trading at US$21.33 per barrel. At this price, oilsands production is cash flow negative.
Facing Saudi Arabia’s determination to keep oil prices low, together with the advent of COVID-19, Premier Kenney’s reaction has been denial and clinging on, declaring oilsands production an essential service.
Long before the arrival of the pandemic and Saudi Arabia’s inundation of global markets with cheap oil, the oil and gas sectors, and the oilsands industry in particular, were already in deep trouble.
In 2019, the five largest publicly traded oil and gas companies paid out US$71.2 billion in dividends and share buybacks, while cash earnings amounted to US$61 billion. ExxonMobil dished out US$9.9 billion more to shareholders than it received in revenue, and for Shell, it was US$7.4 billion more. This contrasts with 2018, when the big five had US$17 billion more in cash flow than was distributed to shareholders. But looking at the past decade overall, the picture hasn’t been that bright for some time. From 2010 to 2019, the big five spent US$556 billion in share buybacks and dividends with a cumulative cash flow of US$340 billion, a shortfall of US$216 billion. The difference was made up by borrowing and selling assets.
Today, oil and gas companies’ selling of assets to obtain further funding from financial institutions appears to have finally reached the end of the rope. BP and ExxonMobil are experiencing difficulty acquiring financing with this approach. ExxonMobil had plans to dump $15 billion in assets in 2020, but this did not help its financing prospects.
By 2025, around $200 billion of oil and gas debts will come due.
All of the preceding considerations pertain to what has happened to date. For the industry, the worst is yet to come: peak oil in the 2020s, the final death blow to the global petroleum industry.
The timing of the peak is inevitable because the massive shift to electric vehicles is likely only a few years away and road transportation accounts for a large percentage of petroleum consumption.
The monumental transition to electric vehicles is based on facts already on the ground, which have led to legislation for new vehicles in China and the European Union, representing the largest and third-largest vehicle markets in the world, respectively. Nearly all global automakers must comply with only a few years to make the colossal transformation.
Without the vehicle legislation in effect in these two jurisdictions, a shift this fast simply wouldn’t happen, because it will take years for the automakers to recover their investments. This contrasts with a US$15,000 or more profit margin on some large SUVs in the U.S.
Purchase price parity for comparably equipped legacy and electric vehicle models will be reached around 2022, making electric vehicles cheaper, since their energy and maintenance costs are lower.
Even if the fossil fuel sector discounts all of this, a report from Wood MacKenzie concluded that COVID-19 means “$210 billion of planned oil and gas investments are now at risk from the coronavirus” and US$110 billion of investment will “almost certainly” be postponed. Committed investments may reach a low of US$22 billion.
In the ongoing pandemic, leading oil and gas multinationals have reportedly lost “an average of 45 per cent of their value since the start of 2020.”. Petroleum supply is exceeding demand at a historic rate. Oil is being stored in ships due to a lack of storage space. On April 20, 2020, one day before the beginning of the May 2020 futures contracts, the price of oil fell below zero as the key crude oil hub, located in Cushing, Oklahoma, came within four weeks of full capacity. Cutting oil production may not be enough. With the recent agreement to lower production to 10 million barrels per day, there may still be storage requirements for 15 million barrels per day. Prior to the COVID-19 outbreak, 4.4 billion barrels of oil were already being held in storage.
Russia has limited storage and refining capacity. With the collapse of the European market, together with an anticipated filling of Chinese storage capacity within the next month, Russia may soon be left with stranded crude assets.
As for the U.S. shale oil party, it’s already over. U.S. banks are readying themselves to seize assets of shale oil companies. These companies collectively have more debts than revenues, estimated at US$250 billion backed by their assets during the last two years. Consequently, these companies’ chances for survival have dropped drastically, and in many instances are nonexistent. For some financial institutions, seizing assets now is better than waiting for the creditor crumbs of bankrupt firms, the thinking being that the banks can hold onto the assets until oil prices rise.
The situation is not much different for offshore oil. According to an article in The Conversation, the March 2020 U.S. government oil and gas lease sale for the Gulf of Mexico drew “the lowest response in four years.” It’s enough to make one wonder whether the Husky and ExxonMobil oil exploration projects on the Grand Banks of Newfoundland will ever happen.
Once the COVID-19 crisis is behind us, it is highly unlikely things will get back to the former “normal.” Thanks to the legislation in China and the EU, there will be an array of competitively priced electric vehicles on global markets. Teleworking may also be more common, having a huge impact on commuter-related oil demand.
With renewables coming in cheaper for two-thirds of the world and having represented nearly three-quarters of newly installed electrical generation capacity worldwide in 2019, the investment risks for LNG and natural gas facilities with a 40-year lifecycle are extraordinary.
Permanent declines in the fossil fuel sectors provide Canada with an opportunity to invest in a green economy for which the decreases in clean tech prices becomes increasingly attractive. This can be done while concurrently diversifying the resource-based jurisdictions to be active participants in satisfying growing global green markets.
Unfortunately, the two March 31, announcements related to pipelines by the Alberta and federal governments suggest that Canada’s recovery plan may be to get back to business as usual — with white elephants.
The LNG Canada and Coastal GasLink projects in B.C. and the GNL Québec (LNG) proposal appear equally doomed. Not only is the natural gas market being undercut by renewables, but there are plans to increase the supply of this fossil fuel from Australia, Russia and Egypt. Nevertheless, Export Development Canada will be providing up to a $500M loan for the Coastal GasLink, for which construction is underway. For now, the GNL Quebec remains just a proposal.
In Norway, 100 per cent of oil revenues and royalties are directed into its US$1-trillion sovereign fund, Government Pension Fund Global, as the country’s insurance for the post-oil era. Norway’s fund brings in healthy returns even with a policy to invest in a low carbon economy. By contrast, Alberta has squandered its poorly financed wealth fund for partisan pet projects. A notable example is the creation of the Alberta government-owned Canadian Energy Centre, with a $30 million annual budget to promote Alberta’s fossil fuel sectors and invalidate the claims of “domestic and foreign-funded campaigns against Canada’s oil and gas industry.”
Tar sands were in trouble before COVID-19
In 2017, at a Houston energy industry conference, Prime Minister Trudeau said, “No country would find 173 billion barrels of oil in the ground and just leave them there.”
Yet the ingredients for a tar sands sector collapse have been present for a long time. The list comprises high extraction costs, higher than average pipeline transportation expenses (due to the high viscosity of bitumen and thus the need to mix it with a condensate), lower than average quality of oil that is high in carbon, specialized high-cost refining capabilities that don’t exist in Canada, and high sulfur content.
Since 2015, ExxonMobil, Shell, ConocoPhillips and Marathon Oil Corporation, Total SA and Devon Energy Corp., Equinor, Koch Oil Sands Holdings, Cenovus, and MEG Energy have reduced or totally withdrawn investments in oilsands. BP and Chevron are also considering getting out of the tar sands sector. The February 2020 decision of Teck Resources to withdraw its Frontier project proposal for the largest tar sands project ever in Alberta, was one, but not the only tipping point.
The announcement last December of a $1.6 billion federal bailout (consisting mostly of loans) for the Alberta energy sector didn’t alter the economics. Nor did the Alberta government’s 2019 tax cuts and royalty reductions.
In April, Prime Minister Trudeau announced the allocation of $1.7 billion to clean up orphan and abandoned wells in B.C., Alberta, and Saskatchewan as part of the COVID-19 emergency relief effort. This is a positive development.The problem is, however, that this emergency fund doesn’t deal with Alberta’s biggest clean-up challenge: tar sands tailing ponds. There are no known tailing pond solutions, so the cumulative volume of these ponds continues to grow.
In 2019, an estimation of the cleaning up of these ponds stood at $130 billion. This is likely an underestimate; oilsands projects have a lifespan of 40 years, making it almost impossible to have an accurate cost assessment in terms of today’s dollars. Be that as it may, in 2018, only $1.6 billion had been collected by the Alberta government as security deposits for the management of tailing ponds. Under current plans, the combined efforts of the federal and Alberta governments are unlikely to be sufficient to pick up the tab.
Green economy, Alberta diversification and solutions abound
The solutions for a migration to a green economy are well known, and the Paris Agreement objectives can be achieved with existing clean technologies. If Canada can come up with a COVID-19 economic survival plan within a few weeks, it can outline paths for a green economy recovery plan quickly as well.
There has never been a more opportune, or socially acceptable, moment for investing in an economic transition.
This is one of Premier Jason Kenney’s worst nightmares; he has called a green transition a “pie-in-the-sky ideological scheme” and referred to a Green New Deal as a “fantasy.” It’s a pity he doesn’t see the COVID-19 global pause and the Saudi Arabia–led oil price war as an opportunity to diversify Alberta’s economy.
Alberta could seize the opportunity to be home to a Canadian equivalent to the U.S. National Renewable Energy Laboratory, with its 327-acre campus in Colorado. This institution currently has 2,685 employees representing 70 countries, and collaborates with a lengthy list of other research facilities.
Partnerships with the private sector, research, and non-profit organizations, plus other government institutions, are central in the National Renewable Energy Laboratory’s mandate. Research activities include clean tech integration, advanced manufacturing, bioenergy, energy storage, transportation — essentially the full spectrum of components of a green economy.
Even Shell has set a precedent for supporting clean tech start-ups in collaboration with NREL. Shell, which is spending US$2 billion per year on clean tech firm acquisitions, many of them start-ups, engaged in a partnership with NREL back in 2018 to establish the Shell GameChanger Accelerator. The goal is to provide an incubator to provide clean tech start-ups with the financial strength to get these technologies out of the lab and into production and on the market.
The list of possibilities for how Alberta, and indeed Canada, can seek to innovate is long, because Canada has so much catching up to do. We can feasibly leapfrog into a competitive advantage by cherry-picking and adapting the initiatives of green transition leaders such as China, the EU, California and other progressive U.S. states, and other innovative jurisdictions.
Legislative and policy initiatives could supplant fossil fuel subsidies to position Alberta and Saskatchewan to work with other provinces on Canadian clean tech agendas. That would be nation-building at its best, simultaneously addressing Western alienation and fostering Canada-wide support. Amidst a global crisis, the provincial and federal governments have been given a rare opportunity to use a reset button. We can only hope they choose to press it.