Canada: Investing in a Changing Climate

Last Updated: July 20 2010

Article by Andrew Little & John Fahey

Originally published in Resource World Magazine, www.resourceworld.com, July 2010.

Many oil and gas operations, mines and construction projects in the Arctic areas of Canada, Alaska, Scandinavia and Russia depend on cold, solid ground and winter roads over frozen lakes and rivers to transport heavy equipment, fuel and supplies. Located where there are few traditional road networks, such operations and their personnel depend on months of frigid winter temperatures that make it possible to access resources that might not be economically viable if access were only by air or sea.

Yet the changing global climate is reducing the number of weeks of dependable cold weather, placing the solid ground and ice roads in peril. Shorter winters and less reliable frost conditions mean fewer weeks during which remote sites can be reached. In recent years, the opening day has become later and the closing sooner, and those times are less reliable.

On the other hand, climate change may bring new opportunities. Consider that the same warming trend that imperils winter drilling and Arctic ice roads is bringing a longer ice-free period in the oceans of the Arctic, making water-borne transportation an increasingly attractive alternative.

Climate change and extreme weather events such as hurricanes are leading securities regulators, company management and investors to recognize that the physical effects of climate change can be a material concern affecting the future success of companies, including resource companies. Investors need to understand how climate change can affect the competitiveness of those companies.

Securities regulators have already taken notice. For example, in its Commission Guidance Regarding Disclosure Related to Climate Change issued in February 2010, the US Securities and Exchange Commission indicates that "in addition to legislative, regulatory, business and market impacts related to climate change, there may be significant physical effects of climate change that have the potential to have a material effect on a registrant's business and operations. These effects can impact a registrant's personnel, physical assets, supply chain and distribution chain."

The Management Discussion and Analysis (MD&A) section of a company's public filings is expected to disclose information on a wide range of matters that are reasonably likely to have a material effect on the company's financial condition or operating performance – a standard that should now include climate change, the SEC's Guidance indicates. It is widely understood that disclosure may include a company's financial exposures to legislation or regulations related to greenhouse gas emissions, such as carbon tax regimes and the trading of carbon credits. But the physical effects of climate change arising from severe weather, sea levels, and water availability and quality – all of which directly affect the resource industry – have not received nearly as much attention.

The MD&A must include Management's analysis of the likelihood of a potential change and the magnitude of its impact on the company's fortunes. Doing so might involve, the SEC says, provision for the purchase of carbon credits, or the measures the company must take to reduce its carbon footprint to reduce its need to purchase credits – or changes to profit or loss arising from increased or decreased demand due to legislation or regulation.

Taking Climate Change Seriously

So far, there is no international political consensus on how to address climate change, particularly in an era of global economic turmoil. For investors, climate change may be addressed much like any other risk factor. There are steps that companies and investors can take to identify and manage their risks. Climate change is one of the risks that the company evaluates as part of its broader enterprise risk management process.

Investors evaluating companies for climate change risk need to determine first whether the issue is being treated seriously. Has the company determined whether there are risks from climate change for its operations? Has it established leadership in this area by assigning responsibility to a member of senior management?

For some companies, there may be few, if any, risk factors associated with climate change – although it may be difficult to imagine a resource company that will not be affected by the extreme weather, warmer temperatures, altered precipitation patterns, higher sea levels and other changes expected from climate change.

The company then needs to make public disclosure if the risks from climate change are material. In many cases, this information will not be just in the fine print of an annual report, but may be in a prominent place in the report, including the MD&A. One indication of how seriously the company is taking its risks and opportunities could be how easy it is to find information on climate change. Currently, many companies do not mention the potential effect of climate change at all in their public filings.

Another key indicator for investors is whether the company is taking a methodical approach to assessing its risks and opportunities. This should include the assignment of human and financial resources to analyze the risks and develop concrete plans to manage those risks, and adapt to long-term changes in the environment. Even if the assessment is not required to be formally disclosed in regulatory filings, lenders and institutional investors may well be very interested in what the company is doing.

Some of those risks relate to the physical operations of the resource company itself. If there is only one road in and out of a mine, drill site or other location, its operations would be vulnerable if a stronger-thanexpected storm washes out the roadway.

Other concerns stem from a company's wider relationships. If the company has a single source for an essential item such as tires or drill bits, resource operations are at risk if a storm or other climate-change event disrupts the ability of the supplier to manufacture or transport it to the site. A sole supplier's risks may easily flow downstream.

THE NEW NORMAL

Still other risks are less obvious and their impact will be felt more slowly. While it's big events like Hurricane Katrina that make the headlines, climate change is a gradual process. It's really "climate creep." For instance, processing plants, pipelines, buildings and roads may deteriorate faster than expected if higher ambient air temperatures mean more freeze-thaw cycles.

Most infrastructure is designed for a certain "envelope" of conditions – a given band of temperature variation, wind strength, rainfall, snowfall or other factors. However, over time, the climate gradually changes and in so doing moves the envelope, possibly towards greater variability. Rainfall may start to exceed the expected norms more often, temperatures may spike higher or lower, or there may be more days of high winds.

Eventually, conditions exceed the previous "normal" often enough that problems become noticeable.

One commonly used design criterion is the "once in a hundred years" event. But as the climate changes, so does the frequency of this "100-year" event.

Consider a resource project access road that crosses a bridge that was designed to handle occasional periods of storm-caused high water. Over the years, storms become more severe, or more frequent – or worse, both – so that now the road gets washed out, disrupting traffic.

Perhaps only after several years of increased interruptions does the resource company realize that "climate creep" has resulted in a "new normal" – one in which it must accept the reality of more severe weather and make plans accordingly. This may increase its costs or require other ways of operating.

One of the difficulties of planning for climate change is that nobody knows what the "new normal" will look like. Investors need to make sure that the companies in which they invest have done their best to understand the risks of climate change and have taken appropriate steps given that understanding. The companies that do so will enhance both their own competitiveness and their investors' long-term prospects.

John Fahey is Global Merger & Acquisitions Lead based in the Toronto office of Golder Associates Ltd.

Andrew Little is a Litigation Partner in the Toronto office of the law firm Bennett Jones LLP.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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