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Corporate directors' duties after Paris: adapting to climate change

Gavin Lowe, responsible for the operation of our seven of Suncor's wind energy facilities. Photo by Suncor Energy.

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This week, Vancouver plays host to the first ministers meeting and the GLOBE Conference. Canada’s major oil and gas players will rub shoulders with federal and provincial government leaders who are working to transform Canada’s energy system. The legally binding Paris Agreement signed by Canada and 195 other national governments establishes a policy framework to transition the energy sector to zero net greenhouse gas emissions by the end of this century, and probably a lot sooner. The agreed upon goal of limiting global warming to below 1.5 – 2 degrees will require a structural transformation of the energy sector away from fossil fuels.

This change implies significant investment risks and opportunities for Canada’s corporate leaders. Even if they are skeptical of the 1.5 – 2 degree emissions targets, the directors of Canada’s largest, most carbon-exposed companies need to consider how their business models would operate under such a transition. This is what the law requires of them as prudent directors.

For most company directors, particularly in the fossil fuel sector and at our national banks, it may not yet be clear what has changed since the Paris Agreement was signed late last year. The ambitious targets set out in the Paris mean that up to 80% of current fossil fuel reserves must remain in the ground. This includes the majority of Canadian oil sands and coal reserves. While projects that are already pumping oil or digging out coal are likely to continue, climate goals indicate that most unexploited reserves will have to stay in the ground. Persistent low oil prices and plummeting demand for coal in China mean that the magic hand of the market is providing a tailwind for climate policy action that will increase business risks to fossil fuel companies.

These changes mean that North American fossil fuel company management and their boards of directors must consider climate change policy action and associated renewable energy breakthroughs as material risks and report to their shareholders accordingly. This will require champions at the board level to ensure that forward-looking risks are addressed by management. Best practice includes stress-testing business models against the 1.5 - 2 degree emissions targets agreed to in Paris. According to corporate governance expert Purdy Crawford, “[m]anagement is typically focused on today’s issues and a board can often fall into the trap of just looking at what has happened, rather than at helping management focus on looking forward.” In other words, it’s time to take the blinders off.

Where is your “2 degree business plan”?

In response to this new reality, we have already seen rapid changes in US energy markets, led by state action in line with the US federal Clean Power Plan. In Canada, the management team at Suncor, one of the largest oil sands operators, have agreed to communicate to their shareholders how the company plans to generate value in a world that sticks to the Paris emissions targets. Management support for the resolution indicates that they recognise that the low carbon energy transition is underway and that responsible directors must indicate a clear path forward for concerned investors. Indeed, Canadian company directors have legal duties to provide this type of information to their shareholders.

Climate risk, negligence, and directors’ duties

As this week’s meetings unfold in Vancouver, it is clearer than ever that climate change policy and associated transformations of the energy and transportation sectors represent major financial risks and opportunities. Detailed analysis and disclosure of business risks is already required under federal and provincial corporate law. After Paris, market regulators must take action where companies fail to meet these disclosure obligations. A disruptive transition to lower carbon mean that market regulators need to help protect investors, including pensioners, from the next Penn West Petroleum accounting scandal or Larcinia Energy bankruptcy by enforcing existing information disclosure rules.

Canadian corporate law requires company directors to act “honestly and in good faith with a view to the best interests of the corporation.” In discharging their duties, directors must “exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.” What would a reasonable person who runs a pure-play oil sands company do if they knew that 196 governments and many of the world’s largest investors have agreed to a zero carbon energy transition? They would make a plan for their business to survive and prosper through the transformation of energy markets… and they would make sure that their shareholders knew about the plan.

Managers of publicly listed companies must communicate to shareholders on “any known trends, uncertainties and risks that could be material to their business, that have affected the financial statements, and that are reasonably likely to affect them in the future.” In simple terms, the directors of Canada's most carbon intensive industries and their publicly-listed financiers (the Big Five banks) now have a duty to communicate the risks and opportunities associated with the energy transition to their shareholders.

This requires more robust corporate reporting. Responsible boards of directors at the world’s largest companies are already analysing climate risks and planning how their businesses will adapt and prosper as the Paris Agreement targets harden into national law. It is time for Canadian company directors to update the information provided to their owners - shareholders - on climate change business risks. Those who fail to do so may face investor claims as the low energy transition disrupts fossilised business models.

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