Trading for Tidewater
How an innovative take on cap and trade could finally move the pipeline debate forward
IT’S A BAD TIME TO BE AN OIL SANDS
investor. Your stocks, once again, finished the year down. Not one new pipeline to tidewater has been permitted, let alone built. Due to that constrained pipeline capacity, Western Canadian Select oil (WCS) still trades at a double-digit discount to West Texas Intermediate and Brent. The Pope thinks your investments look like Hell. Your kid’s school is considering divesting from those same companies and commodities. The Bank of England says those investments could become stranded. Environmentalists just had a big dinner party in Paris with fossil-fuel foie gras as the main course. The loonie follows wherever oil prices go and your winter vacation is priced on the stronger U.S. dollar. Life stinks.
But what’s done is done. All you can do is hope that the new political management will undo some of the damage by trading good environmental stewardship for some pipeline permits. What might that look like? Let’s say you accept that oil sands emissions must get to parity with those of conventional crude, knowing that anything less will continue to expose the sector to the “dirty oil” criticism. Now you come to the issue of how to reduce those emissions. Economists will tell you carbon pricing is the most cost-effective way to do it, but when it comes to the oil sands, a carbon tax has two big disadvantages. First, since it only regulates the price of emissions, it doesn’t guarantee that the objective of emissions parity with conventional crude will be met. And second, to have any hope of meeting that objective, the tax would need to be set high enough to promote inhouse emissions reductions. Most studies put those costs at more than $100 per tonne through carbon capture and storage (CCS) technology, or at least $10 per barrel. That’s a non-starter for most investors and the companies they support.
Cap and trade, on the other hand, both ensures the emissions target will be met and allows firms to keep their costs down by allowing imports of low-cost allowances and offsets from sources outside its facilities, including from other provinces and countries. Cap and trade programs have had ample emissions reductions available at, or below, $15 per tonne – a paltry $1.50 per barrel. Suddenly, there’s an opportunity to profitably arbitrage the WCS: Pay $1.50 a barrel for a pipeline permit and receive a much greater increase in the WCS price in return.
And while environmentalists might be skeptical of cap and trade, you could appeal to their sense of urgency for emissions reductions and their desire to incentivize projects outside of the fossil fuel sector. Using commercialized technologies, the Kyoto Protocol’s carbon offset system generated over one billion carbon credits in just a few years in sectors ranging from landfills and farms to renewable energy.
Still, Premier Notley and Prime Minister Trudeau have been cold on cap and trade, with the former particularly worried that capital will leave Alberta to be spent on carbon credits. But a province that’s dependent on free trade for its energy products can’t really be selectively protectionist, and there just aren’t sufficient reduction opportunities in Alberta to meet the scale required – 55Mt per year and growing – to offset emissions from the oil sands. On the other hand, the Premier is very interested in opportunities for inter-provincial cooperation on pipelines, and Energy East alone entails roughly 100,000 tonnes of daily upstream carbon emissions. At $15/tonne that’s $550 million in expenditures that could be made each year in provinces like Ontario and Quebec to offset the project’s carbon emissions.
Those emission reduction projects located along the route of Energy East – and paid for by Energy East – should appeal to the premiers of Ontario and Quebec. They should also appeal to the Prime Minister, who’s looking for a nationbuilding project to put his signature on. In a perfect world, the pipeline permits would be granted and Mr. Trudeau would agree to a federal role in implementing the offset system and managing linkages between different emissions trading regimes. If he does, 2016 could turn out to be a very busy year for progress on pipelines and cap and trade in Canada. It might even be one where, as you look back at your oil sands investment portfolio at the end of the year, the balance is actually up.