Series finale for Republic of Oil?

Why Newfoundland and Labrador’s oil reserves may be left untapped

Recently, Danny Williams spoke about untapped oil reserves in the offshore as an economic wave that Newfoundland and Labrador will ride for the next few decades. “There’s a lot of oil out there,” Williams said in a Feb. 10 press scrum, suggesting the NL offshore reserves to be three times the size of the North Sea oil basin, in which he says Britain and Norway have drilled 5,500 wells compared to Newfoundland and Labrador’s 200.

These sorts of statements about reserves in the offshore are commonplace, and provide a good deal of comfort to local industrialists and businesspeople. However, there is a growing consensus that this oil must stay in the ground, evidenced by the recent urgency about greenhouse gas emissions expressed by, among others, U.S. Secretary of State John Kerry. And if you happen to have a pension linked to the stock market (i.e. most any pension plan) it is well past time to be concerned.

The market value of stocks in oil companies is linked not only to the production, trade, and consumption of oil, but also to the reserves sitting in the ground. When a company discovers a new reserve, this becomes a metric investors use to understand the value of that company. For example, Exxon’s market value is ~$400 billion, yet in proved reserves it has an estimated $2.2 trillion worth of oil. Each year, Exxon strives to expand its reserves at a greater rate than it produces oil (reserve replacement ratio), thus consistently growing the base value of the company and keeping its investors happy. This is something of an oversimplification but gestures towards why big oil has been a great investment for the last 50-odd years, and also why NL politicians and businesspeople express such confidence in the economic outlook for the province, with its vast untapped reserves.

Enter climate change

To readers who will immediately switch off at the mention of climate change, I implore you to stay with me for a few more minutes, if only to get to the juicy bit about how pensions come into the picture and why you stand to lose money. This is not a bleeding heart analysis about saving dolphins and there will be no quotes from Rachel Carson’s Silent Spring. The warnings about oil reserves and climate change are not, in this case, coming from environmentalists and anti-globalization protesters, but instead from major investors in the oil industry.

At the 2012 Climate Change Summit in Doha, United Nations members reaffirmed that if catastrophic climate change is to be avoided we must ensure that the average rise in world temperatures is no more than 2 degrees Celsius. In order for this to become reality, there must be an 80% reduction in greenhouse gas emissions by 2050. And in order for that to happen, most of the oil reserves need to stay in the ground.

Of course, Canada has willfully ignored these sorts of warnings and even pulled out of the UN Kyoto Protocol on climate change. It is impossible, so the argument goes, to curb greenhouse gas emissions without serious economic repercussions – which seems quite true – and the “drill baby drill” mentality prevails. But as the economic, social, and political costs of climate change mount, governments are quickly coming to realize it’s a zero-sum game: either put in place regulations to curb greenhouse gas emissions, or pay the piper in a looming environmental catastrophe.

Now, about your pension

It is at this point in the discussion that smart investors get nervous. If governments get their act together and impose production limits on big oil, those vast reserves will be “stranded” and, according to estimates from HSBC, oil companies could lose half their stock value. This is why a group of 70 investors, comprising some of the largest pension funds in the U.S., have asked the oil industry what it intends to do to account for a potential $6 trillion in stranded assets. If oil reserves must be left in the ground, and if the market value of big oil companies is chopped in half, pension funds will collapse. These concerned investors, among others, formed a non-profit called the Ceres Coalition, which has been extolling the necessity of a shift from greenhouse gas emission industries purely from the perspective of economic sustainability.

Granted, it’s a through-the-looking-glass kind of scenario, with major investors telling the oil industry to clean up its act and branch out into alternative energy. But from an investment point-of-view, it makes good sense to hedge your bets. And of course, this is not only a U.S. phenomenon, and most residents of the province with pension plans or diversified investment portfolios are similarly at risk. If this is true for you, really there are only a certain number of outcomes and a range of scenarios looks something like this:

1. Danny Williams is correct and all the reserves in the offshore are tapped over the next few decades. Before 2050 the temperature is well above the 2 degree Celsius cap and dramatic climate change-related events (like increased hurricane activity) pummel the province’s infrastructure, disrupting commerce and costing us far more than developing the oil was worth. But, hey, you got your pension!

2. Greenhouse gas related industries are regulated and oil reserves stay in the ground, but big oil has not diversified into other business sectors or revenue sources in alternative energies. Perhaps a climate catastrophe is avoided, but your pension fund collapses.

3. Greenhouse gas related industries are regulated and oil reserves stay in the ground, but big oil has, because of pressure from investors, found new revenue sources. Perhaps a climate catastrophe is avoided, and your pension fund does not collapse.

To be blunt, I think the first scenario is the most likely. You can probably rest assured that every ounce of oil will be sucked out of the ground and no amount of fear-mongering from concerned investors and banking conglomerates is going to dissuade the big oil juggernaut. So maybe the title of this article should be “The calamitous future of the Republic of Oil”. Because it seems true, as Rachel Carson suggests in Silent Spring, “the human race is challenged more than ever before to demonstrate our mastery, not over nature but of ourselves,” and I don’t think we have it in us.

(Yes, I lied about that quote.)

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