Bennett Jones
Produced by Claire Kennedy, Serge Dupont and Vivek Warrier
Canada must make the energy sector a driving force of our economic recovery from the COVID-19 pandemic. Hear how we can do this while pursuing climate change goals, through transformative innovation and partnership between industry, governments and Indigenous communities. Claire Kennedy hosts this discussion with Vivek Warrier and Serge Dupont, all of Bennett Jones LLP.
Transcript
Speaker 1:This is Business Law Talks, the Bennett Jones podcast series that sits at the intersection of law and policy. Join our lawyers and advisors as they examine today's most complex issues to help guide companies doing business in Canada.
Claire Kennedy:Welcome to Business Law Talks. I'm Claire Kennedy, senior advisor at Bennett Jones and moderator for today's podcast on the outlook for the Canadian energy industry and the path to recovery and rebuilding. I'm joined by Serge Dupont, senior advisor and co-author of the recent Bennett Jones spring 2020 economic outlook, and Vivek Warrier, partner and co-lead of our energy industry team.
Claire Kennedy:Canada's energy sector entered 2020 with strengths, but also some significant non-COVID-related pressures. And then came March and an unprecedented economic shock. Serge, can you recap the economic outlook to frame our conversation?
Serge Dupont:Sure, Claire. I'll Make three points on the global backdrop.
Serge Dupont:The first point is that we really cannot overstate the severity of the crisis that we're now undergoing. To give you a sense of the drop in economic activity globally that we've witnessed over the last number of months, the IMF and the OECD are basically projecting now global output for 2020 will be down 5 to 6% relative to 2019. To put that in perspective, in what was called the Great Recession of 2008, '09, the worst year was 2009 when global output dropped by 0.6% roughly. So we're now talking about 5 to 6%. For advanced economies, the drop in output is 8 to 9%. That includes Canada and the United States, for example, versus about 3% in the Great Recession. The drivers of energy demand in some cases have dropped even sharper still. The demand from US refineries for oil at this time is about 20% below where it was a year ago. US inventories are at record high. Of course, imports are down. Prices have recovered from their lows, but there's not much upside on the price side.
Serge Dupont:The second point is that this is unlikely going to be a V-shaped recovery. This was perhaps a hope some weeks ago. It is dissipating fast. Everybody's understanding now that this recovery is going to be slow, uneven, and bumpy.
Serge Dupont:And the third point that kind of goes along with the second is that there is exceptional uncertainty around what is the path ahead. Governor Macklem has spoken about a fog of uncertainty. A lot depends on whether we're going to have a second wave of the virus and when, and when we will actually have a vaccine broadly available. The OECD, for example, produced two scenarios that they called with equal probability. And one has a W-shaped kind of recovery. So no one has seen this movie before, Claire. It's playing in real-time. And of course, businesses have to be very agile to adapting to developments.
Claire Kennedy:Thanks, Serge. The outlook for the next couple of years is therefore very challenging and the preponderance of risks seem to be to the downside. Vivek, how is the industry responding?
Vivek Warrier:What we've seen as Serge just described is a cataclysmic combination of demand destruction and a price collapse to the point where we actually recently saw negative pricing for Canadian crude, and all of this happened at a time where an already cash-constrained industry was coming into what we call redetermination season. So the time of year where banks and lenders reassess the creditworthiness of producers and service companies, obviously that creditworthiness right now has been profoundly compromised.
Vivek Warrier:So we've seen certain companies tip over into insolvency processes both in Canada and the United States, Chesapeake being the most recent, significant example. But we've also seen on the Canadian side of the border banks be very patient and work collaboratively with entities to try and find a path forward. One of the recent transactions that we worked on was for a company called Bonavista Energy, where we were able to assist them recapitalize with, again, the cooperation of their banks and note holders to find a path forward to set themselves up for success when prices recover, which they are forecasted to do. So I think that signals to the world that again, the Canadian industry has been characterized historically by extraordinary resilience. The resources here, it isn't going anywhere. Our technical proficiency is best-in-class globally, and demand is sure to recover once we emerge from the pandemic.
Claire Kennedy:Great. Thank you, Vivek. So a lot of restructuring, balance sheet repair, and maybe some green shoots of optimism, which I'd like to come back to in this conversation. But first, Serge, I want to bring you in on another source of downside risk to the economy. And that's geopolitics. There seems to be this time around even more limited global coordination, I would say even among G7 members than there was say, compared to the Great Recession of '08, '09, and of course, 2020 is an election year in the US. Talk to us about what this context means, or perhaps doesn't mean for the Canadian energy sector.
Serge Dupont:I think what it means fundamentally... I'll describe it very quickly... is that we basically have to find our own anchors in terms of corporate strategy and in terms of policy in Canada, because the world itself isn't really going to give us a lot of guiding posts for the next little while. In the energy sector specifically, we've seen play out the gamesmanship and OPEC [inaudible 00:06:31] strategies of Saudi Arabia and Russia. Are they in fact targeting US shale and trying to basically diminish that sector? If so, Canada is going to be collateral damage. So that's something, of course, we do not control we'll have to adapt to. The China-US strategic rivalry is a cloud over a global recovery that touches upon virtually every sector of the economy. Are we seeing a decoupling of supply chains globally? And what does that mean for global trade and global investment?
Serge Dupont:We're seeing as well a weakening of global institutions like the WTO. Eventually the IMF that could actually have to play more of a role if the crisis becomes worse in some of the developing emerging economies. So all of this is a difficult kind of economic context globally. US presidential elections are an added factor of uncertainty there. Of course, under a renewed Trump administration, you would continue to see the America first strategy play out in ways that are sometimes unpredictable. A Biden administration might be more globalist and come up with a new agenda for infrastructure and for climate change. That would be focused on US interests and their perception of US interests. And that, of course we know, based on these statements from the presidential candidate, would mean cancellation of KXL as he has put it to date. So again, we have to find our own anchors in this very uncertain world. Energy is an important asset. Vivek is absolutely right. I mean, demand will recover at a point in time. We have to be ready with a strategy to address this more uncertain world.
Claire Kennedy:Thanks Serge. So we've talked quite a lot about the intersecting and complex challenges for the industry, but I did want to come back to opportunity. Vivek, can you talk to us about where you see investment likely to occur, potentially occurring?
Vivek Warrier:Yeah, for sure, Claire. I think broadly speaking, it will be, as Serge said, demand-driven, but how can we position ourselves to take advantage of that demand? I think the transactions that we'll see emerge as demand starts to recover are going to be based on value-driven opportunism. And we know surely that investors will be drawn to the jurisdiction with the most inviting combination of return on capital, regulatory, certainty, and ESG advantages. And I think that should be the focus for the industry in Canada working closely along with government. What types of transactions are we likely to see in the second half of the year and going into 2021? Obviously consolidation comes immediately to mind. We've been approached, for example, by a US-based fund that was looking to aggregate assets from a number of distressed companies to create a new entity that might be able to realize both financial and operational efficiencies going forward.
Vivek Warrier:Asset rationalization. The big headline recently was BP's shedding of its chemicals business. We have seen already in Western Canada companies engage in asset rationalization either by disposing of non-core production assets or by spinning off their midstream assets to form a new entity and entering into a relationship with that entity. So investment is hovering. People are interested mostly because there's great value in Canadian assets at this time.
Vivek Warrier:The other thing that I think we will see driving investment is government incentives. So in the Alberta recovery plan just announced yesterday, the Alberta government promised a significant package of incentives to incentivize petrochemical development. We are already seeing interest in act for a number of parties that are exploring developing petrochemical facilities in Heartland County in Alberta. Feedstock is abundant. Labor costs have rationalized. So I think we can look positively towards and optimistically towards seeing developments like that in the future.
Claire Kennedy:Vivek, you've raised ESG factors, environmental, social, and governance factors. Let's talk more specifically about climate change. And I want to come to you Serge and ask you how it needs to be, how it will be factored into the path for recovery and rebuilding of the Canadian energy sector.
Serge Dupont:Thank you for the question, Claire. There are and will continue to be many policy and political debates about climate change. Let's just look at capital, the financial system, and what is playing out there. Number one, institutional investors, the largest globally, have come together to advance in the corporate sector better disclosure of climate risks to ensure that those climate risks are better managed, to exert pressure on corporations to drive emissions down, and to take action on climate change. And that is happening now.
Serge Dupont:A report was written, presented to the Minister of Finance last year, authored by Tiff Macklem, who of course is now the governor of the Bank of Canada, on sustainable finance, how the financial system can actually be an actor of management of climate risks and action on climate change. So that will be an important dimension of how Tiff Macklem will be approaching, I suppose, his position as governor of the bank of Canada. Internationally, central banks, 66 of them with financial supervisors are also quite intent on ensuring that they have climate risk very much on front and center on their screen as a risk for the financial system going forward. So those are forces that are going to affect where and how capital is allocated globally and in Canada. And it is therefore important for corporations to be driving innovation and driving innovation with a view to addressing emissions, into making a contribution to the fight against climate change.
Claire Kennedy:Thanks, Serge. You've raised innovation. And I want to go to you now Vivek, and ask you to help us understand how the industry is applying innovation.
Vivek Warrier:Well, thanks Claire. Just to take a step back, I think it's worth noting that this is a sector that historically has engaged in a constant cycle of innovation and has invested massively in technology primarily with the view of driving down its own cost. Now, the need for such innovation has been dramatically underlined, as Serge noted, by the need for the industry to mitigate its impact on the climate. So in my observation, the industry has been focused on two broad categories of innovation.
Vivek Warrier:The first is incremental and that is displayed through their continued, relentless focus on a year-to-year basis on driving down emissions through enhancing the day-to-day processes of production and transportation of hydrocarbons.
Vivek Warrier:The more important one, which I feel the industry is truly investing in, is what I'd characterize as transformative innovation. I think we all recognize that any pathway to mitigate climate change requires rapid reduction of CO2 emissions. And this means deployment of negative emissions technologies like enhancing carbon capture technologies, like development of hydrogen as a fuel source and feedstock. And in my view, the industry has really embraced these challenges, and I think we've seen from the commitment of various companies in the industry to achieve net zero, as soon as reasonably possible.
Claire Kennedy:Thanks, Vivek. It's clear that innovation is going to be an important lever of growth. So let's stick with growth, but pan out a little bit. And I'm going to ask you Serge, to help us take that step back and outline for us the policy conditions necessary for Canada to realize its energy potential.
Serge Dupont:Thank you, Claire. You're very right to say perhaps beyond the program, beyond the tweaks to this or that particular initiative, what does it take? I would just say three things at a high level, but they're really all quite critical.
Serge Dupont:The first is a recognition... it sounds trivial, but frankly it isn't... a recognition of the importance of the energy sector and oil and gas to our economy. And I would just want to focus on the balance of payments. The net exports of energy in 2019 for Canada were $76 billion. $62 billion of that was crude oil. Of course, we're not going to get the same contribution in 2020 because of what's happening to demand, what's happening to price. But over time, there is nothing that can replace the contribution of energy and oil and gas to our balance of payments, that by the way is in a position where despite this contribution, we actually have a deficit in our merchandise trade, a deficit in our current account, and therefore we have to import foreign capital in order to make up for that. So we really have to recognize how critically important that sector is to our economy.
Serge Dupont:Second, we need clarity in the policy framework. Clarity of our objectives and goals. For example, in GHG emissions, where do we want to go? Clarity of legislation, clarity of regulation in terms of process, in terms of timelines, in terms of the guidelines that are provided to industry for compliance with the regulation. Governor Macklem has spoken about a fog of uncertainty in the global economy. We need to lift the fog of uncertainty over domestic policy. Industry can win, as Vivek mentioned, with its technical proficiency and its innovation proficiency if it knows the rules of the game.
Serge Dupont:And the third ingredient... and Vivek mentioned this as well... is going to be partnerships. We need first, partnerships among our levels of government. Secondly, partnerships between government and industry. For example, in infrastructure. And there's an instrument called the 10 infrastructure [inaudible 00:18:00] yet to play the kind of role that it can play in energy, perhaps more.
Serge Dupont:And for example, in infrastructure projects like [interties 00:18:09] and [inaudible 00:18:10]. And then government industry partnerships in terms of innovation, hydrogen, carbon capture, utilization and storage, SMR technology, nuclear, that's not going to happen with private capital loans. There will have to be some public investments as well. And finally partnerships between indigenous groups and industry as maybe facilitated for example by the Alberta Indigenous Opportunities Corporation. There will have to be that partnership with indigenous groups, indigenous peoples in order to move the sector forward. And there's great examples already available to build upon.
Serge Dupont:So those are three really critical things that can provide the guiding posts for different programs, different initiatives, but there needs to be this recognition, this clarity, and then the partnerships to make things work.
Claire Kennedy:Great. Thank you, Serge. So just on that last point about partnerships, Vivek, can you react to that and give us a flavor for what you're seeing on the ground in terms of the potential for this working together under what is going to be an architecture, hopefully of clarity, that will provide the right platform for growth?
Vivek Warrier:Well, I think, Claire, that it is absolutely the model that we're going to see going forward. Our clients have always been very progressive, and the industry has been at large, in engaging with First Nations and working very hard to meet their obligations, to consult and to engage in proper stakeholder relations. But at the end of the day, what is more beneficial for all parties is where those entities are aligned, working together with a view to a common benefit. So we've seen increasing interest in equity investments by First Nations entities in new projects. We expect that that will be a trend that continues, and kudos to the Alberta government for engaging in a program that will try and expand that type of collaboration.
Claire Kennedy:Great. Thanks, Vivek. We're going to wrap up and I'm going to ask each of you for a brief takeaway for our listeners. Just let me, as I wrap up, say that we've seen, to paraphrase Hobbes, a challenge that is nasty brutish and perhaps longer than we would want. But nonetheless, the energy industry is one that has been resilient, as you said, Vivek, through business cycles before. And there are many opportunities for innovation fostered by perhaps almost unparalleled potential for cooperation and partnership in Canada as we come to understand how essential the energy industry is. So some green shoots on the horizon, we hope. As we wrap up, let me just go to you. I'll go to you, Serge, for your takeaway for our listeners and then over to you, Vivek.
Serge Dupont:Okay, Claire. I mean, typically when you go through a crisis, you'd like things to get back to normal pretty quickly. What's going to happen here is that the new place we're going to be is not necessarily going to be what it was before. So it's not good enough to just survive the crisis. You have to think about where you are on the other side. Got to think about the balance sheet you're going to be carrying in terms of both the assets side of that and the liability side of that. Think about the market strategy. We spoke about some of the risks globally. Think about the corporate strategy, whether you're going to be the partners. What kind of restructuring or consolidation may there be in the industry to help with the next phases? And what's going to be the innovation strategy? What is going to change that is going to be responding to the new opportunities in this new world?
Claire Kennedy:Great. Vivek? Closing words?
Vivek Warrier:[crosstalk 00:22:23] Claire is that these are problems that we wrestle with every day on behalf of our clients and are very pleased to do so. And what we envision and are working with our friends in industry to help accomplish is those ever-greater levels of collaboration with government, with First Nations, and with other players in the market to help this industry recover and find its path back to prosperity and sustainability.
Claire Kennedy:Great. Those are great closing words. So thank you to Serge Dupont and Vivek Warrier. And thank you to you, our listeners. We hope you join our Bennett Jones Business Law Talk series again. In the meantime, I invite you to get more information on our podcast series and access the spring 2020 economic outlook and our COVID-19 resource center at www.bennettjones.com.