INSIGHT ARTICLE  |  October 20, 2021

In this week’s energy industry analysis, we take a look at the continuing global energy crunch, what the increased demand for fossil fuels means for Canada, and highlights from the Northam Energy Capital Assembly conference. Here’s the latest.

1. Energy shortage

The global energy crunch continued this week and attention turned to China, whose government announced that it would relax coal power pricing in response.

“The government had previously implemented tariffs and grid price ceilings on coal-generated power to stabilize the market and meet climate goals,” we wrote earlier in the week. “Relaxing pricing mandates will in effect cause prices to the consumer to rise further, up to 20%, according to Bloomberg, and will certainly have an impact on energy-intensive industries such as manufacturing.”

The move also raised uncertainty around base metal production for iron, steel, copper and aluminum.

“While the overall impact on manufacturers will depend on the duration and scale of the hit to production, there are several consequences to consider. China is a major trade partner with the United States, and one of the leading sources of U.S. metal imports. A slowdown in production in China will lead to higher prices and a lower quantity of metal imports into the United States.”

Check out our previous blog post to learn more.

2. Increased demand for fossil fuels

Statistics Canada reported last week that the country’s energy exports increased 5.1% to CA$12 billion in August, which is above the pre-pandemic high of CA$11.4 billion in March 2019, and the highest level since the all-time peak of CA$12.8 billion was set in March 2014. The global demand for liquefied natural gas (LNG) has hit such extreme highs that LNG spot prices in Asia surged above $56 per million British thermal units (mmBtu) last week, an increase of approximately 870% over the 2021 low of $5.80 per mmBtu in February. As a result, countries are opting to revert to cheaper alternatives such as coal and fuel oil, which do not burn as cleanly as LNG.

The current global energy shortage has shown that the transition away from fossil fuels will likely be a decades-long endeavor as global demand is expected to increase for several years, especially for emerging countries lacking the national infrastructure to rely on renewables. With energy demand remaining high both globally and in Canada—which is one of the world’s largest energy consumers due to its geographic size and climate—the country needs to support production to prevent energy price shocks, while also focusing on reducing emissions. Canada has missed several opportunities to reduce carbon emissions globally while capitalizing domestically from the demand for fossil fuels with its current energy policy.

Canada’s restrictive approval processes for LNG projects has resulted in none of its export facilities being online to supply overseas markets as the demand is increasing for cleaner energy. LNG Canada is the furthest along, and announced last week that it has just surpassed 50% completion. The project is not expected to go into service until 2025. This is while the United States is exporting approximately 10.5 billion cubic feet per day (bcfd) of gas into LNG, which is 10% of its gas production.

Numerous LNG projects on the east and west coasts of Canada have fallen through over the past decade, and federal support for the construction of export facilities would have supplied global markets with a cleaner alternative to coal or fuel oil, while remaining competitive with the United States.

Continuing fossil fuel production while developing carbon capture, utilization, and storage (CCUS) technologies should be a key goal for Canada to achieve net-zero emissions realistically as energy demands increase. Canada’s federal government has proposed a CCUS investment tax credit in its 2021 budget which is currently in the consultation period with industry and stakeholders, but it is not expected to be as competitive as the Section 45Q tax credit offered in the United States for CCUS.

As demand for fossil fuels remains high, Canada will need to balance energy security—and supplying cleaner energy globally—with reducing carbon emissions. Failure to provide support for increasing LNG export capacity, and investment in critical technologies such as CCUS, will leave Canada at a competitive disadvantage to its peers.

3. Conference takeaways: Northam Energy Capital Assembly

At the Northam Energy Capital Assembly conference in Houston this week, a number of conversations focused on environmental, social and governance issues and energy sector performance. Here are some highlights from the conference, a major event for the North American exploration and production sector.

ESG

Environmental, social and governance issues—an increasingly prominent topic in the broader economy—came up in every single panel and keynote discussion at this year’s conference. Here are some key takeaways on this topic:

• There is a growing sense of urgency, not just from public consumers, but also from investors, that companies must have a thoughtful, strategic ESG plan.
• Companies can expect pressures in the form of investor mandates referencing ESG performance, policy and regulatory movement, and in broader consumer choices and demands. But policy makers need to be careful that regulatory pressures do not constrain the operational environment.
• Private equity-backed companies should lean on the sponsoring firm to assist with data collection and reporting efforts, which will help prepare the portfolio company for future investments and/or mergers and acquisitions.
• Operational and back-office efficiencies can materially contribute to ESG goals.
• There is not a standard, accepted framework with which companies can evaluate their ESG performance. This is a huge opportunity for the industry to help shape the requirements.

Companies should make sure they have a thorough understanding of all three components of ESG, how their business measures up on disparate ranking systems, what data can help them achieve their ESG goals, and develop a roadmap to get there.

Sector performance

Macro and micro trends are always a hot topic in the energy sector. In today’s environment, with $75- to $80-per-barrel oil, there is some optimism in the industry that we’ve missed these last few years.

Here are some key takeaways on this topic:

• There is a palpable bifurcation in the behaviors and expectations between publicly traded companies (with emphasis on the majors) and the privates, between oil- and gas-heavy entities, and across the various basins.
• Large cap investors want to see consolidation of publics. There are bloated general and administrative budgets that can be stripped down and synergies/efficiencies to be realized.
• Volatility in commodity prices makes it hard for buyers to value targets and contributes to shifting motivations for deals or property sales. With volatility, the bid-ask spread widens and it is harder to do deals. If there is a strategic reason to do a deal where the buyer realizes synergies that the seller cannot, there are ways to bridge that gap. Sellers need to know who their buyers are and target them to open dialogue and close deals.
• There is consensus and commitment toward capital discipline, but a concern that limited reinvestment in the business to maximize free cash flow will result in poor reserves replacement and supply constraints down the road. The intersection of the two metrics will be where companies are rewarded by the market.

Understanding cost structures and identifying opportunities for improvement will be key for companies that want to respond to these factors. Service costs, labor costs and inflation are on the way up. Companies need to determine how to seek growth without layering in more costs.