Oil and gas extraction has been a cornerstone of Canada’s economy for decades, but plans for expansion of the oil sands represent an enormous economic risk in a world moving to electric vehicles and action against climate change.
The federal and some provincial governments of Canada are not only planning to keep the oil and gas industry running at full steam, but to massively expand it. At the same time, the majority of demand for oil comes from fuel for road vehicles, a segment undergoing a huge technological transformation towards electrification. Canada appears to be grossly underprepared for a future where global demand for oil declines and not only that, our political and industry leaders are currently doubling down on oil as an economic engine — oil that is more expensive to produce than virtually anywhere else in the world.
The plans and investment decisions of the Canadian Government and oil industry leaders imply that, despite what they may be saying in press releases, they are assuming that we are headed towards two, three or more degrees of catastrophic warming globally. In other words, they are betting on global climate failure.
Increasing Pressure for Climate Action
The IPCC’s recent special report, along with countless others, highlight the absolute urgency of addressing climate change. Global protest movements like the student climate strikes, Extinction Rebellion, Ende Gelände and others are increasing pressure on politicians, while at the same time dramatic cost reductions in renewable energy, battery storage systems and electric vehicles (EVs) mean solutions are clearly affordable and available. As global policy makers are finally starting to seriously consider the implications of these warnings and as technological solutions become clearly affordable, it increasingly looks like a massive shift will occur in the coming decade.
Rapid EV Adoption
One of the most important technological advances and the one that poses the biggest threat to Canada’s economy is the electrification of transportation. According to the International Energy Agency (IEA), road transportation accounts for about 50 per cent of global oil demand; the United States Energy Information Administration reports an even higher share of oil demand dedicated to road transportation for the U.S., Canada’s primary oil customer.
EVs feature significantly better performance for most applications and much lower maintenance costs when compared to standard internal combustion engine vehicles. Continued technological advancements are widening the performance gap, especially given the comparison between a new technology and one that has plateaued for decades. At the same time, economies of scale are driving EV prices down.
In addition, many cities and countries are already planning policies to significantly restrict the use and sales of internal combustion engines by 2030. This includes Copenhagen, Paris, Rome, Mexico City, Brussels, China, Norway, France, Ireland, Netherlands and many more.
There is little doubt that EVs will become the primary mode of land transport in advanced economies in the coming years and EV adoption will result in a decline in global oil demand. EV adoption is accelerating dramatically and even conservative new technology adoption assumptions show that EVs will overtake internal combustion engines within 10 years. This is great news for public health, which will improve as a result of reduced localized air pollution, as well as for total greenhouse gas emissions.
Impact on Oil Demand
Although rapid EV adoption is excellent news from an emissions standpoint, it will put a major share of Canada’s oil industry at risk. The last oil price shock of in 2014-16 was caused by an overcapacity of about 2M barrels per day (a mere 2-3 per cent of production) and resulted in oil prices dropping to below 30 USD per barrel and economic crisis in Alberta. In fact, it is already likely, in my opinion, that enough internal combustion engine vehicles will be taken off the road by 2025 to permanently reduce oil demand by more than 2M barrels per day.
This is a global mega-trend, meaning there is not much Canada could do to slow down EV adoption even if it wanted to. Whether this turning point happens by 2023, 2025 or 2030 is somewhat irrelevant in terms of long-term investment. Once this point of mass EV adoption is reached, oil prices high enough to justify oil sands development would never be seen again.
High-Cost Canadian Oil Will be First on the Chopping Block
This is an immense risk for Canada in particular because the oil produced in the Canadian oil sands is on average the highest cost crude oil in the world — in a commodity market. When the price for crude oil drops, oil sands production is among the first globally to become unprofitable.
As shown in the graphic below, Rystad Energy identifies the Canadian old sands as the resource with the highest cost of production amongst significant oil producing regions globally. This is in line with estimates from other groups, such as the International Energy Agency. Declining oil demand, resulting in chronically low oil prices, foretells a bleak future for Canadian oil development.
When EVs displace enough oil demand globally — which is almost certain to happen by 2030 — Canada’s oil industry will be the first and hardest hit. The international oil industry has begun to understand this situation and is already reacting.
Texas-based Kinder Morgan made the decision to abandon the Trans Mountain expansion project due to risk considerations and was unable to sell the project to anyone except the Canadian government. In February this year, Devon Energy became the latest in a long list of international oil players to pull out of the Canadian market. Between 2017 and 2018, Royal Dutch Shell divested the vast majority of its oil sands assets. In early 2017, Norway’s Statoil (now Equinor) completed the sale of 100 per cent of its oil sands assets. Also in 2017, Marathon oil sold off its assets in the Canadian oil sands.
These international oil companies see the writing on the wall; when it comes to investment in the oil sands, the future supply outlook does not match the picture painted by the Trudeau government. As international companies exit the market, the investors left with what the Bank of Canada now says will be a fire sale will increasingly be Canadian energy firms, banks, government entities and individuals.
Despite all the red flags, the Liberal government has decided to buy the Trans Mountain Pipeline and expansion project for $4.4 billion, an amount the Parliamentary Budget Office has already reported may have been one billion dollars above the project’s actual value.
Canada’s Oil Dependency
It is widely known that Canada’s economy is heavily dependent on resource extraction, particularly oil production and exports. Oil and gas extraction alone typically represents about 5 per cent of Canada’s GDP according to Statistics Canada numbers. It is important to note that this does not include all the related services (e.g., refining, transportation, distribution) or the shares of other industries (e.g., banking and insurance) that are focused on fossil fuels. A sudden and dramatic decline in this industry would cause lasting damage to the Canadian economy.
The Canadian government and Canadian oil industry appear to have fallen victim to the status quo bias, which is typical when disruptive technological advancements emerge. If a fundamental shift towards EVs within the next 10 years seems aggressive, consider that automobiles were owned by under 10 per cent of U.S. households in 1915, but grew to 60 per cent in 1930. The speed of technological adoption has only accelerated since.
The Canadian oil industry has had its time and has been spectacularly successful, but the past is not necessarily a reliable proxy for the future and all signs point to a decline in the fortunes of the oil sands sooner rather than later.
The Liberals (and Conservatives) may argue that the $160 billion oil and gas sector cannot be shut down overnight, which is true. But what is the plan for replacing it? Shall we just keep investing as if oil demand will grow forever and sleepwalk into a financial crisis? Rapid oil sands expansion is not a realistic plan because a sober, rational analysis reveals that the oil sands will not be profitable in the long- or even mid-term; new projects will likely never be economically viable without heavy subsidies or long-term destabilization of global oil-producing countries. Rapidly expanding oil sands production would come at a great cost to our environment and an even greater cost to Canadians.
Buying Trans Mountain, continuing to subsidize the oil sands and bailing out American energy companies were nowhere to be found in the Liberal election platform in 2015. Even more worrying than this massive sunk cost, there will be many more billions spent if the Trans Mountain expansion actually moves forward and is constructed. Pipelines are expected to be used for 50 years or more, but the likelihood that the Trans Mountain expansion would still be transporting bitumen anywhere near 50 years from now is vanishingly low. Spending on this project would be disastrously counter-productive — it’s bailing water from the lake into an already sinking canoe.
The policy of the Liberal government on this file is somewhat perplexing and Canadians should receive honest answers to some fundamental questions:
- How are the oil sands going to compete with Saudi Arabia, Kuwait, Iran, Russia, the USA and all the other much lower-cost producers in a shrinking global oil demand scenario?
- If Canada is instead betting on growing oil demand, if we are planning to profit from this at the expense of a 2-degree, 3-degree or much warmer planet, should there not be a corresponding investment in and greater focus on adaptation to the coming changes?
- Where are the billion-dollar investments in improving public transit? High-speed rail? Country-wide, comprehensive EV charging network? Renewable energy generation? Energy storage? Passive buildings? Sustainable agriculture? These are all missed opportunities, while the government spends on oil and gas.
Though the Liberal government has made some improvements compared to its predecessor regarding Canada’s climate policy like the carbon tax, unfortunately they are nowhere near ambitious enough.
Furthermore, the Liberal Party’s duplicitous reversal on electoral reform means that the carbon tax could be terminated almost immediately after being implemented based on a tiny change in voter intentions. If the Liberal Party’s plan to expand oil production – already the country’s largest emissions source – is successful, any progress associated with its climate legislation will be swept away and Canada will not meet its Paris Agreement emissions targets.
Profiteer in a tragedy of the commons
The Liberal government is claiming to be the first to seriously address climate change, while at the same time making economic bets that assume climate change will not be addressed either in Canada or globally. In doing this, the government is playing the profiteer in a tragedy of the commons; and furthermore, not playing this game well, because for Canada there will likely be no profit.
We all have family and friends under the age of forty who will face terrible uncertainties within their lifetimes if action on climate change is not taken. But in Canada the burden will not be carried by the young alone. We are all likely to face economic crisis in the next ten years as a consequence of the current plan to double down on expensive oil.