The Untold Story about Canada’s "Defection"
Even after the scores of lectures I've sat through on environmental economics, or the long discussions about energy policy with think tanks at the Johns Hopkins D.C. campus…
I never expected this to happen.
At least not from the perpetrator in drama…
Not Canada. They were supposed to live by example for the West…
But, on Tuesday, citing economic and political concerns, Canada became the first country to officially withdraw from the Kyoto Protocol, a 1997 agreement under which 37 countries committed to reduce carbon emissions below 1990 levels.
On the surface, this represents a breakdown in transnational climate negotiations.
But underneath, there's more important trend. And it's very good news for oil and energy investors like you and me.
So… while policy wonks debate “what's next” for climate talks, we need to discuss what this means for the future of energy investment in North America.
And it's positive… for now.
A Policy Breakdown
As you'll see, there are actually two stories here.
The first is about policy failure and the blow to members' expectations that economies could meet emissions reductions by 2012.
But the Canadian government has, for at least a decade, expressed dissatisfaction with the Kyoto Treaty since it fails to hold two of the largest emitters and economies in the world – India and China – accountable for meeting reductions targets. In addition, the United States, the second-largest emitter in the world, never ratified the treaty in the Senate.
Meanwhile, Canada was reducing its emissions. The country has been weaning itself off coal for the better part of a decade.
Its decline in coal consumption was mainly due to the Ontario government phasing out its remaining 6.1 gigawatts of coal-fired plant capacity through 2014.
Still, that reduction would never have been enough to meet Kyoto's rigid standards.
Under the agreement, Canada was supposed to cut its emissions to 6% below 1990 levels during the four years between 2008 and 2012.
As of today, the country is roughly 30% above its target.
So, in order to fulfill its obligations, Canada would now have to buy carbon emission permits from other Kyoto signatories to offset this imbalance and meet its agreed target.
That price tag was estimated at $14 billion – or $1,600 from every Canadian household – even though these permits still wouldn't reduce global emissions levels.
Now, Canada will likely avoid these costs.
But the second story was more troubling to politicians.
In order to reach future emissions targets, the country would likely have to curb significant levels of economic activity and strip down its oil and gas production, particularly in the Alberta tar sands, its largest source of new emissions.
And this is the story every oil and energy investor needs to know, but isn't hearing anywhere else.
A Nod to Energy Producers
The Canadian economy continues to be a shining example to a Western world struggling to rebound from the global financial crisis. The resource-rich nation has enjoyed a nice buffer from the aftershock of the crisis, thanks to strong production in energy, minerals, and agriculture.
In the last nine years, Canada's GDP has doubled.
And leaders would like to keep this going.
The country has immensely benefitted from the boom in oil and gas production in the sands of Alberta. But tar-sand mining is far more carbon-intensivethan traditional crude oil production.
The rise in tar sand production naturally has led to increased emissions since 2008, even though a heavy majority of the crude is used as energy in places like the United States or China – two countries that aren't bound by the emissions treaty.
So even though Canada is a very small emitter of carbon by comparison, political leaders had to be asking themselves one question: Why should Canada buy credits for their emissions from oil production, when two of their largest consumers of oil and gas are not required to do the same for burning their imported oil?
And, why should they cut production or stall growth in order to meet these obligations?
It appears Canada isn't willing to turn off the pumps or pay the costs for now, not with global energy demand rising and financial conditions ripe for production in Alberta.
As Kent has noted before, the price of oil needs to be roughly $70 to $75 a barrel in order for production in new oil sands fields to be profitable.
Existing fields require crude prices to be at least $50 to $55 in order to justify extraction of crude. With global prices expected to swell well past $100 a barrel in 2012, now is the right time to be producing oil in Alberta.
Profiting Upstream (and Midstream)
Canada is the largest supplier of oil and gas to the United States, shipping approximately 75% of its exports here each month. According to the government of Alberta, nearly 173 billion barrels of recoverable oil rest in these tar sands, based on current production costs.
This represents nearly 75% of the total North American reserves currently available.
And such a tally has attracted a great number of upstream and integrated companies looking to produce with demand rising and access to conventional sources falling.
It was just last year, in an interview with Money Morning, that Kent explained why Asian state oil firms, led by China, were acquiring interests in oil sands projects and spending billions to satisfy their rising energy needs.
And this trend is expected to continue as greater production from unconventional sources is needed to meet this demand. With margins increasing, upstream producers are settling in and expecting strong returns.
In fact, in August, Travis Davies, a spokesman for the Canadian Association of Petroleum Producers, told the New York Times that the sector expects oil sands production to roughly double by 2020, depending on the long-term price of crude.
This should also be welcome news to midstream service providers.
Despite the delay of the Keystone Pipeline between Canada and the United States, it's clear that production will continue, uninhibited, and that politicians are on board.
And anywhere the oil is flowing is a good thing for midstream providers.
Remember, these companies are assessing fees in order to move oil and products from the production points (upstream) to processing, treatment, and retail centers (downstream).
So the greater the levels of production, the more these services will be needed to transport and store these fuels.
Canadian rail companies were already increasing domestic transporting capacity with the growth of the Bakken shale field. Now, expansion of tar sand production will only pique their interest even more as they aim to profit on this “black gold” rush.
Of course, Canada has stated that it is willing to step back to the table to negotiate a long-term treaty that binds all countries to specific emissions cuts, which would likely introduce new taxes or fees on producers.
But given the lukewarm outcomes in Durban last week and Copenhagen in 2009, I'm expecting Mr. Davies' prediction will come soon long before these nations, all seeking to grow their economies, can reach a profound agreement.
It's a good time to look north for opportunity.
P.S. Canada's withdrawal is the latest twist in a huge story about the energy markets. And for months, Kent has been talking about the next big trend and what it means…
It means… you can profit.
To learn more, go here now.