How will Canadian pensions respond to waning demand for oil sands?

Competitive prices on renewable energy and low oil prices are raising tough questions for investors in Canadian oil sands.

As both the US and China signal moves towards lower-carbon energy systems, the oil sands are looking like a ticking time-bomb for investors. A number of oil sands operators, including former Canada Pension Plan sweetheart Larcinia Energy, have filed for bankruptcy protection, forcing investors to question if Canada's oil sands are headed the same way as the US coal industry: into terminal decline.

As investors consider whether to make a calculated move to the exit door now—or wait and risk having their savings trampled in an investor stampede to get out— oil sands industry investors would be wise to remember the old joke: “How did you go bankrupt? Two ways: slowly at first; then all at once.”

The world’s largest investors, and pension funds in particular, are asking whether they should be investing members’ savings into oil sands companies that continue to pump money into high-cost, high-carbon projects that will never see the light of day. After all, who wants stranded assets in their investment portfolio?

Oil sands and liquefied natural gas projects require large upfront investments and long lag times before generating positive cash flows. As such, they are especially exposed to the risks associated with carbon pricing and a low-carbon energy transition in markets for Canadian fossil fuels.

With Brent crude oil futures for the next five years averaging about $74 a barrel, no one in the oil patch will be making much, if any, money.

Unfortunately, in the high-altitude ivory towers where pension trustees sit on behalf of their members— managing hundreds of billions of dollars in member savings— too few people consider climate change an investment risk.

For Canadian investors who say that there will always be markets for oil sands bitumen, consider that not so long ago we used whales for light; horses for power; coal for steam to drive locomotion; coal again for electricity; and incandescent bulbs for light. Today, we have a highly complex energy system that is in transition, and one in which the world’s most inefficient sources of power — oil sands and coal — are in terminal decline.

And while it is true that oil will remain part of the energy mix, it will not be high-cost Canadian oil sands, but cheaper and more efficient oil from the Gulf and Russia. Investors must be ready for these changes.

In spite of all the signs of an energy transition underway, many investors, including most Canadian pension funds and our chartered banks, continue to ignore these risks. Global financial NGO Carbon Tracker has coined the term the "fossil fuel risk premium" to explain this structural flaw, waving a red flag to pension trustees who keep their head in the sand.

The risk of stranded assets and sustained low oil prices identified by Carbon Tracker and others is growing as companies invest in ever-costlier projects despite trends in commodity price volatility, climate regulation, demand fluctuations and a rapid decline in clean energy costs.

The markets for Canadian fossil fuels are contracting

In April, Bloomberg noted that the race towards renewable energy has passed a turning point, with the global economy now adding more capacity for renewable power each year than coal, natural gas, and oil combined.

Nowhere is this more evident than in the United States — far and away the largest market for Canadian energy exports — and in California in particular, where the solar power sector is taking off.

Alongside shifts in US policy, and the energy matrix in key states that will damage the already badly-wounded Canadian oil sands sector, in the coming five years China will invest approximately RMB¥2-trillion (C$405-billion) per year in green sectors of the economy in order to meet environmental targets announced by the Chinese Ministry of Environmental Protection.

While the Bank of Canada keeps over-extended oil sands operators on life support with ever-lower interest rates and cheap loans, the latest five-year plan from China’s central bank has green finance as a core element and will require the financial sector to play a prominent role in financing green investments— while discouraging polluting and natural resource intensive ones.

As both the US and China shift towards renewable energy this creates new investment opportunities. But it also spells more trouble for investors in Canada’s most carbon-intensive companies. As a nation of pension savers, we will have to look to our pension leaders to wisely manage the risks and opportunities associated with this transition.