In the world of energy investing right now, two visions of the future are on a collision course.
In the one corner, global energy demand will keep ticking along status quo for decades to come. In the other, the risks of climate change become too great for the international community to ignore and there's a unified effort to cut down the amount of atmospheric carbon that's allowed to billow out of smoke stacks and tailpipes. Whichever way the world breaks, today's energy companies find themselves caught in the middle.
In the next decade or so, the global oil industry has plans to spend $1.1-trillion on projects that require high crude prices to make economic sense. The magic number looks to be around $95 (U.S.) a barrel. If crude prices are above that level, the lion's share of these projects will likely get the green light, according to numbers compiled by the Carbon Tracker Initiative, a non-profit think tank based in London. At current prices that money looks to be all but spent. Of course, the world rarely moves in a straight line. The amount of carbon that will need to be combusted to keep prices in the triple-digit range could be more than the planet is able to handle. According to the International Energy Agency, if the rise in average global temperatures is to be held to 2 degrees Celsius, we're going to have to cut back on the amount of oil we burn sooner rather than later.
Clearly, something has to give. Either we ignore ever-increasing evidence of climate change (the calving of the western Antarctic ice sheet being the most recent and startling) or we take steps to cut down on the 10 billion tonnes of carbon the global economy emits every year. If the latter is chosen, how realistic is the $95 a barrel needed to accommodate the energy industry's hopes for capital spending?
These days, projecting oil prices is largely an exercise in modelling demand. To figure that out with any accuracy, it should be noted, is as much art as it is science. That is to say, expectations for how much oil we'll burn is very much in the eye of the beholder. Take Exxon, for instance. In its carbon asset risk assessment report, Exxon argues that stabilizing atmospheric carbon at the key threshold of 450 parts per million is far too costly to be a realistic option. Instead, the company projects the world will require more than a third more energy than it does today, the bulk of which will come from burning fossil fuels.
What Exxon doesn't mention is that such oil consumption would put the planet on course for a rise in average temperatures of 4 to 5 degrees. An increase of that magnitude would translate into rising sea levels, huge shifts in global precipitation patterns, and crop-killing heat waves. Not to worry, according to Exxon. Even as the earth suffers through such cataclysmic changes, the company forecasts global energy demand will not only be resilient, but will continue to grow.
Let's suppose for a second that our survival instincts trump our need to burn ever-greater amounts of fossil fuels. What happens to oil demand then? According to the IEA's projections, if we're going to get serious about holding atmospheric carbon to 450 parts per million our days of increasing oil consumption are at an end. In this scenario, global oil demand will have already peaked and by 2035 it will be 10 per cent lower than it is today. Where demand goes, prices will follow. Given that today's oil prices would barely justify the industry's massive spending plans, tomorrow's lower prices will render many of the projects on the drawing board uneconomic.
Few countries in the world will feel that particular squeeze more than Canada. Of the $1.1-trillion in planned capital spending on high cost projects, nearly 40 per cent is slated for Alberta's oil sands. The nearly $400-billion to be spent in the oil sands is twice as much as the runner up, the U.S. Gulf Coast, and roughly four times what's slated for offshore Brazil, the next leading region.
If oil prices continue to rise, Alberta's oil sands are clearly the place to be. Of all of the unconventional oil resources out there, the oil sands hold the greatest potential production growth. By 2035, hundreds of billions in spending would more than double production to 5 million barrels a day, making Alberta one of the world's premier oil producers. On the flip side, if oil prices fall the oil sands are the last place energy companies will want to be. No other oil-producing region risks losing more capital spending due to lower crude prices than Alberta.
Without that spending, of course, the huge projected increases in production won't ever come to pass. That would be a win for the environment and it doesn't necessarily need to be a loss for investors. For carbon emissions, it means the oil will stay trapped in the same place it's been for millions of years. For investors, a successful outcome hinges on choices the industry is making right now. If companies choose to sink billions into unconventional plays that demand high oil prices to turn a profit, then shareholders better hope those mega-projects don't turn into white elephants down the road.
Jeff Rubin is the former chief economist of CIBC World Markets and the author of the award-winning Why Your World Is About To Get A Whole Lot Smaller. His recent best seller is The End of Growth.
Jeff Rubin