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Another Inconvenient Truth

On February 24, 2022, Russia invaded Ukraine. The resulting war continues to rage, displacing over 10 million Ukrainians according to the United Nations. Almost four million people have now fled the country. This is the largest war in Europe since World War II. It is also the largest refugee crisis in Europe since that time. This is an invasion by an authoritarian regime against a much smaller, non-threatening neighbor. It is an invasion that is widely condemned by the international community. It is a brutal war that is funded largely by resource revenues generated by one of the largest producers of oil and natural gas in the world.

It is an inconvenient truth that the Western world has, for too long, turned a blind eye to funding brutal authoritarian regimes by buying their “dirty” oil and natural gas.

According to the U.S. Energy Information Administration, Russia was the world’s third-largest producer of petroleum and other liquids in 2020. It was also the second-largest producer of dry natural gas in 2020. Given its large production of oil and natural gas, and its geographic proximity, Russia is a major source of oil and natural gas for Europe. It is an inconvenient truth that the Western world has, for too long, turned a blind eye to funding brutal authoritarian regimes by buying their “dirty” oil and natural gas.

In 2010, the notion of ethical oil came into the spotlight with the publication of Ezra Levant’s book “Ethical Oil: The Case for Canada’s Oil Sands”. Levant argued that production of Canadian oil should be judged in terms of the environment, conflict, economic and social justice and freedom from oppression. Indeed, many large oil producers, such as Russia, Saudi Arabia and Venezuela, score miserably on those criteria. For years, the argument for so-called ethical oil came almost solely from the Canadian oilpatch. It was amazing how little traction it had with the general populace. Whatever criticism people may have for the notion of ethical oil, Russia’s brutal invasion of Ukraine has finally resulted in the concept being discussed around dinner tables globally.

Environmental, social and governance (ESG) considerations have been all the rage for years – and understandably so. However, environmental considerations have clearly been the dominant feature of ESG. Despite Canadian oil and natural gas production being amongst the most environmentally friendly production in the world, it has been demonized by environmentalists. In fairness to environmentalists, Canadian oil sands production has higher emissions intensity than conventional Canadian oil production. However, due to the significant research and development efforts of the Canadian oil and gas sector, emissions intensity of even Canadian oil sands production is now approaching the average emissions intensity of global crude oil production. And, as you can imagine, Canadian conventional oil production has significantly lower emissions intensity. On balance, Canada should be a preferred supplier of energy globally.

If Canadian oil and natural gas production is environmentally preferred production, why then is it subjected to significantly more environmental activism than other jurisdictions? Perhaps it is time to reconsider the S and G in ESG. Is it possible that the same social environment in Canada on which the Canadian oil and gas sector should be very positively scored leads to it being targeted, while vicious authoritarian regimes continue to produce unabated by such ESG concerns? Brutal regimes are rewarded with little environmental outcry and, as a result, increased market share, while the nice guy/country finishes last. Will a brutal war waged by a brutal, authoritarian regime be what it takes to open minds to considering the unintended consequences of what has been an almost singular focus on halting all fossil fuel production in jurisdictions that truly care about ESG, such as Canada?

On balance, Canada should be a preferred supplier of energy globally.

Suddenly, energy being supplied by ESG positive countries such as Canada is being touted as a possible answer to energy security. How this was ever forgotten is the real mystery, but I will try not to digress more than necessary. The West should have realized it had a problem on its hands when President Biden resorted to asking OPEC+ members, including Russia and Saudi Arabia, last year to increase oil production. The irony is that the U.S. is the largest crude oil producer in the world, but production has been constrained at least somewhat by restrictive regulatory policies. The same is true for Canada, the fourth largest oil producer in the world. Does constraining relatively cleaner North American oil production and encouraging production from countries such as Russia, Saudi Arabia and Iraq help the environment? If oil consumption is unchanged, the only impact is ceding market share to countries such as Russia. The environment is worse off not only because cleaner North American production is displaced but also because Canada and the U.S., who spend significant tax revenues on climate change initiatives, see decreased tax revenues. Conversely, Russia uses government revenues to wage an expansionist war in Ukraine – “dirty” oil indeed. If nothing else, perhaps it is time for the public to have a more honest conversation about the continued need for fossil fuels and what government policy choices truly mean for the world.

Oil and natural gas prices have climbed globally over the last year – even before the Russian invasion of Ukraine. The increase in prices has been driven by both increased demand, particularly as the world gradually re-opens after two years of COVID restrictions, and decreased supply due partly to punitive government policies. Typically, the best cure for high prices is high prices. High prices incentivize producers to increase supply while also encouraging consumers to seek lower priced alternatives. However, in the current wacky world of energy, we have large problems on both the supply and demand sides of the equation.

On the supply side of the equation, limited takeaway capacity in Canada for both oil and natural gas due to opposition from the federal, Quebec and B.C governments has severely constrained production growth. On March 24, 2022, after a meeting of the International Energy Agency, Canada’s Minister of Natural Resources, Jonathan Wilkinson, said that Canada can be in a position this year to increase oil exports by 200,000 barrels per day and natural gas exports by 100,000 barrels of oil equivalent per day. While any additional exports will be helpful to Europe as it attempts to wean itself off Russian energy supplies, these quantities are a drop in the bucket relative to both European needs and Canadian reserves. Had there not been such a negative policy stance in Canada, we could have been in a position to supply significantly more energy to our friends and allies in Europe. One cannot fault Canadian oil and natural gas producers or Canadian pipeline companies for not ramping up expenditures. Canadian pipeline companies have wasted billions of dollars following what used to be well-defined regulatory processes. However, constantly moving goalposts have resulted in massive regulatory uncertainty. Even with Minister Wilkinson’s statement of support for increasing energy supplies to Europe, no pipeline proponent would find any comfort to invest materially in Canada. Sadly, the same is true for Canadian oil and natural gas producers. Without clearer government support (or, perhaps, less government opposition), companies and their investors have little incentive to make the long-term investments needed to ensure energy security for the West.

But, some may ask, what about the Trans Mountain oil pipeline expansion? Didn’t the federal government step in with taxpayer dollars to buy the pipeline and expansion project? Is that not clearly government support? To answer those questions, we need to step back and refresh our memories. After government rejections of multiple other pipeline projects, all of which would have been privately funded by investors, and continued B.C. government opposition to the Trans Mountain pipeline expansion, the owner of the Trans Mountain pipeline decided to suspend the expansion project due to significant regulatory risk. It was only when faced with the reality that new export takeaway is crucial to Canada that the federal government found itself with no choice but to buy the existing pipeline and expansion project. If Canada had more reasonable government policies toward energy production, no taxpayer dollars would have been required. It was truly a case of reaping what you sow. For those that insist that this was a poor financial investment, keep in mind that private investors were happy to invest until government policies kept moving the goalposts. Companies and investors require some measure of regulatory and policy stability. Governments can either foster private investment or find themselves forced to spend taxpayer dollars on such necessary investments. The war in Ukraine has reminded the world of this, but nothing in Minister Wilkinson’s statement provides the comfort needed for private investment to increase sufficiently for Canada to be the energy source Europe needs us to be.

As inconvenient as it may be to hear, it is true that the world needs energy security in the form of not only renewable energy but also cleaner oil and natural gas from countries that care about the environment and the international rule of law.

On the demand side of the equation, there is much talk about how both high commodity prices and the fact that Europe is held hostage to Russian fossil fuel supplies should speed up the transition away from fossil fuels. There is some validity to this suggestion as high prices are an incentive to explore alternatives. Indeed, that is the purpose of carbon taxes – incentivize consumers to change behavior by artificially increasing prices. In today’s environment, prices are up significantly due to carbon taxes and, even more so, supply and demand dynamics. Advocates of carbon taxes should be cheering on the price increases as the macro economic environment is greatly amplifying the price increases intended by carbon taxes. However, as our friends in Europe would surely attest, despite these large price increases, there are currently insufficient alternative forms of energy available to move entirely off fossil fuels. And most alternative forms of energy are likely not cheaper alternatives, even with the current high oil and natural gas prices. Governments globally will no doubt increase subsidies and grants to encourage clean energy production, as perhaps they well should. But they will also need to encourage increased fossil fuel production to meet consumer demand. Any suggestion otherwise is simply unrealistic. As such, governments need to move on all levers available – that includes investment in clean energy, but also in emissions reduction that encourages cleaner fossil fuel production during the transition period.

As I mentioned in a previous article, energy transition does not occur overnight. The war in Ukraine and the move to free the West from Russian oil and natural gas highlight the difficulties of such a transition. Energy prices go up. Energy transition will mean even higher prices, even as countries around the world work towards solutions. And this is a long-term game, so talk of not pursuing some alternatives because they will not provide short term solutions is not helpful. As inconvenient as it may be to hear, it is true that the world needs energy security in the form of not only renewable energy but also cleaner oil and natural gas from countries that care about the environment and the international rule of law.

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