In this week’s energy industry analysis, we take a look at recent factors affecting oil prices, the oil revenue landscape in Canada and a new board that aims to create more consistency around measuring companies’ progress on environmental, social and governance issues.
Market update – OPEC+ and omicron
Markets are reacting to several recent developments, including the coordinated effort from the U.S. and its allies to release crude oil from strategic reserves and the emergence of the coronavirus omicron variant. On Nov. 26 (Black Friday), oil experienced its largest one-day drop since April as omicron news hit the market, with West Texas Intermediate dropping 13% to $68.15. Prices are likely to remain somewhat volatile amid mounting uncertainty facing the market in the coming months, including OPEC+’s next move and what happens with the omicron variant.
While OPEC+ continues with its plan to increase output via easing previously instated 2020 production cuts, some producers are likely to experience capacity constraints, calling question to the actual supply that will hit the market. While OPEC+ output for November was 220,000 barrels per day higher than October, it was still 254,000 bpd below the allowable supply target for the month, according to Reuters. The confluence of such capacity concerns, the coordinated reserve release, and omicron variant concerns are raising the pressure on OPEC+.
OPEC+ met Thursday and agreed to move forward with planned oil output increases and plans to add another 400,000 bpd in January, signaling that the group is not yet overly concerned about demand impacts of omicron variant.
At this point, it is too early to determine the impact of the omicron variant on fuel demand, and most of the price movement is purely speculative as the public fears the worst-case scenario. One area to watch, however, is jet fuel, as flight activity is already being disrupted as new travel restrictions across Europe and Africa go into effect. Jet fuel consumption this week will be more than 130,000 bpd less than forecasted (if all scheduled flights had operated) according to Bloomberg. Although this current decrease is not considered material, there is an impending risk that demand will further deteriorate as omicron unfolds and travel restrictions rise.
While the overall impact of omicron on fuel demand is uncertain at this point, we do expect continued market volatility until the true severity of omicron is better understood.
The oil revenue landscape in Canada
In Canada’s oil-dependent Alberta province, royalties from oil sands production are expected to comprise a record 70% of the provincial government’s non-renewable resource revenue this fiscal year, according to an update from the government this week. The province has also revised its 2021-22 budget deficit to CA$5.8 billion, down significantly from its February forecast of $18.2 billion, largely because oil prices have been on the rise; the earlier forecast budgeted for WTI benchmark pricing at US$46 per barrel and the new forecast expects it to be US$70.50 per barrel.
While higher oil prices have provided spending flexibility for the public sector and helped repair balance sheet damage for companies in Canada’s oil and gas industry, we do not expect this improved outlook to result in the typical boom that the province has historically experienced with oil upswings. This is largely because of the current labor shortage in the industry and the fact that exploration companies have been pressured by shareholders to practice capital discipline and return value through debt repayment and share buybacks as opposed to reinvestment.
Additionally, the emerging spread of the omicron variant has tempered expectations for oil demand in the short-term as some countries impose travel restrictions, creating headwinds for oil prices. In the long-term, shifting public perceptions on climate change are demanding more immediate action toward the energy transition, resulting in lowered oil exploration investment and increased regulatory red tape.
Pipeline project constraints are another factor that will prevent producers from getting their oil to market, suppressing domestic oil prices as a result. This week additional arrests of protestors were made at blockades preventing the completion of the Coastal GasLink pipeline in British Columbia, and Michigan governor Gretchen Whitmer dismissed her case in federal court to prioritize a separate case in state court in the continued legal battle to shut down Enbridge’s Line 5 pipeline.
We believe that these factors will present obstacles that cap the potential economic upswing from a rise in oil prices moving forward and that budget planning, both in the private and public sectors, will need to take them into consideration.
More consistency around ESG measures
Efforts around environmental, social, and governance issues have in recent years become paramount for companies across all industries, especially the energy and hydrocarbon sectors. As attention has grown around ESG issues, though, companies, investors and consumers have struggled to reconcile the variety of standards to measure progress in these areas. At the recent COP26 conference, the International Financial Reporting Standards Foundation Trustees announced the formation of a new board to make such measures more consistent.
With the creation of the International Sustainability Standards Board, the IFRS aims to provide the foundation for consistent global ESG reporting standards for companies across industries.
Two leading sustainability focused organizations—the Climate Disclosure Standards Board and the Value Reporting Foundation—plan to consolidate to form this new board by June 2022. These organizations are investor-focused, and the consolidated board is expected to enact standards for sustainability reporting that are as rigorous and dependable as those used for financial reporting.
This is a step in the right direction as consumers and investors seek to evaluate companies’ ESG progress. Currently there is no unified set of reporting standards or expectations by which to do so. This makes comparing ESG progress between different organizations extremely difficult, as each company has taken it upon themselves to seek to understand what is important to their stakeholders and report on those items to the best of their ability.
The market will continue to see growth related to ESG initiatives as management teams seek to move along the ESG maturity curve and ensure that they are prepared for any associated regulatory requirements.