Investors are increasingly relying on environmental, social and corporate governance (ESG) criteria to complement the various nancial factors that guide their investment decisions. Strong performance in these metrics can make a business an attractive investment opportunity.
While strong ESG performance is, rst and foremost, the responsibility of businesses, jurisdictions can establish themselves as attractive destinations for capital by regulating industry in an ESG-compliant manner. In this article, we brie‑y outline recent legislative and regulatory changes that are aimed at improving the Canadian oil and gas industry's performance in respect of the rst two letters of the ESG acronym: environmental and social concerns.
ESG as financial risk management
One of the greatest drivers of the widespread incorporation of ESG factors into investing practices is the role they play in nancial risk management. Companies that perform poorly in regard to their environmental impact, social and community engagement, and internal governance practices present a higher risk level to a portfolio's performance than companies that more closely adhere to the principles underlying these concerns. The rise of ESG in institutional and private investment decision making re‑ects a growing understanding that corporate nancial performance is intertwined with socially responsible business practices and investors are starting to demand increased disclosure in this regard.
For example, the chief executives of eight major Canadian pension funds recently called for companies and investors to place a larger emphasis on the role of sustainability in their planning, operational and reporting practices, emphasising that such practices, depending on how they are managed, can signicantly contribute to value creation or erosion. To that end, these pension funds requested that companies measure and disclose their performance on material, industry-relevant ESG factors. Around the same time, Institutional Shareholder Services updated its proxy voting guidelines for Canada, adding "demonstrably poor risk oversight of environmental and social issues" to its illustrative list of failures of corporate risk management.
As these trends continue and investors and other nancial institutions increasingly rely on ESG factors to balance opportunity and risk, companies that can demonstrate their business practices and operating environments are in alignment with ESG factors may be better positioned to raise funds in the equity and debt markets.
ESG as legal compliance
Inertia can be a powerful force and, while strong ESG performance can be good for business, not all sectors have responded as quickly as some investors would like. To address this, investors and investor organisations, such as the Principles of Responsible Investment, have actively engaged policymakers and regulators to establish laws that better integrate environmentally sustainable and socially responsible business practices with the legal requirements of doing business. Why? Because targeted government regulation will facilitate the widespread adoption of an ESG-compliant business environment and ensure that ESG-targeted capital can be protably deployed. As legislators and regulators get on-side, ESG is not simply a choice or value that companies adopt or promote to attract capital – it is the law.
One of the greatest collective action problems we will face in the coming decades is climate change. In this respect, there is no question that, from an investment perspective, businesses operating in high-emitting sectors are at an increased risk of divestment or, in a worst-case scenario, becoming 'stranded'. Recognising the risks this poses to any nation's future, and realising that businesses may not react to this imperative in a timely way, governments around the world are enacting ESG-informed laws and regulations. As one of the world's largest oil and gas producers, Canada is among the rst of its peers to broadly embrace ESG in its approach to government regulation.
In 2018, the Canadian government enacted what is referred to as the 'Carbon Tax', which implements two different pricing standards that apply uniformly across the country. The rst – a fuel charge – imposes a charge on fuels based on their greenhouse gas emitting potential. The second – an output-based pricing system for large industry – is intended to encourage emissions reductions from large industrial emitters by setting emissions reduction targets and pricing emissions to the extent those targets are not met.
Importantly, the price on emissions will steadily ratchet upwards over the next decade. While the Carbon Tax is a federal law, provincial governments are able to administer their own, equivalent, emissions pricing programmes. In Alberta, for example, the provincial government administers an output-based pricing system called the technology innovation and emissions reduction (TIER) programme and the funds that it generates support the development and use of emissions-reducing technology, such as alternative fuels and carbon capture, utilisation and storage.
Recognising that methane is another potent source of greenhouse gas emissions, the Canadian government has developed regulations intended to signicantly curb methane emissions from the oil and gas sector by 2025 and, like the Carbon Tax, various provinces have developed their own equivalent regulations. The Canadian government also plans to introduce a clean fuel standard that is, again, intended to reduce the emissions intensity and greenhouse gas emitting potential of liquid fuels distributed in Canada.
Finally, the Canadian government has tabled legislation outlining its commitment to, and establishing a process to help it achieve, net-zero emissions by 2050. Supplementing this effort, a number of Canada's largest oil and gas companies have voluntarily adopted their own net-zero targets.Taken together, the legal changes outlined above will help reduce both Canada's contribution to global emissions and the degree to which its economy is exposed to the nancial risks associated with a changing climate.
The depressed oil prices of the last half decade have thrust Canadian oil and gas producers into the limelight, as decommissioning practices have become central to the integration of environmental performance in Canada's oil and gas industry. Historically, laws that required the abandonment of oil and gas infrastructure imposed no hard timelines on industry. When prices are high, the risks posed by this approach lurk out of sight. But in a low price environment, higher rates of insolvency mean that many of these assets and their abandonment obligations are simply left behind as 'orphans' for others to deal with.
Responding to this environmental hazard, legislators and regulators are acting to ensure closer adherence to the 'polluter pays' principle, so that end-of-life liabilities and obligations do not fall to industry generally or the public. In effect, ESG considerations have in‑uenced an accelerated evolution of liability management programmes in Canada and have become a key part of new policies intended to minimise the long-term environmental impact of oil and gas activity. In Alberta, for example, the Inactive Well Compliance Program and the Area-Based Closure Program started this process and it is expected that licensees will soon be required to spend a certain amount per year on liability reduction. In British Columbia, the Dormancy Regulation imposes regulated timelines for the decommissioning of dormant and inactive sites. Addressing asset clean-up now improves environmental performance in the short term and reduces the long-term risk posed by mounting contingent liabilities.
To supplement these efforts, Canadian legislators and industry regulators have started to implement regimes intended to make sure that operators are able to satisfy their clean-up obligations before they begin operating. In 2017, for example, the Alberta Energy Regulator (AER) introduced new disclosure requirements for industry participants seeking to operate oil and gas assets. The AER uses this disclosure to carry out a risk assessment of the prospective licensee and is in the process of making these requirements more robust. Importantly, the AER is empowered to refuse to issue or transfer licences if it believes that a prospective licensee or the nature of a transaction poses an unreasonable risk of orphaning oileld infrastructure.
Regarding the social component of ESG, governments at both the federal and provincial levels are acting to align major project development in Canada with important social values. For example, the Canadian government's new Impact Assessment Act was designed to better integrate social factors into the regulatory assessment of major projects. Although the new regime still considers environmental impacts, it now places an increased emphasis on social, economic and environmental sustainability, as well as critical health and social factors in areas impacted by new development, including impacts on Canada's indigenous peoples and other historically disadvantaged groups.
Indigenous engagement has also become an increasingly important part of government and corporate engagement in Canada. While Canadian courts continue to develop the parameters of the governments' duty to consult with indigenous peoples impacted by government decision making, project development and industrial activity, legislatures are starting to address these matters head-on. In British Columbia, for example, the provincial government has passed a law intended to ensure that British Columbia's laws align with the United Nations Declaration of the Rights of Indigenous Peoples and the Canadian government has also introduced legislation that is intended to achieve similar goals.
ESG-informed laws and regulations now permeate the Canadian federal and provincial landscape. In this article, we have focused on legal compliance measures that have been enacted in support of this trend, but we should not forget that governments are also using other tools at their disposal to implement ESG objectives, including targeted funding and other incentive programmes designed to make the transition to an ESG favourable business environment more attractive and less costly. Canadian policymakers, legislators and regulators are responding to the ESG imperative and we fully expect that trend to continue.
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