Canadian Energy Industry Resigns Itself to Kyoto Protocol

Abstract:Oil and gas companies operating in Canada have resigned themselves to living with the Kyoto Protocol. Some of the acceptance stems from expectations that Paul Martin, predicted to become the next Prime Minister, will be careful not to damage the oilpatch because of its importance to the country's economy as well as to his current leadership campaign.

Analysis:Like survivors of some traumatic experience, the Canadian energy industry is leaving behind anger and denial and moving into resignation about the Kyoto Protocol.

Some of the acceptance is based on expectations that Paul Martin, widely predicted to be the next Prime Minister, will be careful not to damage the oilpatch because of its importance to the country's economy and to his leadership campaign.

The rhetoric of executives and provincial politicians, particularly in petroleum-rich Alberta, has cooled significantly in recent weeks as they resigned themselves to Prime Minister Jean Chretien's determination to pass the international agreement before the end of this year.

The Liberal-dominated parliament in Ottawa voted overwhelmingly this week in favor of Kyoto, which mandates Canada to reduce greenhouse gas emissions by six percent below 1990 levels. Growth in the Canadian economy over the past decade, with the boom in Alberta's oilsands a major contributor to increased gross domestic product, means carbon dioxide emissions are expected to rise 33 percent above 1990's level if no action is taken by 2010.

Some critics contend the grieving process was partially self-induced. The Canadian Association of Petroleum Producers (CAPP), which represents companies responsible for 95 percent of the country's daily oil and gas output, concentrated on quietly lobbying federal and provincial politicians for most of the past five years. It was only in recent months that a high-profile and confrontational approach was taken to warn of the economic dangers of passing the accord, which was repudiated last year by President George W. Bush because of the harm it could do to the U.S. economy.

The Monday morning quarterbacking ignores the fact that Chretien's desire to create an internationally respected legacy before his retirement, currently scheduled for February 2004, would have caused CAPP to fail no matter what strategy it chose.

With the most contentious Canadian energy program in decades forced down the their throats, oilpatch executives have little choice now but to swallow their anger and learn how to deal with the costs of Kyoto implementation strategies.

Unfortunately for players in key cities such as Calgary, Houston, Toronto, and New York, it will still be years until the financial implications are fully understood, even though the Canadian government has made some positive steps to clarify a situation as opaque as a beaker of bitumen.

Of the target to reduce Canada's greenhouse gas emissions by 240 megatonnes per year, 55 tonnes has been allocated to the largest emitters. However, the energy industry's share has not been finalized.

The federal government has also committed that the cost of emissions credits, which will be an important part of the Canadian plan, will be capped at C$15 per tonne. Ottawa previously used a ballpark figure of C$10 per tonne in studies that calculated Kyoto's implementation would only add a few pennies per barrel of produced oil.

If the costs of credits exceed the proposed limit, Ottawa could be on the hook for billions of dollars. It has not spelled out how the extra costs would be handled. This is scary for both industry and Canadian taxpayers, who recently learned that the bill for a national gun registry program has unbelievably ballooned to nearly C$1 billion from the original estimate of C$2 million.

Adding to the confusion is the ambiguity surrounding the position of Martin, the front-runner in the race to replace Chretien as Canada's leader. The former finance minister is widely supported in western Canada, home to the majority of the country's petroleum production, companies, and workers.

Martin voted in favor of Kyoto, although he spoke against the process by which it was passed despite the objections of numerous provinces. He has also said implementing the agreement should not disadvantage any particular region, music to the ears of politicians in Alberta and British Columbia.

A noted fiscal conservative who prefers compromise to confrontation, Martin is no fan of buying credits from Russia, which stands to cash in on a surplus stemming from the implosion of its economy in the past decade. The likelihood of Martin adopting a "made-in-Canada" approach, such as one focusing on emissions intensity as has been suggested by several provinces, certainly dampened the fires of Ralph Klein, Alberta's premier.

Speaking to business leaders In New York earlier this week, Klein expressed confidence that Martin will not move forward until the federal government has a plan that balances environmental responsibility with economic growth.

"The current administration of the country is not going to last very long, and I can tell you that the next leader has a different approach to this issue," he said.

Does this mean oilsands projects, which produce three or four times the carbon dioxide per barrel of synthetic crude compared with emissions from a conventional barrel of oil, are out of the woods? Not by a long way.

Uncertainty about Martin's plans will keep firms such as Petro-Canada, Husky Energy, Canadian Natural Resources, and Nexen guessing on whether multibillion-dollar investments in oilsands make economic sense. Canadian Natural has already delayed C$100 million in spending in 2003 on its C$8 billion Horizon project, and it's likely Nexen will prune spending in 2003 on its C$2.5 billion Long Lake development, currently pegged at C$115 million.

"I would say that we're a lot better off today in that knowledge than we were two months ago. We still have some uncertainties and we want to have those things clarified as we go forward," Charlie Fischer, chief executive of Nexen, said this week during a conference call with analysts.

But delays are not cancellations, and Alberta's oilsands reserves, pegged at 175 billion recoverable barrels by the Energy Information Administration, are too large to ignore. Unrest in Venezuela shows security of supply is becoming increasingly important to the U.S. market, especially as its dependence on imported oil grows over the next two decades.

An analysis by Peters & Co., a Calgary brokerage firm specializing in energy issues, predicted Canada's Kyoto implementation plans will increase the cost of producing synthetic crude by 27 Canadian cents per barrel. With operating costs for oilsands players generally running between C$12 and C$15 per barrel, a one or two percent increase in expenses is relatively small potatoes compared with the swings in commodity prices the projects will endure over their 20- to 50-year lifespans.

Kyoto will slow down Alberta's and Canada's growth in the future, but it will not bring the doom and gloom that some oilpatch executives have predicted. The reduced rhetoric reflects the reality that the battle to prevent the agreement from being adopted has been lost, but the war will continue to ensure that oil, gas, and oilsands in Canada do not go MIA.