Commentary – Crude Oil Investors Can Measure and Manage Their Climate Change Risk

Source: © Archerix
Source: © Archerix

Do tougher climate change policies diminish investment returns from crude oil assets, facilities and pipelines? Not necessarily, because not all crude oils are the same.

Tougher greenhouse gas (“GHG”) policies are to be expected over the next several years. Last December at the COP conference in Paris, 196 countries pledged to reduce their carbon emissions. As a result, governments around the world are drafting new policies aimed at curbing their GHG emissions.

These new policies, along with climate change concerns, have sparked a debate about the merits of investing in fossil fuels. Not a week goes by without a new headline mentioning a municipality, university, pension fund or faith based group who is considering divesting of fossil fuels.

But climate change policy will not impact all fossil fuels equally. In the case of crude oil, more stringent GHG policies will create opportunity for some producers, because not all crude oils are created equally. There is a wide divergence of carbon content in the 93 million barrels of oil and lighter petroleum liquids that are produced every day.

Under stricter GHG policy, oil wells that produce less carbon will tend to have a competitive advantage, since they will realize greater demand for their lower carbon products and will have lower energy costs. In general, oil wells with greater carbon intensity – in other words, more carbon per barrel produced – will be progressively challenged with increasing levies over time. The lowest cost barrels will have the greatest ability to withstand the policy-tightening trend.

To understand how oil assets in their portfolio could be impacted by future GHG policy, investors need to first understand the carbon intensity of their specific crude oil asset. While there is a wide spectrum of data on the carbon footprints of various crude oils in the public domain  ̶   including the GHG intensities of everything from California heavy oil to North Sea crude oil  ̶  these are average values.  The values do not necessarily represent the emissions from a specific production facility, which can vary significantly from the average.

ARC Financial Corp.’s recently published report – Crude Oil Investing in a Carbon Constrained World – provides investors with a “How to Manual” for estimating the GHG emissions for any crude oil asset. Using the “ARC method” outlined in the report, investors can crunch the numbers to estimate their carbon liability. The calculation uses academic and scientific methodologies that are available in the public domain, including models developed at the University of Calgary and at Stanford University.

Using the ARC Method, investors can generate the data they need to assess risk and return as a function of the carbon footprint of any crude oil asset. This will enable them to test and quantify the sensitivity of their investment returns under different carbon policy scenarios. The method also allows investors to gain context on how their investments compare to other crude oil types.

Investors have long had methods to manage and report risks relating to price volatility and other externalities to the oil business. Informed crude oil investors now have a tool to do the same for carbon policy. What can be measured can be managed.