What do decision-makers care about when investing in future-fit hydrocarbons?
John McNally is a Senior Research Associate and the Manager of the Clean Growth team at the Smart Prosperity Institute. He is a member of the working group for the Energy Futures Policy Collaborative.
Alberta’s hydrocarbon sector faced an uncertain future in a world moving towards lower-carbon energy before the pandemic, with existing trends accelerating since March 2020. This uncertainty towards the future of the sector offers both risks and opportunities. The province’s rich natural resource wealth and highly skilled workforce have potential to capture a growing share of the clean technology market, and play a pivotal role in reaching climate targets.
In order for Alberta’s oil and gas sector to play a significant role in advancing either objective, it must first address its challenge in attracting private capital. In order to do that, the province will need to advance projects that are attractive to investors. Recently, a range of standards have emerged that are used by investors to evaluate attractiveness, with criteria going beyond traditional financial returns. Investors increasingly care about progress towards climate targets, preventing environmental degradation, and taking a more fulsome view of the costs or investment required to realize an investment opportunity.
A new policy brief by the Smart Prosperity Institute, as part of the Energy Futures Policy Collaborative hosted by the Energy Futures Lab, conducted an evaluation of some of these criteria and standards. This evaluation seeks to answer a specific question: What makes an investment in future-fit hydrocarbons attractive to decision-makers? This work will help provincial stakeholders identify what criteria are used to assess their performance and attractiveness to decision-makers, ensuring they can advance projects that meet those criteria.
Being graded on a curve
The future is an uncertain place. Investors, policymakers, and academics are increasingly trying to make it less so. This group of stakeholders, collectively referred to as decision-makers, are all thinking about which investments align with the future they (or the Boards and citizens to whom they are beholden) want to live in. These definitions of future fitness have progressed into the evaluation and assessment stage. Decision-makers globally are increasingly using established criteria to evaluate the future-fitness of investment opportunities, including investment frameworks, transition taxonomies, and transition pathways.
Importantly, these criteria are based on different sets of concerns than investors have had in previous decades. As efforts to reduce emissions and adapt to climate impacts grow in ambition to match the scale of the challenge, investors are growing increasingly concerned about the risks of stranded assets and maintaining social license to operate. This concern has shifted into action, with quantifiable assessment criteria and performance metrics being developed to minimize risk and measure performance in translating historic principles into current and future practices.
Any region or government wanting to attract private capital is aware of these changes. However, while a new investment framework or taxonomy pops up on a seemingly monthly basis, it is not always clear which criteria are emerging as areas of consensus across disciplines and frameworks. Yet these areas of emergent consensus matter a great deal: If Alberta wants to attract capital and support from a broad array of decision-makers, it will need to ensure the projects it advances are attractive based on the criteria they are using.
Better identifying these areas of emergent consensus, in turn, can inform how the province wants to define future-fitness in its own right. A definition that aligns with that of decision-makers whose capital is desired could prove catalytic in driving greater investment into provincial opportunities, and could be substantiated by adding Made-in-Alberta criteria that advanced the province’s own goals as well.
To support this discussion, Smart Prosperity is conducting analysis to identify what criteria have emerged as implicit areas of consensus between different types of decision-makers internationally, and has identified three questions that virtually all stakeholders ask when evaluating future-fitness:
1. Does a project reduce absolute emissions in line with achieving science-based targets? The primary metric being used to assess environmental performance is not whether emissions are reduced, but whether absolute emissions decline at a rate aligned with global achievement of science-based targets set by international bodies. Unless improvements in carbon intensity or efficiency improvements can demonstrate alignment with science-based international targets, they are not likely to meet this standard.
2. How robust is a project against potential futures? Robustness across potential futures is the primary lens through which investors assess risk, and policymakers and academic assess attractiveness in a low-carbon future. The primary variable investors use to stress-test projects is how much risk of asset stranding accompanies an investment across futures with different rates of decarbonization. The more aligned an investment is with a zero emissions future, the more robustness (and less risk) it offers to a portfolio.
3. What level of specialized infrastructure is required to realize this investment opportunity? Frameworks and taxonomies stress that evaluating the amount of specialized infrastructure required to commercialize a given investment is critical to accurately assessing risk. The less new specialized infrastructure that is required to realize an opportunity, the more likely that commercialization can occur rapidly. If new specialized infrastructure is required at scale, indications of high levels of government support can also serve to reduce risk.
Each of these three questions emerges almost uniformly across decision-maker frameworks, taxonomies and pathways discussions. This highlights the need for a given project that credibly respond to all three question if it wants to be considered attractive by a wide range of stakeholders making or influencing investment decisions.
Alberta needs to be net-zero aligned if it wants to attract capital
Investors want evidence that projects are aligned with a zero, or net-zero, emissions future within the upcoming decades, that a given project is robust across a range of decarbonization scenarios, and that the costs of new infrastructure are being appropriately considered. If those three criteria are not met, then capital will go towards opportunities that can credibly answer these questions.
It’s that simple: If a project wants to attract private capital, it needs to score well on the criteria being used by decision-makers. If not, the task is made more difficult. Any Made-In-Alberta definition of future-fitness will need to keep these criteria in mind, since attracting capital is ultimately required to drive the prosperity stakeholders seek to achieve. For a deeper dive into this topic, read the policy brief Evaluating future fitness: What matters to decision-makers when considering whether a hydrocarbon investment is future fit?.
