Assessing Alberta s climate change policy after our Calgary visit

Transcription

1 1 December 4, 2015 INVESTMENT STRATEGY NOTES Nick Majendie, CA Director, Wealth Management ScotiaWealth Senior Portfolio Manager, with responsibility for advising the Anchor Assessing Alberta s climate change policy after our Calgary visit Stock market outlook In our early October Anchor Note, which was our quarterly market outlook, we published a target of 14,780 for the TSX. Including estimated dividends, that would give a total return of about 16% from current levels (13,075 at time of that writing). After all the volatility of the last couple of months, the TSX, however, is ahead of the early October level to date by a less than 400 points. The potential for better Canadian returns from this point is chiefly a function of a continued strengthening in the price of financial stocks in general and banks in particular combined with a reversal of the weakness in the commodity sectors. The latter is partially dependent on a short term peak in the U.S. dollar, which depends largely on how much a December rate hike by the federal government and further possible hikes have already been discounted in the recent rise of the currency, together with some improvement in the price of oil. We regard any agreement to cut back production by OPEC at its December 4 th meeting as unlikely but a crossover between global demand and supply for oil could be evident by the spring and allow some recovery in the energy sector between now and then. Our Outlook 2016 will be published in mid- January of the New Year. Assessing Alberta s climate change policy after our Calgary visit and the implications for Canadian investors relative to our comments in our last Anchor Note In our last Anchor Note, we commented that the key objective of the two-week Paris Climate Conference starting on November 30 th was to find a way to lower the global emission of greenhouse gases over the next number of decades in order to avoid the world s average temperature rising by more than 2 C by the end of this century. The U.N. reports that scientists have concluded that an increase above that temperature would see significant increases in storms, floods, heatwaves and other drastic environmental changes around the globe. Without any measures to limit emissions, they estimate that there would be a 5 C rise in temperature by the end of the century. However, we note that the fifth and latest assessment for the United Nations Intergovernmental Panel on Climate Change (IPCC) actually projects that temperatures are likely to be anywhere from 1.5 to 4.5 degrees Celsius warmer by the latter part of the century a very wide range which covers outcomes that are between slightly beneficial to significantly harmful. Nevertheless, the U.N., the sponsor of the Paris conference, asked every country to submit proposals ahead of time for what they are prepared to do to cut greenhouse gas emissions (these have been termed Intended Nationally Determined Contributions or INDC s). As we said in that Anchor Note, so far, 155 countries accounting for 90% of global emissions have submitted INDC s including China and India. As a whole, these indications represent a commitment by the world to reduce fossil fuel demand by 30% to 40% over the next 20 years. This flies in the face of the forecasts by the major global oil companies who are forecasting growth in fossil fuel use by anywhere between 35% and 43% by 2040 or 25 years from now. According to the U.N., sticking to the INDC commitments would result in the world s temperature rising by 2.7 C by Although an ultimate agreement along these lines would fall short of the 2 C reduction goal, it would represent very significant progress and provide solid

2 2 momentum for further improvements in coming decades. Five provincial premiers and the Canadian prime minister are now in Paris and the Federal Government has committed only to a 90-day target in coming up with a new national emissions target and a plan for all of Canada. The Conservative government s target had been a 30% reduction in Greenhouse gases (GHG s) by ) The broad details of Albert s climate change policy and differences with other provinces The policy announced in the latter part of November saw Alberta set GHG emissions limits of 100,000 tonnes in the oil sands (compared to current emissions of 70,000 tonnes), force closure of coalfired power plants to close by 2030 thus putting this source of emissions at zero by that date and the imposition of a broad-based carbon tax of $20 per tonne in 2017 and $30 per tonne in Previously, only large emitters those that produce emissions of over 100,000 tonnes of carbon per year were forced to pay the carbon tax. The plan is expected to reduce Alberta s absolute carbon emissions despite industry and population growth but provides no exact targets. The biggest contribution to carbon reduction will come from the closure of coal-fired plants. The surprise in the new policy was the determination to replace two thirds of the coal electricity generation by renewable energy, primarily wind power. Currently, 9% of power comes from renewables. Despite the abundance of natural gas in Alberta, its role is to be restricted to base load reliability. It is estimated that at least $15 billion will have to be invested in new power generation. Other provinces have different schemes. For example, Ontario is about to introduce a cap-andtrade system which gives three years of free pollution permits before any market auction kicks in. British Columbia has had a $30 per tonne broad carbon tax in place for several years but has not increased it or announced any future increase to compensate for additional carbon emissions from liquefied natural gas (LNG) plants. The challenge will be for the federal government to come up with an overarching carbon reduction national target since three quarters of carbon reduction by 2020 will come from provincial actions and, even with Alberta s new policy, provincial plans do not achieve the previous Conservative government s 30% reduction target by ) Our conversations in Calgary with energy industry executives Although our one-week Calgary visit preceded the NDP s announcement of its new climate change policy, the actual announced policy was very much in line with the wishes of most executives we spoke with. For example, CNQ wanted to see a portion of the new taxes being committed to funding carbon reduction technology and the NDP government has said that part of the expected $3 billion in additional revenues from the carbon tax will indeed be committed to new technology funding as well as to compensate low-income earners hit by the additional taxes and subsidizing investment in renewable energy. Imperial Oil also pointed out to us the technological progress they have been making in GHG reduction. For example, they mentioned that Kearl product was being produced at the same GHG level as an average US barrel. Its solvent assisted SAGD technology produces a smaller GHG footprint than steam assisted SAGD and is commercially viable. It also has a cyclic solvent process in a pilot operation to test further reductions in emissions below the industry average. In sum, the company spends $150-$200 million a year on research into new technologies. The research has three objectives: to improve the environmental footprint as well as the performance and economics of the operations(s). In addition, research on its paraffinic froth treatment to remove sand and water from the bitumen would mean that no upgrader would be required since the bitumen can be put directly into a pipeline if treated in this way. In fact, Imperial s CEO has said that, in his view, this type of advance would mean that no upgrader will be built in Alberta in the years to come. While the new climate change policy was in line with industry leaders hopes, it was better than generally feared in terms of the impact on oil sands operators and the energy industry generally. Despite flattish energy prices in the week after the announcement,

3 3 oil sands stocks and energy stocks were generally flat to slightly up. However, this is no doubt that the cost to the Alberta of the new carbon tax, which the government has estimated at $3 billion annually, will be a drag on the Province s GDP. However, it has at least removed one source of uncertainty in terms of the energy industry s future plans. Aside from the price of oil, the other major uncertainty for the industry is the royalty review. However, the expectation of the executives that we spoke to in Calgary was that the negative impacts of any changes would be minimal. These executives were encouraged with the composition of the Royalty Review panel as they had also been with the Climate Change panel. The members of the Royalty Review panel were deemed by them to be superior to the composition and experience of the Stelmach Royalty Review panel. They felt that although the Government will not be bound by the recommendations of the panel (not the case with Stelmach s panel), there was general sympathy that the industry could not afford additional royalties at current energy prices although they would generally not be surprised to see an additional royalty hit if prices moved back to much higher levels ($80-$100 per barrel was mentioned). The general conclusion from the executives we spoke to was that the industry does not work at oil prices of $40 to $45 a barrel and so any increase in costs beyond what has been proposed in the new climate change policy would result in decreased activity and jobs in the energy sector in Alberta. 2) Investment implications a) Low cost and low emissions oil and gas producers will likely be favored by investors The 40% required reduction in methane gas emissions under Alberta s new policy is tough to assess at this early stage but investors are likely to pay increasing attention to what companies like Imperial Oil are doing in terms of reducing their emissions. In our last Strategy Note on the implications of the upcoming Paris climate change conference we asked to what extent would carbon capture technology be commercially viable. We mentioned the Saskatchewan carbon capture Boundary Dam project but omitted to mention Shell Canada s Quest carbon capture project near Edmonton, which will capture and store more than one million tonnes of CO2 each year from Shell s oil sands upgrader. Shell is the technology facilitator and is receiving funding from both Alberta and the federal government. The Company is openly sharing its technology and processes with other countries to help bring down costs of future projects worldwide. b) The risk of stranded assets In that same Anchor Note two weeks ago, we discussed the risk of stranded assets without adequate compensation particularly in light of the prospect that coal fired generation would likely be the main target in the Province s reducing GHG emissions - and what that might mean for a company such as TransAlta. Complete exposure of all coal fired plants by 2020 was largely expected but, following the November 21 st release of Alberta s new climate policy, TransAlta expressed its relief in its own press release, which included the following statement by its CFO: In the past six months we ve seen a significant devaluation of our stock price due to the uncertainty of the future value of our coal assets in Alberta. The province s 15-year transition, and the commitment to appoint a negotiator, confirms that Alberta does not intend to strand capital. The next day, TransAlta and TransAlta Renewables (RNW) announced a dropdown of $540 million of assets from the parent to RNW and associated financing. These assets comprised 611 MGW s of contracted power generation assets (specifically a co-gen operation and wind and hydro facilities) located in Ontario and Quebec. c) The demand for increased energy from renewables will be considerable With two thirds of the replacement of coal-fired plants to be in the form of renewables and the balance in gas-fired generation, there is further opportunity for investment in this segment by TransAlta and TransAlta Renewables over the next number of years. However, these are not the only companies that can benefit from further investment in renewables.

4 4 Enbridge sees significant opportunity in wind where it is already a significant factor. In just over a decade, Enbridge has invested in more than 2,000 MW (gross) of wind-power capacity in North America, en route to becoming the second-largest wind energy generator in Canada. In 2011, Enbridge entered the U.S. wind energy market with its acquisition of the 250 MW Cedar Point wind farm, in Limon Colorado. In 2014, it expanded its U.S. renewable energy footprint with three new facilities the 110 MW Keechi Wind project, in Jack County, Texas; and its 80-per-cent interest in the 202 MW Magic Valley facility, located near Harlingen, Texas and, the 200 MW Wildcat wind farm near Elwood, Indiana. ENB s 14 wind farms across North America now have a total gross generational capacity of 2065 MW (more than 1,400 MW net) -- including the 300 project near Lethbridge, Alta., the largest wind facility in Western Canada. Currently, wind comprises 3% to 4% of its profits but ENB estimates that in 5 years, wind could contribute 6% to 8% of its profits and double that percentage again in the following five years. Like Brookfield Renewable Energy Partners L.P., ENB is seeing a lot of opportunity in Europe both for its expertise and its capital as well as in the United States. On November 26 th, ENB announced the $200 million purchase of a wind operation in Virginia. Currently operating wind, hydro and nuclear plants as part of its 111,800 MW of power generation, TransCanada is likely slightly disappointed that gasfired generation is to play second fiddle to renewable energy in Alberta s new plan. Nevertheless, there will likely be a need for several new gas-fired plants over the next number of years. Our interview with TransCanada management revealed that an average gas fired plant would likely require in the area of a $1 billion investment with attractive rates of return for a company like TRP with a low cost of capital. Several of these will be required over the next number of years and TRP should be capable of getting its fair share of that incremental investment. Conclusions In sum, we would suggest that the Alberta climate change policy has largely satisfied the environmental critics while at the same time providing the incentives for the energy industry to grow but with a much lower than otherwise carbon footprint. The industry participants we spoke with were far more concerned about the possible implications of the new climate change policy than the royalty review (new rules likely to be announced early in the New Year). Of course, the price of oil and gas remains a major uncertainty and, as a result, the industry is being run on the basis that oil prices will be lower for longer (in the $40 to $45 area). The valuation of the related stocks is generally reflecting that sort of assumption so that any rally in oil prices, which we believe could be evident in the next few months, could result in a significant rally in the equities in the sector. It is our strong feeling from our trip that the sector is very much under owned both sides of the border. Portfolio changes There were no changes in the Anchor funds since we issued our last Anchor Note. Nick Majendie, CA Director, Wealth Management, Senior Portfolio Manager, ScotiaWealth PLEASE NOTE: IMPORTANT DISCLOSURES AND DISCLAIMERS ARE CONTAINED ON THE FOLLOWING PAGES.

5 5 i The Bank of Nova Scotia is the parent company of Scotia Capital Inc. ( SCI ) and is therefore a related issuer of SCI. Scotia Managed Companies Administration Inc., a wholly-owned subsidiary of SCI, is the manager of the Anchor. ScotiaWealth, a division of SCI is the portfolio advisor to the Anchor. Nicholas L. Majendie, who is employed by ScotiaWealth, provides portfolio advice to the Funds. This information reflects Mr. Majendie s opinions as of the date of these notes. These opinions may change at any time and neither Mr. Majendie, ScotiaWealth nor their affiliates undertake to update the information or opinions. This information and opinion does not constitute investment advice or an offer to trade securities. Anchor hold securities of the following issuers referred to in this note: Brookfield Renewable Energy Partners L.P., Enbridge, TransAlta, TransAlta Renewables. Nick Majendie, who provides portfolio management advice to the Anchor, personally holds securities of the following issuers referred to in this note: Brookfield Renewable Energy Partners L.P., Enbridge, TransAlta, TransAlta Renewables. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. These Anchor are distributed under a Simplified Prospectus. The Simplified Prospectus, Fund Facts and Annual Information Form are available from ScotiaWealth or on This publication is intended only to convey information. It is not to be construed as an investment guide or as an offer or solicitation of an offer to buy or sell any of the securities mentioned in it. The author is an employee of ScotiaWealth, a division SCI, but the data selection, analysis and views expressed herein are solely those of the author and not those of SCI. The author has taken all usual and reasonable precautions to determine that the information contained in this publication has been obtained from sources believed to be reliable and that the procedures used to summarize and analyze such information are based on approved practices and principles in the investment industry. However, the market forces underlying investment value are subject to sudden and dramatic changes and data availability varies from one moment to the next. Consequently, neither the author nor SCI can make any warranty as to the accuracy or completeness of information, analysis or views contained in this publication or their usefulness or suitability in any particular circumstance. You should not undertake any investment or portfolio assessment or other transaction on the basis of this publication, but should first consult your investment advisor, who can assess all relevant particulars of any proposed investment or transaction. SCI and the author accept no liability of whatsoever kind for any damages or losses incurred by you as a result of reliance upon or use of this publication in contravention of this notice. CONT D ON NEXT PAGE

6 6 The statements in this newsletter may contain statements related to future financial performance of certain securities, indices or the Anchor Managed funds that may constitute forward-looking statements. These statements may be identified by words such as expect, look forward to, anticipate, believe, seek, estimate, project, potential, predict, or words of similar meaning. Such statements are based on the current expectations and certain assumptions of the author, and are, therefore, subject to certain risks and uncertainties. A variety of factors, many of which are beyond the author s control, affect the performance of the securities and capital markets indices and therefore the performance of the Anchor funds and could cause the actual results, performance or achievements of the securities, indices or the Anchor funds to be materially different.