Sustainability Perspectives

Sustainability Perspectives

Unconventional RisksAn investor response to Canada’s Oil Sands

A headlong rush to develop the oil sands in Alberta, Canada is creating a unique set of complex environmental and social impacts that bring risks to energy companies and their investors. Technologies are emerging that could reduce, if not eliminate, some of the impacts - but project development is outpacing mitigation capacity. What’s going on in the oil sands, and what questions should institutional investors be asking the oil sands companies they own? October 2008

Unconventional Risks — An investor response to Canada’s Oil Sands

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Brief At a GlanceAlberta’s oil sands: 173 billion barrels of established reserves, second only to Saudi Arabia, located in stable, dependable, development-friendly Canada. No wonder major oil companies have been rushing in to stake their claim. Yet recent headlines suggest that all is not well. Environmental non-governmental organizations have labelled the oil sands as “the world’s dirtiest oil”, while surveys show most Canadians are concerned about the way the resource is being managed. Further, project delays, construction cost overruns, market volatility, oil price fluctuations, and the appearance of a recession, have sent the share price of some companies tumbling.

While Canadian oil sands have been under development for decades, new technology, rising oil prices, shrinking conventional reserves and voracious demand have fuelled a modern-day development rush to rival the gold rushes of the past. Participation in this rapid expansion is no longer restricted to Canadian stalwarts like Suncor and Syncrude – almost all the world’s major oil and gas companies are now involved, including BP, Shell, ExxonMobil, ConocoPhillips, Total and Statoil. Institutional investors in Canada are invariably involved as energy comprises a large portion of the Toronto Stock Exchange by assets.

Too much development too fast has created a complex set of significantly adverse environmental and social impacts. These impacts introduce a heady mix of litigious, liability, regulatory, and reputational risks to oil sands companies. These risks have the potential to impact company valuations and thus the performance of investment portfolios. Institutional investors are taking note, expressing particular concern about the carbon intensity of unconventional oil. Some call for better disclosure, while others call for divestment.

In this issue of Sustainability Perspectives The Ethical Funds Company® takes a look at the impacts of oil sands development, considers the implications for investors, and proposes a third investor response: calling for the suspension of new oil sands development pending completion of conservation and land use planning, while accelerating the development and application of technologies that could improve project environmental and social performance and reduce portfolio risk. To facilitate this response, we recommend that institutional investors work to secure answers from oil sands companies on a set of questions covering:

Engagement with First Nations and Métis Air pollution and greenhouse gas emissions Water use and pollution Habitat protection Support for conservation and land use planning

Recession in the US suggests that a pause in oil sands development is likely. This gloomy scenario presents an opportunity to put things right. Investors should be looking for companies to provide clear evidence that emerging technologies are under active consideration. Costs of corporate action — or inaction — must be weighed against the impacts. The environmental and social challenges are significant. The risks acute. The controversy intensifying.

Why the rush?The modern oil sands era began in the 1960s. Oil sands development was pioneered by Canadian companies Suncor and Syncrude, and as recently as the 1990s, just a handful of companies were involved. They struggled to make the business pay, and their projects were viewed with skepticism by investors. Over the last decade the industry has boomed, and today, although relatively few projects have reached the operational stage, almost every major Canadian and international oil company has interests in the oil sands.

Who’s in?

Before 1999 Canada’s massive unconventional oil reserves were not widely recognized or promoted. Recognition coincided with a growing realization that conventional reserves were shrinking - and were concentrated in unstable regions of the world. Meanwhile the economics of oil sands had improved through a combination of rising oil prices and technology improvements that reduced production costs, aided by generous tax breaks for the oil and gas industry and, until recently, by an industry-friendly provincial royalty payment regime. The nearly decade-long boom has resulted in energy dominance in the Toronto Stock Exchange with a sector weighting ranging between 25% and 30%. Canadian-based institutional investors needing to benchmark performance – because that is the way they are evaluated – are invariably invested in oil sands companies.

In Canada, the provinces control resource development. In the case of the oil sands, that means Alberta: a province governed for decades by the same conservative, business-friendly party, with a frontier attitude to resource development, and a hands-off approach to regulation. Alberta has been through cycles of boom and bust before. Provincial leaders recall with particular bitterness the National Energy Policy, which contributed to, if not caused, a severe downturn in theprovincial economy in the 1980s, creating a lasting legacy of hostility to federal government intervention in resource policy.


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Company Operating Construction Approved Application

BP XCanadian Natural Resources X X X XCanadian Oil Sands Trust (Syncrude) X XChevron X X X XConnacher Oil & Gas X XConocoPhillips X X X XDevon Energy X XEnCana X X X XExxonMobil XHusky Energy X XImperial Oil X X XJAPEX (JACOS) XMarathon Oil X X X XNexen X XOPTI Canada X XPetro-Canada X X XShell X X X XSinopec XStatoilHydro (NAOSC) X XSuncor Energy X X X XSynenco Energy XTotal X X

Major publicly-traded companies involved in one or more oil sands projects at the operating, construction, approval or application stage.

Alberta’s oil sandsThe oil sands underlie about 140,000 km2 in the Province of Alberta. Deposits are concentrated in three regions: Athabasca, Peace River and Cold Lake. Much of the development is centred around Fort McMurray, a city of about 80,000 people located 435 kilometers northeast of Edmonton.

Oil sands are a mixture of water, sand, clay and bitumen (solid or semi-solid oil). Bitumen can be extracted and either upgraded to synthetic crude oil (SCO) or diluted for pipeline shipment to refineries elsewhere. Upgrading bitumen to SCO is an energy intensive process that requires using hydrogen, or a combination of high temperature and pressure and hydrogen.

About 20% of oil sands reserves, mainly in the Central Athabasca region, are at depths shallow enough for surface mining. Oil sands ore is mined using power shovels and large trucks, then crushed and mixed with hot water to separate the bitumen. Surface mining accounts for the majority of current oil sands production.

About 80% of oil sands reserves are in deeper deposits. Various methods are used to inject heat into the deposits to separate the bitumen in place (“in situ”) and make it fluid enough to extract through wells distributed across the project site. The most common techniques are cyclic steam stimulation (CSS) and steam-assisted gravity drainage (SAGD). Some deep deposits are fluid enough to recover without heat, using cold heavy oil production with sand (CHOPS) and horizontal wells.

Company Operating Construction Approved Application

BP XCanadian Natural Resources X X X XCanadian Oil Sands Trust (Syncrude) X XChevron X X X XConnacher Oil & Gas X XConocoPhillips X X X XDevon Energy X XEnCana X X X XExxonMobil XHusky Energy X XImperial Oil X X XJAPEX (JACOS) XMarathon Oil X X X XNexen X XOPTI Canada X XPetro-Canada X X XShell X X X XSinopec XStatoilHydro (NAOSC) X XSuncor Energy X X X XSynenco Energy XTotal X X

At year end 2007, Canada’s proved oil reserves were just below 179 billion barrels - second only to Saudi Arabia. 173 billion barrels (97%) of Canada’s reserves are oil sands, of which just 22 billion barrels are under active development. Oil sands make up a growing percentage of Canadian oil production - around 40% in 2007. Average bitumen production was 1.32 million barrels per day (bpd) in 2007, and the Canadian National Energy Board estimates production could reach 3 million bpd by 2015. If all currently-proposed projects were to be built and met their start-up dates, production would total 6.3 million bpd in 2020.

At present the US is the biggest market for Canadian oil. Canada edged out Saudi Arabia to become number one supplier to the US in 2004, and provided 18% of US oil imports in 2007.

Over the period 2000-2007 some C$67 billion was invested in oil sands development, 2008 investment was expected to exceed C$19 billion, and the total value of projects currently proposed or underway is as much as C$170 billion.

The investment profile of oil sands and conventional oil projects is different. Oil sands “finding” costs are lower, and development costs are higher, than for conventional oil. Oil sands production projects have long development lead times and investment horizons of 40 years or more. The oil price at which oil sands production is considered economic has risen sharply. In 2006 the National Energy Board quoted a “break-even” oil price of US$ 30-35 per barrel. ln 2008 National Bank Financial calculated that the break-even oil price for new mining projects had reached US$85 per barrel, and US$70 for new SAGD projects.


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Monthly US Crude Oil and Petroleum Products Imports from Canada

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30,0001994 1996 1998 2000 2002 2004 2006 2008

Souce: US Energy Information Administration

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World Proved Oil Reserves (Year end 2007)

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DirectProduction

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Figure 1. Life Cycle CO2 Emissions for the Production of Petroleum from Oil Sands Operations and from Conventional Methods.

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Monthly US Crude Oil and Petroleum Products Imports from Canada

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30,0001994 1996 1998 2000 2002 2004 2006 2008

Souce: US Energy Information Administration

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UAE

Venezuela

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0 50 100 150 200 250 300billion barrels

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World Proved Oil Reserves (Year end 2007)

Fuel End Use

Refining

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Refining

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DirectProduction

Indirect Production

Figure 1. Life Cycle CO2 Emissions for the Production of Petroleum from Oil Sands Operations and from Conventional Methods.

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Conventional Production


Oil Sands

ImpactsNot only is oil sands production expensive, but it also has a heavy impact on the environment and human health.

Air

Alberta is becoming the industrial air pollution hotspot within Canada. Extracting and upgrading bitumen produces a variety of pollutants that can harm human health and the environment. Nitrogen oxides (NOx) and sulphur dioxide (SO2) are not only respiratory irritants in their own right, but they also contribute to smog, as well as to acid deposition (“acid rain”) - which damages forests and lakes. Benzene, a volatile organic compound (VOC) associated with oil sands operations, is a carcinogen. Particulate emissions have been linked to lung and heart problems. Because of extra process steps, oil sands NOx and SO2 emissions per barrel are double those for conventional oil. Despite reductions in emissions intensity per barrel, industry expansion has caused total emissions of NOx, SO2, VOCs and particulates from the oil sands to increase sharply, against the national trend.

The oil sands are Canada’s fastest-growing source of greenhouse gas emissions (GHGs). Estimates vary, but production phase GHG emissions for synthetic crude oil may be 3-5 times higher than for conventional crude. Extraction phase emissions for “in situ” methods CSS and SAGD are higher than in oil sands mining, because of higher energy requirements for steam production. As a result of a more energy-intensive production phase, “wells to wheels” life cycle GHG emissions estimates for oil sands range from 15% to 40% higher than for conventional oil. Regardless of source (conventional or oil sands), “downstream” use of oil still accounts for the majority of emissions.

Water

Oil sands mining is a water-intensive process: 2-4.5 barrels of water are required to extract and upgrade one barrel of synthetic crude oil. Oil sands mining operations are already licensed to divert an annual total of 349 million m3 of water from the Athabasca River. With the addition of planned projects, licensed withdrawals would exceed 500 million m3. Particular concern focuses on withdrawals during the winter, when river flow is sometimes low enough to affect fish habitat. Although there have been some moves to tighten the water licensing regime, oil sands mining operations are still permitted to withdraw water at times when low flows threaten the river ecosystem.

Current mining processes create “tailings” - a mixture of water, sand, clay, silt, residual bitumen and solvents that is too toxic to be released back into the river system. Tailings are pumped into large ponds to settle and await reclamation. The water in the tailings ponds is toxic to aquatic life, and there are concerns about contamination of surrounding soil and ground water systems through leaching, in addition to the potential for a catastrophic breach of pond containment. Fine clay particles in the tailings mix pose a special problem. It can take decades for these “mature fine tailings” to settle, and they are too wet and toxic to be easily reclaimed. The method proposed for disposing of mature fine tailings that cannot be consolidated and reclaimed into the landscape is to use mine pits to dump the waste and top them off with water (the “end pit lake” method). However, this method is unproven in the oil sands context and current regulations do not cover some of the toxics involved. As yet no tailings ponds have been reclaimed - the first reclamation is scheduled for 2010.

Source: Bergerson J and Keith D (2006)

Land

The Boreal Forest, a mosaic landscape of forest and wetlands stretching across 53% of Canada’s landmass, is of immense value: culturally, for biodiversity, and for the ecological services it provides. The Athabasca oil sands deposit lies entirely within the Boreal.

Oil sands mining requires the complete removal of surface vegetation and soil. Companies must return land to the province reclaimed to a vague standard of “equivalent land capability” – but they are not required to restore the site to its pre-impact state. In fact there is no known way to restore Boreal wetlands destroyed by mining to their previous state: the reclaimed landscape will be radically different. Ecosystem conversion is likely to create significant long-term impacts for wildlife and the water system.

Although the immediate landscape impact of an “in situ” operation is less dramatic visually, it creates a network of structures (including well pads, pipelines and roads) dispersed over a wide area, which fragments forest habitat. This results in greater disturbance to wildlife than the more concentrated impact of oil sands mining. Already, threatened woodland caribou populations in north-east Alberta have declined by more than 50%.

Compared to the scale of disturbance, the rate of land reclamation in the oil sands is low. In 2008 oil sands operators claimed that just under 14% of some 48,000 hectares of disturbed land had been reclaimed, but to date only 0.2% of disturbed land has been certified as reclaimed.

Risky Business?How do these impacts translate into company-level risk and uncertainty for institutional investors?

Litigious risk

The most immediate risk arising from environmental and social impacts, and the one with greatest potential to delay or halt projects, may be litigious.

A highly significant litigious risk for oil sands projects lies in an aspect of the Canadian constitutional landscape that may be unfamiliar to international oil companies, and to international investors. In Canada, Aboriginal people (First Nations, Métis, Inuit) have constitutional rights to practice traditional lifestyles. There is a Crown (federal and provincial government) duty to consult and accommodate Aboriginal people before permitting development within their traditional territories. In cases relating to resource extraction projects elsewhere in Canada, Aboriginal peoples’ rights have been recognized and upheld by Canada’s highest court, and permits for company operations have been denied or voided as a result.

Many First Nations and Métis people in the oil sands regions are dissatisfied with the Alberta government’s record on consultation. Several First Nations have launched legal challenges against leases and approvals for oil sands projects within their traditional territory:

The Chipewyan Prairie Dene First Nation has brought a case against the government of Alberta alleging it was not properly consulted when oil sands leases were issued within its traditional territory. A judicial review of the validity of the leases is underway.

In May 2008, the Beaver Lake Cree Nation filed a case against the governments of Alberta and Canada relating to the cumulative effects of oil sands development, alleging that the environmental impacts of over 15,000 project approvals in their traditional territory had undermined their treaty rights to hunt, trap and fish. Experts believe the case has a strong chance of success.

Leaders of Aboriginal people in the region have passed joint resolutions calling for a moratorium on oil sands project approvals until strategic watershed and land use planning has been completed, and they have committed “to take all steps in our power to protect our lands, sustain our communities and assert our rights.” It seems likely that further litigation will follow.


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Another potential flashpoint for litigation may be health impacts in communities downstream and downwind of oil sands projects. Concern has focused on a cluster of serious and unusual illnesses in the mainly Aboriginal community of Fort Chipewyan. Controversy erupted over the censuring of a doctor who had publicized an abnormally high cancer rate – including 6 cases in a population of 1200 people of a rare bile duct cancer with an expected occurrence rate of 1 in 100,000. A comprehensive review of cancer incidence is now underway. Environmental research conducted on behalf of the community found high levels of contaminants associated with industrial air and water pollution, posing a particular risk for people whose diet includes a significant amount of local game and fish.

Asset Retirement Obligations risk

Another significant risk may arise from uncertainties about reclamation of oil sands project sites. Tailings reclamation is a special concern, given the doubts about the feasibility of using end pit lakes as a way of reclaiming tailings waste.

In February 2008 the Ontario Securities Commission (OSC) sounded an alarm over the quality of environmental disclosure in Canadian corporate reporting. Its review of securities issuer compliance with continuous disclosure obligations highlighted weaknesses in several areas, including asset retirement obligations (AROs) - legal obligations associated with the retirement of tangible long-lived assets.

Although the reclamation requirements for oil sands projects may be weak, they nevertheless create obligations on companies. Accounting experts point to the lack of a well-established and consistent basis for calculating AROs in oil sands mining, when compared to practice among peers in the mining industry. Meanwhile, reclamation experts are concerned that the funds set aside for reclamation of land disturbed up to the present are inadequate, and question the basis on which companies calculate reclamation costs. Based on their own calculations of reclamation costs, companies post a reclamation bond, which will be returned when reclamation is certified. In June 2008 the reclamation fund held a total of just $721 million.

Regulatory risk

Alberta does not have a strong tradition of industrial regulation, and up to now the province has indulged externalization of environmental and social costs by oil sands developers. Regulatory risk may therefore be less immediate. Heavy oil sands impacts, however, are forcing the province to begin to take steps towards regulation:

In 2006 a new water management framework was introduced for the Athabasca River, somewhat tightening restrictions on permitting, and on the amount of water that can be withdrawn in low flow periods. Stricter rules may be implemented in a second phase of the framework, expected in 2011. In response to decades of lack of progress on tailings reclamation, in June 2008 the Alberta Energy Resources Conservation Board (ERCB) released a draft tailings directive. Under this proposal new tailings management criteria would be defined, companies would have to file a timeline for reclamation, and enforcement action would be undertaken if performance targets were not met, including shutting down operations. While an improvement, the directive proposed would not address all concerns about tailings waste, and it remains to be seen if it will be implemented, and in what form. However, given the slow progress in tailings reclamation up to now, and uncertainties surrounding the technical feasibility of reclaiming mature fine tailings, there is a risk that some companies could fail to meet their obligations under a tougher regime.

Regulation of carbon emissions is weak at both Canadian federal and Alberta provincial government levels. Both have introduced intensity-based regulatory frameworks setting a low price on carbon without absolute emissions caps in the short or medium term. However, all the main federal opposition parties favour tougher regulation - and a direct carbon tax has already been introduced in the province of British Columbia.

Regulatory risk does not stop at the border. Given that most oil sands production is exported to the US, potential demand risk is emerging in the form of US standards penalizing high carbon fuels:

Section 526 of the Energy Independence and Security Act 2007 bars US Federal agencies from contracting to buy transportation fuel from new unconventional sources where the life-cycle GHG emissions exceed those for conventional oil. Under the new California Low Carbon Fuel Standards, by 2020 suppliers must reduce by 10% the average life-cycle carbon footprint of transportation fuels they sell in California.

In 2008, US Conference of Mayors passed a resolution against the use of High Carbon Fuels in municipal fleets.

Some observers doubt that in these uncertain times the US would really turn away from a secure supply of Canadian oil on the basis of carbon content – and if it did, they point to China as a replacement market. However, increasing exports to Asia could present significant challenges. A proposed new pipeline from Alberta to the Pacific Coast of British Columbia would need to cross the traditional territory of as many as forty Aboriginal peoples.

Regulation may be weak at present, but all the movement is in the direction of tougher regimes. Given the high capital costs and long investment horizons of oil sands projects, companies should be taking into account scenarios of environmental regulation that may impact directly on operations, increase development costs or reduce return on investment.

Social license risk

Risk to oil sands companies’ social license to operate is hard to evaluate. Canadians consistently rank the environment as a top concern. The oil and gas industry does not enjoy a high level of public trust: according to the 2008 Globescan Survey, Canadians asked to name an irresponsible company were most likely to point to oil and gas companies. Against this context, Canadians are questioning the way that the oil sands are being developed. In a 2008 Globe and Mail survey, a majority of Albertans (83%) said they thought the oil sands were “good thing” - but over 60% believed the oil sands industry is harming the environment, and over 60% favoured a tougher approvals process.

As oil sands impacts become more apparent, negative public sentiment is likely to grow in Canada and internationally. Failure by industry to proactively address the impacts that inspire concern may lead to pressure for tougher regulation at local and national level, a rougher passage for companies negotiating the project approval process, and reputational damage to companies and the investors who support them.


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Solutions?To mitigate these risks, companies need to tackle the impacts that are creating them. The Ethical Funds Company believes there are technologies and approaches to oil sands development that have the potential to reduce, if not eliminate, some of the impacts. These potential solutions need to be surfaced by investors, their technological and economic feasibility tested, and companies need to be held to account on the status of implementation. If these technologies are not viable, investors need to consider the impact of a business-as-usual scenario for oil sands development – and the attendant intensifying of impacts – on company valuations and portfolio performance.

Engaging Aboriginal Peoples

Standards are emerging from the mining and forestry sectors for corporate engagement with Aboriginal peoples. Although they do not eliminate the litigious risk posed by inadequate provincial consultation processes, they can help to generate and protect local license to operate. Free Prior Informed Consent (FPIC): By respecting the right of Aboriginal people to be fully informed about exploration, development and closure activities on a timely basis, to approve operations prior to commencement, and if necessary to refuse consent, companies can avoid confrontations that could delay or halt projects and better protect their investment1. Impact and Benefit Agreement (IBA): An agreement between a company and Aboriginal communities affected by its operations, through which Aboriginal rights and interests are accommodated. Typically, an IBA provides for benefits to flow to the Aboriginal community in return for support during the approval process and operation of the project.

Mitigating impacts to air Air pollutants per barrel could be reduced through rigorous application of established technologies (such as stack gas scrubbing to abate SO2, and use of ultra-low NOx burners for furnaces).

GHG emissions could be reduced by developing renewable energy sources to reduce current reliance on natural gas in production processes2. Several alternative “in situ” extraction methods are being developed that may have potential to reduce the energy intensity and GHG emissions profile of oil sands production - although caution must be exercised to ensure that they do not create more adverse impacts than they resolve.

Vapour extraction (VAPEX) would use solvents to make bitumen fluid, replacing steam. Toe-to-heel air injection (THAITM) would use underground combustion to make bitumen fluid and provide upgrading in situ. Other methods under development include electrical heating to make bitumen fluid without the use of steam. Companies can compensate for unavoidable GHG emissions by purchasing high quality carbon offsets (emissions credits from GHG reductions achieved by another organization).

Carbon Capture and Storage (CCS) may be feasible for large concentrated point sources of CO2 in the oil sands, although as yet little progress has been made in implementing this strategy. One area with potential for capture is hydrogen production for upgrading, which already involves CO2 separation. The Western Canada Sedimentary Basin, which underlies Alberta, is seen as a suitable candidate site for geological storage. According to a study by the Pembina Institute, the cost of CCS could be recovered where captured CO2 can be deployed in enhanced oil recovery projects, but could range as high as US$100/tonne with “non-productive” storage. Given these costs, regulatory action to set a hard emissions cap and a significant price on carbon would be a helpful stimulus for the development of CCS. However, progress should be possible even without this stimulus, given historic oil industry profits and large government surpluses. In addition to available corporate funds, in 2008 the Alberta government launched a $2 billion fund to advance CCS projects.


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Top 10 Canadian oil and gas companies by 2007 after tax profits

Profits (C$ billion)

2003 2004 2005 2006 2007

EnCana 2.36 3.51 3.43 5.65 3.96

Imperial Oil 1.71 2.05 2.60 3.04 3.19

Husky Energy 1.33 1.01 2.00 2.73 3.21

Suncor Energy 1.09 1.08 1.16 2.97 2.83

Petro-Canada 1.65 1.76 1.79 1.74 2.73

Canadian Natural Resources 1.40 1.41 1.05 2.52 2.61

Talisman Energy 0.98 0.65 1.56 2.01 2.08

Nexen 0.58 0.79 1.14 0.60 1.09

Canadian Oil Sands Trust 0.31 0.51 0.83 0.83 0.74

Penn West Energy Trust 0.45 0.27 0.58 0.67 0.18

Total 11.85 13.04 16.14 22.76 22.62

Annual budget surpluses (C$ billion)

2003-04 2004-05 2005-06 2006-07 2007-08Government of Canada 9.1 1.6 13.2 13.8 9.6Government of Alberta 4.4 5.0 8.7 8.9 4.6

Mitigating impacts to water

To reduce the need for water extraction from the Athabasca River during low flow periods some oil sands mining projects are incorporating water storage facilities. There may be potential to create shared upstream water storage capacity, although care should be taken to ensure that this does not create other negative impacts.

With respect to tailings, trials are underway for various techniques to manage the problem of mature fine tailings, and to reduce their production:

Using centrifuging of tailings, chemical treatments and other methods to produce “dry stackable tailings” that can be integrated into reclamation sites. The Bitmin™ process would produce dry and thickened tailings using filtered tailings technology.

Mitigating impacts to land

No new technology would be required to accelerate the rate of land reclamation to keep pace with the rate of disturbance. Where reclamation is not possible, or cannot be undertaken in a timely way, biodiversity offsets (conservation offsets) may offer a solution: conserving lands of equal or greater biological value elsewhere, with the objective of no net loss in biodiversity.

Strategy and cumulative impact: too much, too fast?Opportunities certainly exist to reduce the impacts of individual oil sands projects, but this may not be enough to mitigate investor risk. Over time, oil sands companies have reduced the energy and water intensity requirements and pollution produced per barrel of synthetic crude oil, through implementation of new technologies and process improvements. However, the scale of development has effectively wiped out the benefit of these improvements, so that absolute impacts have increased even though intensity impacts may have dropped. Meanwhile the speed of project development is outpacing capacity to research, develop and implement new solutions.

Even if individual companies make efforts to reduce their own impacts, at present Alberta sets no limits on the scale and cumulative impact of oil sands development, and there is no completed strategic land use plan defining which areas will be set aside for conservation, and how the remaining area should be managed for development purposes. A multi-stakeholder group, the Cumulative Environmental Management Association (CEMA) was established to work with the provincial government to implement a Regional Sustainable Development Strategy. However, progress has been slow in

key areas, and recently several Aboriginal peoples and environmental non-governmental organizations have withdrawn from CEMA on the grounds that continuing sale of leases and approval of projects before an integrated conservation and land use plan is completed makes a mockery of the process.

In a time of oil price volatility, the scale and pace of growth in the oil sands industry is also having a negative impact on industry economics, especially for new projects. Oil sands return on investment looked solid in 2006, when the Canadian National Energy Board estimated production to be economic at an oil price of US $30-35/barrel, and oil prices over the year averaged US $66/barrel. Since that time accelerating demand for labour, materials and natural gas to supply a proliferation of oil sands projects has driven up the break-even oil price to US $70-85. Lack of skilled workers has created delays pushing construction costs for Canadian Natural Resources’ Horizon project 36% over budget. When it was revealed in September 2008 that costs for the Fort Hills integrated oil sands project had increased 50% over the previous year’s estimate, partners Petro-Canada, UTS and Teck Cominco saw their share prices plunge. StatoilHydro has announced that rising costs and regulatory uncertainty might further postpone the already delayed start for its Strathcona upgrader. The necessary cost of mitigating environmental and social risks would likely push the break-even price up further.

Things could get worse: most oil sands projects have not yet reached the operational or construction phases; lease auctions and project approvals continue; and as of October 2008 some 55% of oil sands acreage was still available for leasing.

How proactive company action can mitigate risk from government inaction

Many of the risks associated with oil sands development could be mitigated more quickly and effectively by action at the strategic level, rather than by dealing with issues on a piecemeal basis. A completed integrated conservation and land use plan could provide win-win solutions and reasonable compromises that would benefit companies in the long term. During the 2006 oil sands consultation, Ethical Funds added our voice to calls for a moratorium on new development pending conclusion of strategic planning. Nothing we have seen since has changed our view, but the government has failed to act. This is not an excuse for companies to continue with business as usual. Sitting back and waiting for government to make things happen is not advisable: the result may come too late and may not address risks to company value. Consensus recommendations resulting from proactive effort by diverse stakeholders can lead to bold strategic policy decisions that governments might otherwise be challenged to take.

In 2003 the Boreal Leadership Council (BLC), a collaboration between companies, NGOs and Aboriginal people, launched the Boreal Forest Conservation Framework, an inspirational shared vision for Canada’s Boreal Forest: to protect at least 50% of the Boreal in a network of large interconnected protected areas, and to support sustainable communities, world-leading ecosystem-based resource management and state-of-the-art stewardship practices across the remaining landscape.

In July 2008, Ontario’s Premier announced the Far North Planning Initiative – an integrated land use planning process that would bring 50% of Ontario’s Boreal Forest – 225,000 square kilometers – into interconnected protected areas. It may not have been possible for the Ontario government to take this step without the impetus provided by the Boreal Forest Conservation Framework – and companies which had not participated in the BLC had no input into deciding the protection threshold.

The QuestionsAs more and more oil companies join the rush into Canadian oil sands, and the oil sands contribute an increasing percentage to their reserves, more and more investors are becoming exposed, and the level of their exposure is increasing. Project impacts and the overall scale and pace of development pose significant risks for companies, and to their investors. As investors, how can we respond?

Some institutional investors have been calling for enhanced disclosure, particularly on carbon risk. Many companies involved in the oil sands now respond to the information requests of the Carbon Disclosure Project. Carbon disclosure is important and necessary, but not sufficient to resolve a complex of performance issues relating to GHGs and other impacts. Other investors have called for divestment from companies engaged in oil sands development. Recognizing that different responses to the sustainability challenges of the oil sands industry may be appropriate for different institutional investors, we propose a third investor response: calling on the companies we own to suspend new oil sands development pending completion of integrated conservation and land use planning, while accelerating the development and application of potential solutions that could improve project environmental and social performance and reduce portfolio risk.

In this context, The Ethical Funds Company proposes the following list of questions for engagement with oil sands companies.

Engaging with Aboriginal people:

What is your company’s assessment of the risk to its projects from First Nations and Métis constitutional challenges to Alberta’s oil sands leasing and approval system? Is your company engaging with First Nations and Métis whose traditional territories are or will be impacted by its projects in a manner consistent with emerging standards such as Free, Prior and Informed Consent (FPIC) and Impact and Benefit Agreements (IBA)?

Mitigating impacts to air:

What has your company done, and what is it doing, to implement best practice and reduce absolute emissions of air pollutants that pose health and environmental risks, such as NOx, SO2, VOCs (especially benzene) and particulates? Given the uncertainties regarding future climate change-related regulation in Alberta and Canada, how would your company be exposed to risk under different carbon regulatory scenarios? Given the need to be able to respond to a variety of risk scenarios, what is your company doing to achieve production phase carbon neutrality for your oil sands projects, and by what date?

- What is your company doing to achieve absolute carbon emissions reductions, for example through switching energy sources or by deploying new technologies?- Is your company buying carbon offsets to compensate for unavoidable emissions; if so to what standards do the offsets comply?- How is your company participating, and how much is it investing, in research and development for carbon capture and storage (CCS) for oil sands production emissions? When will CCS be operational?

Mitigating impacts to water (for oil sands mining projects):

What is your company doing to manage risks associated with fresh water use? - How much fresh water are your projects using (absolute and intensity figures)? - What are your company’s targets for reducing the intensity of water use and absolute water use? What is being done to achieve goals for reducing demand on water resources? - What is your company doing to eliminate water withdrawals from the Athabasca River during its low flow periods, for example by using water storage? - How is your company demonstrating proactive leadership for management of total withdrawals from the Athabasca River?

What is your company doing to manage risks associated with tailings production? - What is your company’s process for estimating reclamation costs and asset retirement obligations associated with tailings? - What is your company doing to eliminate the risks posed by mature fine tailings, for example by implementation of new technologies?

Mitigating impacts to land:

What is your company doing to minimize habitat disturbance and speed up reclamation? What is your company doing to compensate for loss of habitat which cannot be reclaimed in a timely way, for example by using biodiversity offsets?

Support for conservation and land use planning:

What is your company doing to create sustainability and certainty in the operating environment through proactive leadership on integrated conservation and land use planning for the oil sands regions? What is your company doing to ensure First Nations, Métis, and environmental NGOs are meaningfully involved in regional land use planning? Are you supporting the call for no new approvals prior to the completion of land use planning? If your company has projects located within the Boreal Forest, what is it doing to promote and support the Boreal Forest Conservation Framework?


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Time for actionDespite a proliferation of announcements, applications and approvals, most projects have not yet reached the construction or operation stages. Faced with rising capital costs, oil price volatility and recession many companies are re-evaluating the oil sands and some have shelved projects.

While not welcoming market turmoil, this is, in some ways, a welcome breather. Oil sands development has far outpaced mitigation technologies and the ability of labour, government, First Nations and Métis people to respond. There is now a glorious opportunity for institutional investors to ensure that the oil sands are developed in a less risky and more responsible fashion. If institutional investors want to effect change, the time to make our views known to companies is now.

For The Ethical Funds Company, given the prevalence of the energy sector on the Toronto Stock Exchange, all roads lead to Fort McMurray. We welcome investment industry colleagues to join our efforts in asking the hard questions and advancing potential solutions to the significant challenges of the oil sands.

Author This report was written by Michelle de Cordova, Manager of Sustainability Research at The Ethical Funds Company with the support of the Sustainability Department.

About The Ethical Funds CompanyThe Ethical Funds Company is Canada’s leader in socially responsible investing. Founded by Canada’s credit unions in 1992, Ethical Funds delivers a successful track record of combining financial performance with making good companies better. Ethical Funds offers a full family of funds across a variety of asset categories, including the Ethical® Advantage Series of lifecycle (target date) funds. The Ethical Funds Company has multiple award-winning funds, Canada’s largest team of sustainability analysts and Canada’s most comprehensive Shareholder Action Program. The Ethical Funds Company is a division of Northwest & Ethical Investments LP.

Sustainability DepartmentBob Walker, Vice President, SustainabilityAmanda Carr, Manager, Shareholder Action Program (Acting)Jennifer Coulson, Manager, Shareholder Action Program (Maternity Leave)Michelle de Cordova, Manager, Sustainability ResearchChristie Stephenson, Manager, Sustainability EvaluationsChris Ballance, Senior Sustainability AnalystJamie Bonham, Senior Sustainability AnalystCatalin Chiloflischi, Senior Sustainability AnalystSteve Carley, Sustainability AnalystDominique Ramirez, Sustainability AnalystKarima Esmail Shajani, Sustainability AnalystAlicia Woods, Sustainability Analyst


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Further readingEarlier reports by The Ethical Funds Company:

Head in the Oil Sands? Climate Change Risks in Canada’s Oil and Gas Sector (2007) www.ethicalfunds.com/SiteCollectionDocuments/docs/Head_in_the_Oil_Sands_Final.pdf

Winning the Social License to Operate: Resource Extraction with Free, Prior andInformed Community Consent www.ethicalfunds.com/SiteCollectionDocuments/docs/FPIC.pdf

Reports on prospects and challenges for the oil sands industry include:

National Energy Board (2006) Canada’s oil sands - opportunities and challenges to 2015: an update www.neb-one.gc.ca/clf-nsi/rnrgynfmtn/nrgyrprt/lsnd/pprtntsndchllngs20152006/pprtntsndchllngs20152006-eng.pdf

Alberta Chamber of Resources (2004) Oil Sands Technology Roadmap: Unlocking the Potential www.acr-alberta.com/PROJECTS/OilSandsTechnologyRoadmap/tabid/81/Default.aspx

Alberta Environment (2008). Alberta Oil Sands. Resourceful. Responsible. www.environment.alberta.ca/2558.html

For industry perspectives on oil sands development:

Canadian Association of Petroleum Producers www.capp.ca/default.asp?V_DOC_ID=688

Canada’s Oil Sands – A Different Conversation www.canadasoilsands.ca/en/

The Oil Sands Developers Group www.oilsands.cc/

The Calgary-based consultancy Strategy West publishes regular updates on the status of oil sands development:

Strategy West (2008). Canada’s Oil Sands – A World Class Hydrocarbon Resource. www.strategywest.com/downloads/StratWest_OilSands.pdf

Strategy West (2008). Canada’s Oil Sands Industry – Production and Supply Outlooks. www.strategywest.com/downloads/StratWest_Outlook.pdf

Strategy West (2008). Existing and Proposed Canadian Commercial Oil Sands Projects. www.strategywest.com/downloads/StratWest_OSProjects.pdf

The University of Calgary Institute for Sustainable Energy, Environment and Economy has published a number of papers on technical aspects of the oil sands production, including:

Bergerson J and Keith D (2006). Life Cycle Assessment of Oil Sands Technologies. University of Calgary Institute for Sustainable Energy, Environment and Economy www.iseee.ca/files/iseee/ABEnergyFutures-11.pdf

The Pembina Institute www.pembina.org/ has published a series of reports describing the environmental impacts of the oil sands industry:

Woynillowicz, Dan, Chris Severson-Baker, and Marlo Raynolds. Oil Sands Fever. Calgary: The Pembina Institute, 2005. www.oilsandswatch.org/pub/203

Griffiths, Mary, Paul Cobb and Thomas Marr-Laing. Carbon Capture and Storage: An Arrow in the Quiver or a Silver Bullet to Combat Climate Change — A Canadian Primer. The Pembina Institute, 2005. www.pembina.org/pub/584

McCulloch, Matthew, Marlo Raynolds, and Rich Wong. Carbon Neutral 2020: A Leadership Opportunity for the Oil Sands. Calgary: The Pembina Institute, 2006. www.oilsandswatch.org/pub/1316

Dyer, Simon, Jeremy Moorhouse, Katie Laufenberg, Rob Powell. Under-Mining the Environment: The Oil Sands Report Card. Calgary: The Pembina Institute and WWF, 2007. www.oilsandswatch.org/pub/1571


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Dyer, Simon, Jennifer Grant, Marian Weber, and Terra Lesack. Catching Up: Conservation and Biodiversity Offsets in Alberta’s Boreal Forest. Ottawa: Canadian Boreal Initiative and The Pembina Institute, 2008. www.oilsandswatch.org/pub/1650

Grant, Jennifer, Simon Dyer, and Dan Woynillowicz. Fact or Fiction: Oil Sands Reclamation. Calgary: The Pembina Institute, 2008. www.oilsandswatch.org/pub/1639

Information on air pollution emissions trends associated with the oil sands can be found in Alberta Environment (2008) Alberta air emissions trends and projections www.environment.gov.ab.ca/info/library/7964.pdf

Key legal decisions on Aboriginal peoples’ rights include Haida Nation v. British Columbia (Minister of Forests), 2004 SCC 73 www.canlii.org/en/ca/scc/doc/2004/2004scc73/2004scc73.html, which describes the duty to consult and accommodate.

In 2008 the Ontario Securities Commission published a review of environmental disclosure by securities issuers: Ontario Securities Commission Staff Notice 51-716 - Environmental Reporting www.osc.gov.on.ca/Regulation/Rulemaking/Current/Part5/sn_20080229_51-716_enviro-rpt.pdf

The Boreal Forest Conservation Framework can be found on the website of the Canadian Boreal Initiative, which acts as secretariat to the Boreal Leadership Council www.borealcanada.ca/framework-e.php

Information on the Carbon Disclosure Project can be found at www.cdproject.net/aboutus.asp

Several environmental organizations have published recent reports on carbon-related investor risk in the oil sands:

WWF-UK and Co-Operative Financial Services (2008) Unconventional Oil: Scraping the Bottom of the Barrel www.assets.panda.org/downloads/unconventional_oil_final_lowres.pdf

Greenpeace UK (2008) Rising Risks in Tar Sands Investments www.greenpeace.org/canada/en/recent/oil-giants-underestimate-investor-risk

In January 2008 the Globe and Mail, Canada’s leading national newspaper, published Shifting Sands, a series of articles on the oil sands industry: www.theglobeandmail.com/oilsands

1 See our report Winning the Social License to Operate: Resource Extraction with Free, Prior and Informed Community Consent www.ethicalfunds.com/SiteCollectionDocuments/docs/FPIC.pdf 2 The Ethical Funds Company does not consider nuclear power to be a sustainable energy source. See our report Considering Nuclear in a Time of Climate Change www.ethicalfunds.com/SiteCollectionDocuments/docs/Considering_Nuclear_Final.pdf.

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