Month: June 2024

Biodiversity, which encompasses all living things on earth – including microorganisms, plants, animals, and the ecosystems they form – is being destroyed at an alarming rate. One quarter of the world’s plants and animals are at risk of extinction, and 40% of ice-free land is in a state of degradation.

Five main drivers are responsible for biodiversity loss: climate change, pollution, overexploitation of natural resources, changes in land and sea use, and invasive non-native species. Many business activities contribute to these pressures, with the food, energy, infrastructure, and fashion value chains accounting for 90% of human-caused pressure on biodiversity.

What’s at stake

Biodiversity and ecosystems touch every aspect of human life. From the food we eat to the medicine we need, humans are heavily reliant on functioning ecosystems. More than 75% of global food crops rely on animal pollination, and over 70% of medicines used to treat cancer are natural or synthetic products made possible because of biodiversity.

According to the Convention on Biodiversity, 40% of the world’s economy relies on biodiversity. The already present decline in ecosystem health costs the global economy $5 trillion annually.

Given these dependencies, biodiversity loss can translate into a wide range of risks for companies, including risks to operations resulting from supply chain disruptions, liability risk, price volatility risk, and regulatory, reputational and market risks.

Additionally, ecosystem loss has major implications for tackling the climate crisis. Land and the oceans absorb more than half of all carbon emissions produced by human activities, but as ecosystems disappear, nature’s ability to act as a “carbon sink” will be diminished and the consequences for our fight against climate change could be severe. Emissions reductions must therefore be coupled with measures to protect biodiversity if we are to meet our net-zero goals.

Regulators and investors take action

Since the Kunming-Montreal Global Biodiversity Framework was adopted in 2022, biodiversity – and nature more broadly – has been moving up the agenda for investors and regulators.

Key players are taking real action against the global threat of biodiversity loss, and we expect to see a continued focus on this issue. Numerous regulatory measures have been put in place, including the EU Deforestation Act, the EU’s Corporate Sustainability Reporting Directive, and Article 29 in France, all of which require increased company disclosure on impacts and dependencies on nature.

Investors are increasingly examining the financial risks associated with biodiversity loss. The Taskforce for Nature-Related Financial Disclosures (TNFD) launched their final framework to evaluate these financial risks in September 2023. The TNFD guidance is closely aligned to the Task Force on Climate-Related Financial Disclosures framework, incorporating the same four pillars of Governance, Strategy, Risk Management, and Metrics & Targets. The TNFD framework provides an essential starting point for companies to begin identifying, assessing, and disclosing their nature-related impacts and dependencies.

Other investor-driven engagement initiatives such as the Finance for Biodiversity Foundation, Nature Action 100, and the PRI Stewardship Initiative on Nature are beginning to take shape and gain momentum.

As companies realize that continued access to capital is increasingly contingent on making meaningful progress towards true stewardship of nature, real change with generational impact will follow.

Vancity Investment Management Ltd. is the sub-advisor of the IA Clarington Inhance SRI Funds.

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RIA Disclaimer

The views and opinions expressed in this article are solely those of the authors and do not necessarily reflect the view or position of the Responsible Investment Association (RIA). The RIA does not endorse, recommend, or guarantee any of the claims made by the authors. This article is intended as general information and not investment advice. We recommend consulting with a qualified advisor or investment professional prior to making any investment or investment-related decision.

Don’t Divest. Invest in Change

According to Bloomberg Intelligence, Global Environmental, Social, and Governance (ESG) assets are predicted to hit $40 trillion by 2030, despite macro challenges. Among the methodologies utilized, two common strategies that exist today are known as: ESG exclusion, the intentional exclusion of certain sectors or companies, and ESG integration, the integration of ESG factors into one’s fundamental analysis.

The Efficacy of Exclusion

The exclusionary approach was one of the first iterations of ESG investing, resulting in the divestment from companies in sectors deemed “bad” or “brown,” excluding them from investment portfolios. Sectors commonly subjected to exclusion include weaponry, tobacco, coal, nuclear energy, and oil and gas.

While the exclusionary approach can avoid exposure to these “bad” or “brown” sectors, studies have shown the long-term ineffectiveness in this approach. In a recent paper, Kelly Shue of Yale’s School Of Management and Samuel Hartzmark of the Carroll School of Management at Boston College, concluded “investing that directs capital away from brown firms and toward green firms may be counterproductive in that it makes brown firms more brown without making green firms more green”. When a heavily polluting firm is starved of capital, they are most likely to revert to the cheapest (and often most polluting) methods of production to continue to generate cash. If that same “brown” company wanted to improve their practices, while facing divestment, the firm would not have the capital required to make the investments and changes needed while conducting business as usual. Shue and Hartzmark also observed that a heavily polluting “brown” firm that reduced its emissions by just 1% would have a much greater impact than a typical “green” firm that reduced its emissions by 100%. See Figure 1 which highlights the decarbonation opportunity of a high emission intensity company.

Figure 1: Low emission intensity company (Company A) vs. a high emission intensity company (Company B)

Source: The green inflection point, UBS Sustainability & Impact Institute, 2022

ESG Integration: Recognizing Change

Unlike an exclusionary approach, ESG integration does not limit the investable universe. Rather, it incorporates the consideration of ESG risks and opportunities into fundamental analysis.

A 2022 study by Capital Group found that 60% of investors cited ESG integration as the ESG approach most used. At Waratah Capital Advisors, we look for opportunities in “ESG improvers” that show positive ESG momentum through our ESG integration strategy that we have run since 2018. Consider a company with a historical reputation for poor ESG practices that is also behind its peers in implementing ESG considerations. The company would be deemed an ESG improver if it began demonstrating tangible ESG improvements. By providing capital to firms considered ESG improvers, we can help to “make the bad better” and be more impactful long term.

An example of a potential ESG improver is Canadian Natural Resources (“CNQ”). CNQ is one of the largest independent crude oil and natural gas producers in the world. Despite oil and gas companies often being in the spotlight for their negative environmental impact, they possess the ability to drive meaningful, positive advancements toward the world’s Net Zero target which is crucial in meeting the Paris Agreement. The International Energy Agency (IEA) has deemed carbon capture, utilization, and sequestration as an essential technology in their Net Zero by 2050 Roadmap. CNQ is currently the largest owner of carbon capture capacity in the Canadian crude oil and natural gas sector. Holistically, we believe their overall ESG practices are among the top of their peer group. We see CNQ in a position to lead peers as an ESG improver, not only in the net zero transition but also in industry ESG best practices.

Companies within the mining sector have historically been viewed as negative ESG actors, due to the high environmental and social risks. The IEA deems several critical minerals, such as copper, lithium, nickel, and cobalt, as having an imperative role in the net zero transition. Mining companies, with exposure to energy transition minerals, will be essential to successfully build clean energy technologies. As shown in Figure 2, copper is of high importance to solar, wind, power grids, electric vehicles and batteries, and hydrogen electrolyzers as well as being of mild importance to nuclear and hydropower technologies. ESG improvers in this space show real signs of change, working on initiatives towards reducing emissions, improving operational efficiency, and demonstrating positive progress in their ESG performance data.

Figure 2: Materials used in clean energy technology

Source: Material and Resource Requirements for the Energy Transition, Energy Transitions Commission, 2023.

By solely divesting from a “brown” or “bad” ESG company, investors lose out on the opportunity to invest in change. ESG integration strategies allow investors to dig deeper into a company’s practices, compared to just looking at them from the surface through an exclusionary approach. Investors can put a spotlight on the “bad” ESG companies that are showing real signs of positive ESG momentum and in turn, have more opportunity and impact to make a change across all sectors.

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RIA Disclaimer

The views and opinions expressed in this article are solely those of the authors and do not necessarily reflect the view or position of the Responsible Investment Association (RIA). The RIA does not endorse, recommend, or guarantee any of the claims made by the authors. This article is intended as general information and not investment advice. We recommend consulting with a qualified advisor or investment professional prior to making any investment or investment-related decision.

Canadians are obligated to respect human rights in Canada and around the world. In this article we raise awareness regarding elevated human rights risks to Indigenous Peoples in Latin America and what investors can do to fulfill their human rights due diligence responsibilities across all regions under evolving regulatory and stakeholder expectations.

Demand for minerals to support the energy transition is anticipated to soar over the next years and decades. Indigenous Peoples around the world are at risk of being disproportionately impacted despite contributing the least to climate change given 50% of known transition minerals are located on or near to their traditional lands. These Peoples also protect and maintain up to 80% of the world’s remaining biodiversity. While Canadian institutional investors are increasingly aware of and educated on how to respect Indigenous rights and reconciliation in the Canadian context, there is less awareness of best practices to ensure respect for Indigenous Peoples’ rights in other regions and contexts. At the same time, investors are increasingly expected to account for adverse impacts on people and planet linked to investing and financing activities under voluntary standards like the United Nations Guiding Principles for Business and Human Rights (UNGPs) and new related mandatory sustainability laws like the European Union’s Corporate Sustainability Reporting Directive (CSRD). Major Canadian financial institutions and other large Canadian corporate entities with European subsidiaries or branches and a certain amount of turnover in the European Union, may eventually have to report against them. Given the extent of Canadian mining activities in Latin America, we outline significant risks to Indigenous rights from land-based projects in that region and what investors can do to help prevent and mitigate related human rights and investment risks.

The Human Rights Context of Indigenous Peoples in Latin America

Canadian companies in scope of the European Union’s mandatory CSRD will be required to disclose the most material impacts on society and the environment from business activities and how these are being managed as implementation of the law expands over the next few years. Evidence finds that severe impacts on human rights related to resource development occur most frequently in Latin America and disproportionately impact Indigenous Peoples.

Threats include multiple cumulative negative impacts from business and industrial activities, criminal groups and the compounded effects of climate change and environmental degradation that infringe on rights to safety and security, and the right to enjoy traditional cultural practices and livelihoods, amongst other human rights. Many Indigenous leaders have been persecuted, targeted, and even assassinated for defending their rights in these contexts.

Latin America is also home to an estimated 185 distinct Indigenous populations in voluntary isolation, whose rights to remain isolated are enshrined in international laws such as the Universal Declaration of Human Rights and the United Nations Declaration on the Rights of Indigenous Peoples.

While the concept of economic reconciliation as a benefit of resource development has gained traction in the context of negotiations with Indigenous governments in Canadian, it may be foreign to many Indigenous Peoples in Latin America, and it cannot necessarily be assumed that such concepts are welcomed in all sectors. This underscores the importance of a rights-based approach in every context that centres around the need for proponents to seek out and respect local perspectives through good faith due diligence, avoid complicity, and respect for the right to free prior and informed consent (FPIC).

Environmental and Climate Risks

Latin America is home to many unique ecosystems and habitats, including the Amazon, that are critical for ensuring the livelihoods of its inhabitants including Indigenous Peoples and for global climate change mitigation and biodiversity protection. Respect for, and protection of Indigenous Peoples rights, including to their lands, resources and territories is proven by research as necessary for protecting nature.

Nonetheless, scientists are already warning that the Amazon might be close to an irreversible tipping point. This year, stories of record-setting droughts made headlines across various news outlets and are expected to get worse.

Indigenous Peoples’ organizations have been clear about the need to reverse the trend towards irreversible tipping points. The Coordinator of Indigenous Organizations of the Amazon River Basin (COICA), along with other organizations have called for the protection of 80% of the Amazon by 2025, strict adherence to free, prior and informed consent, a moratorium on deforestation and degradation of primary forests, among other interventions.

Canadian Company Involvement in Latin America

Canada, being home to many companies in the mining sector, also hosts a significant share of the mining companies operating in Latin America. 2014 estimates were that between 50 – 70% of mining activity in Latin America involves Canadian mining companies. The same report found that the lack of consultation and implementation of FPIC by Canadian mining companies in Latin America was the rule rather than exception. Other reports have found many examples of Canadian companies with operations in Latin America being linked to acts of violence. In 2023, a coalition of more than 50 civil society organizations published the report “Unmasking Canada: Rights Violations Across Latin America,” highlighting human rights issues connected to 37 Canadian projects across Latin America and the Caribbean.

The Legal Context of Indigenous Peoples’ Rights and Associated Obligations in Latin America

While articulated most clearly through the UN Declaration on the Rights of Indigenous Peoples, Indigenous Peoples’ rights in Latin America are also protected by various legal frameworks and instruments*, national constitutions, national legislation, and judicial decisions.

*Those instruments include but are not limited to the International Covenant on Civil and Political Rights (ICCPR); International Covenant on Economic, Social and Cultural Rights (ICESCR); International Convention on the Elimination of all Forms of Racial Discrimination (ICERD); Convention on the Elimination of All Forms of Discrimination against Women (CEDAW); ILO Convention 169 on Indigenous and Tribal Peoples, and the American Convention on Human Rights.

For example, the Inter-American Court of Human Rights has established that the State must abide by the following safeguards: effective participation (including FPIC), reasonable sharing of benefits from any development plans within the territory, and that no concessions on Indigenous territory are granted before prior environmental and social impact assessments are conducted.

Many national court rulings have also established safeguards that in effect, require FPIC. For example, in Colombia and Brazil, courts have ruled that Indigenous Peoples’ own autonomous free, prior and informed consultation and consent protocols and laws are binding.

However, those rights and obligations are in practice only implemented after investments have been made, leading to significant risks. For example, in Ecuador, a decree regulating permitting with affected Indigenous Peoples was later ruled to be unconstitutional and suspended by Ecuador’s constitutional court for failing to guarantee the constitutionally enshrined rights of Indigenous Peoples in Ecuador, thus generating significant risks for mining projects. In Peru, a regional court found that the granting of concessions to businesses on Indigenous territories where formal Indigenous land title had not yet been granted was unlawful. It is this gap between international and, or constitutionally enshrined Indigenous rights and lack of protection of these rights by local and regional authorities that presents significant risks for both adverse human rights impacts and investments.

Priority Investor Actions

Institutional investors in Canadian mining companies can help ensure investee companies ‘mind the risk gap’ by advocating for them to adopt and implement, in every case, rights-based approaches that align with international human rights standards regardless of whether local and regional authorities actively respect and protect these rights. The UNGPs were developed over a decade ago to explicitly address this risk gap and ensure multinational companies operating abroad respect human rights no matter where they operate. They now provide the foundation upon which mandatory corporate sustainability laws, like the CSRD, and France, Germany, and other EU member states’ supply chain due diligence laws, are based. While investors can advocate for benefit-sharing mechanisms and other types of partnerships that create more equitable economic and social benefits from mining or other resource development activities on the traditional territories of Indigenous Peoples, the starting point should be a rights-based approach, including FPIC giving due consideration to the local legal and human rights context, and risks to Indigenous human rights defenders.

Key immediate actions Canadian investors can take to add to their due diligence include:

– Screen all portfolios for company involvement in Latin America, with a focus on land and resource-intensive sectors and conduct enhanced due diligence to understand implications for locally affected Indigenous Peoples;

– Ask investee companies for disclosures of evidence of FPIC;

– Consult Indigenous Peoples’ representative institutions or others from civil society working with Indigenous Peoples in Latin America regarding appropriate investor action;

– Spread awareness of the need for urgent investor action on human rights in Latin America

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RIA Disclaimer

The views and opinions expressed in this article are solely those of the authors and do not necessarily reflect the view or position of the Responsible Investment Association (RIA). The RIA does not endorse, recommend, or guarantee any of the claims made by the authors. This article is intended as general information and not investment advice. We recommend consulting with a qualified advisor or investment professional prior to making any investment or investment-related decision.

Pressure mounts to rethink balance sheets to account for natural capital—arguably the world’s most important asset. Are you prepared?

Nature is deteriorating at an alarming rate, and with over half of the world’s GDP (US$44 trillion) at risk due to rapid biodiversity loss, environmental degradation is quickly climbing to the top of corporate and investor agendas.

In a major step forward, the international Taskforce on Nature-related Financial Disclosures (TNFD) released landmark guidance last September to help organizations identify and assess nature-related risks, impacts and dependencies. Interested and affected parties in many jurisdictions, including Canada, are evaluating the standards and international developments to determine the best path forward.

Having finalized its climate and general requirements standards in June 2023, the International Sustainability Standards Board (ISSB), an independent standard-setting body charged with streamlining sustainability reporting by developing a global baseline, has turned its attention to discerning its next areas of focus. In April 2024, the ISSB announced that it will commence a research project on the disclosure of risks and opportunities associated with biodiversity, ecosystems and ecosystem services, shining a spotlight on the value of accounting for nature.

Following the release of the TNFD’s risk management and disclosure framework, the ISSB announced that it would “look to the TNFD recommendations—where it relates to meeting the information needs of investors—in its future work.”

Improving nature-related practices and disclosures

A growing global network of TNFD consultation groups is working diligently to identify knowledge gaps on nature-related issues and to engage with regional markets on its recommendations. The Chartered Professional Accountants of Canada (CPA Canada) and the Institute for Sustainable Finance (ISF), as co-convenors of the Canadian consultation group, are responsible for fostering awareness, education and capacity building for TNFD in Canada.

For more than 20 years, the Canadian accounting profession has been at the forefront of championing sustainability as a good business practice. With a long history of ensuring that organizations manage risk and report credible information in the capital markets, the accounting profession will play a pivotal role in guiding organizations and investors through the integration of nature into decision making, helping turn ambitious environmental pledges into practical actions.

Catalyzing sustainable investment

Commitments made at the COP 15 Biodiversity Conference in Montreal to safeguard 30 percent of natural habitats by 2030 have intensified the global focus on building capacity for nature-based reporting to support frontline conservation and adaptation efforts.

In resource-based economies like Canada, there is particular urgency to see stakeholders across the financial and corporate systems work collaboratively to shift business models, budgets and financial flows away from nature-negative to nature-positive outcomes. Investors increasingly recognize that they hold nature-related risk in their portfolios and want to understand how those threats are being managed to deliver robust financial returns and minimize environmental disruption. In fact, a 2023 study of ESG sentiment among institutional investors found that 63 per cent of respondents consider nature-related factors when making decisions.

Credible and comparable data is essential for building trust to drive effective capital reallocation and to attract new investments for scaling up sustainability efforts. The TNFD’s emphasis on transparency and accountability will help bridge the gap between financial markets and the natural world.

Climate and nature goals inherently linked

A collaborative and proactive approach to reporting could not be more urgent as climate change proves to be an increasingly important driver of biodiversity loss. Consequences of the climate crisis, from deforestation to water scarcity, can materialize as financial risks to businesses that inevitably impact the broader financial system. Conversely, restored ecosystems rich in biodiversity can enhance business operations, create new markets and play a critical role in achieving net-zero goals by removing carbon from the atmosphere.

Indigenous communities hold a profound connection to the land, rooted in centuries of stewardship and traditional knowledge. Despite comprising only 6.2 per cent of the world’s population, Indigenous Peoples safeguard an astonishing 80 per cent of the planet’s biodiversity, making the Indigenous perspective another vital component in combatting climate change and environmental degradation.

Natural capital underpins healthy societies and resilient economies. Halting and reversing nature loss hinges on our ability—as businesses, financial institutions and asset managers—to understand our dependencies and impacts on the natural world.

There is a significant need to empower both the users and preparers of climate- and nature-related information with best practices for disclosing sustainability performance. I can say with confidence that the CPA profession is up to the capacity-building challenge, but we are only one piece of the puzzle. With growing recognition of the intrinsic value of nature, investors are increasingly being called upon to finance this change.

Your blueprint for action

By aligning investment decisions with sustainability goals and advocating for robust reporting standards, investors are well positioned to drive transformation in nature-related reporting practices. Your role extends beyond mere financial support; your requests for transparency, accountability and standardized metrics have the power to catalyze a more holistic approach to accounting and reporting practices.

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RIA Disclaimer

The views and opinions expressed in this article are solely those of the authors and do not necessarily reflect the view or position of the Responsible Investment Association (RIA). The RIA does not endorse, recommend, or guarantee any of the claims made by the authors. This article is intended as general information and not investment advice. We recommend consulting with a qualified advisor or investment professional prior to making any investment or investment-related decision.

There is a growing recognition of the business risks related to modern slavery within a company’s operations and supply chains, as well as increasing regulatory expectations. As a result, this important issue is increasingly front of mind for many companies and investors.

Modern slavery generally refers to situations of forced labour or child labour. It is both a human rights and employee rights issue and occurs when a person faces a situation of exploitation and cannot refuse or leave due to threats, violence, coercion, deception, and/or abuse of power. According to the Global Slavery Index, in 2021 an estimated 50 million people were living in modern slavery on any given day, which is an increase of 10 million people since 2016. In addition to the moral and ethical issues associated with modern slavery, companies also face business risks. These include reputational risks (e.g. boycotts, protests, or customer backlash), legal risks (e.g., fines, criminal charges, and litigation, depending on jurisdiction), financial risks (e.g. supply chain disruption, increased operating costs, decreased productivity, higher cost of capital, loss of market share), and/or supply chain risks (e.g. disruption in the flow of goods and services, lack of efficiency and performance of supply chains).

The United Nations (UN) established the UN Guiding Principles on Business and Human Rights (UNGPs) in 2011 to set common human rights expectations for governments and corporations. While the UNGPs are not binding, since their establishment, various countries have put in place legislation that requires companies of a certain size to prepare and publish an annual statement outlining the actions they are taking to address modern slavery in their operations and/or supply chains. Canada is one of the most recent countries to put in place its own act to address modern slavery in supply chains (the Act), which was passed in 2023 and came into force as of January 2024. Corporate entities covered by the Act must publish and submit to the government a report regarding modern slavery risks and mitigating actions by May 31, 2024. Unlike in some other jurisdictions, failure to comply with this Act comes with a fine of up to $250,000 per offence and may lead to personal liability for board members.

While most of the regulatory actions for corporations focus on transparency and disclosure, these statements in and of themselves are not sufficient to address modern slavery. They do, however, provide investors and others with insights on the policies and practices companies have in place to identify and address the risks of modern slavery in their operations and/or supply chains. They can also serve to inform engagement with companies on these issues. While often thought to be more prevalent in developing nations, modern slavery occurs in every country in the world and many cases in low-income countries are in fact linked directly to demand from higher-income countries. Some of the products imported from developing countries that are most at risk of using modern slavery are electronics, garments, palm oil, solar panels, and textiles.

Investment teams, [1] such as those at RBC Global Asset Management (RBC GAM), [2] may consider material ESG factors [3] when making investment-related decisions within the portfolios that they manage, for applicable types of investments. [4] This may include human rights, employee relations and working conditions, discrimination, modern slavery, and/or supply chain risks. As active stewards of clients’ capital, investment teams also engage with issuers on topics that they deem to be material to their investments. [5] Through proxy voting, shareholder proposals that call on companies to respect internationally recognize human rights and comply with relevant international agreements regarding the protection of those rights can generally be supported. For example, we will generally support shareholder proposals that call on companies to disclose their practices, policies, and oversight for assessing, preventing, and mitigating human rights risks. This includes within the company’s investments, operations, and/or activities in countries with historical or current evidence of labour and human rights abuses.

For Canadian investors, improving transparency and disclosure on policies, practices, and actions related to modern slavery and supply chain risks are welcomed. As companies continue to expand reporting on these issues, it will be important to assess the depth and quality of such reporting in order to identify best practices and to engage with companies where gaps are identified. Ultimately, addressing modern slavery in supply chains will require concerted and coordinated efforts by governments and private sectors, which must go beyond disclosures.

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[1] References to RBC Global Asset Management (RBC GAM) include the following affiliates: RBC Global Asset Management Inc. (including PH&N Institutional), RBC Global Asset Management (U.S.) Inc., RBC Global Asset Management (UK) Limited (RBC GAM UK), RBC Global Asset Management (Asia) Limited, and RBC Indigo Asset Management Inc., which are separate, but affiliated subsidiaries of the Royal Bank of Canada (RBC).

[2] References to RBC Global Asset Management (RBC GAM) include the following affiliates: RBC Global Asset Management Inc. (including PH&N Institutional), RBC Global Asset Management (U.S.) Inc., RBC Global Asset Management (UK) Limited (RBC GAM UK), RBC Global Asset Management (Asia) Limited, and RBC Indigo Asset Management Inc., which are separate, but affiliated subsidiaries of the Royal Bank of Canada (RBC).

[3] Material ESG factors refer to ESG factors that in our judgment are most likely to have an impact on the financial performance of an issuer/security and may depend on different factors such as the sector and industry of the issuer

[4] Certain fund products do not integrate ESG factors, including but not limited to money market funds, index funds and certain third-party sub-advised funds.

[5] In some instances involving certain fixed income investments, quantitative investment, buy- and maintain, passive and certain third-party sub-advised strategies, there is no engagement with issuers by RBC GAM.

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RIA Disclaimer

The views and opinions expressed in this article are solely those of the authors and do not necessarily reflect the view or position of the Responsible Investment Association (RIA). The RIA does not endorse, recommend, or guarantee any of the claims made by the authors. This article is intended as general information and not investment advice. We recommend consulting with a qualified advisor or investment professional prior to making any investment or investment-related decision.

Picture a typical Canadian winter. The scenes are likely long, cold, and grey. And most importantly, there is snow – lots of it. Winter 2024 was anything but that, it seemed to be over before it even started and without many of the wintery elements we have come to both love and loathe. Across the country warmer temperatures flourished, while dreams of skiing flashed by in an instant. The unusually dry and mild winter – a result of the El Nino phenomenon, a warming of certain parts of the Pacific Ocean surface – is bringing the potential for drought across certain regions of the country. Alberta is a province that Canadian investors should pay close attention to as we head into summer as the dry winter has intensified pre-existing drought conditions.

The province began warning of serious drought conditions in late 2023. At the time of writing in early spring 2024, Alberta is in a level 4 (of 5) drought, meaning that adverse impacts to socio-economic conditions are likely. The next level means those impacts are almost certain. Drought conditions this year are being brought on by less snow and precipitation than usual, leaving less run-off into the rivers that feed Alberta’s water needs. The unusually warm winter also led the province to declare an early start to wildfire season, which historically begins on March 1 every year. A particularly intensive wildfire season would lead to further strains on the water system over the summer.

Under Alberta’s surface water withdrawal system, users such as municipalities, farmers and private companies are given licenses to withdraw specific amounts of water from designated water systems. Alberta’s water licensing program is a first in time, first in right (FITFIR) system. This means that the holders of the oldest water licenses get the right to extract the water first, and the newest license holders are last to get rights. Licenses in Alberta can go as far back as the 1800’s. Unlike other regional FITFIR systems, Alberta does not have any provisions for drought scenarios in place, meaning the government cannot overrule and proactively manage water rights in exceptional circumstances, such as severe drought. Instead, Alberta will need to rely on negotiations for voluntary reductions from senior license holders to ensure there is enough water to satisfy the balance of human, ecological and commercial needs.

Sector analysis

No sector or company is immune from the effects of drought and potential water restrictions, but some will be impacted more than others. Geography, the needs of your neighbours, ability to recycle water and contingency planning will be important factors as commercial water-users navigate the summer. Within the province, irrigation used primarily for agriculture requires the biggest amount of water, representing about 47% of all water licensed for diversion in the province. Oil and gas accounts for about 12% of water licensed for diversion, the same amount as water licensed for municipal purposes.

In late December 2023, the Alberta Energy Regulator (AER) issued a memorandum to its principal constituents – Alberta’s energy companies – advising them to prepare for drought conditions in 2024. The AER said that some companies may not be able to direct water toward their operations throughout 2024, particularly in the southern portion of the province. In January, Alberta’s Environment Minster added in a town hall that “we don’t expect that Alberta will receive enough precipitation to prevent a serious drought. We have to prepare for the worst.” The province’s Minister of Environment and Protected Areas, Rebecca Schulz, said the oil and gas sector will not be singled out when it comes to reducing water use.

It should be noted that the worst conditions are expected in the southern portion of Alberta – below Edmonton. The biggest oil and gas operations, notably the oil sands, are well north of this critical area, but there are several large refineries that operate within the severely impacted area. Also, the northern portion of the province is not in the clear yet. As of February measurements, the mountain snowpack that feeds the Athabasca Basin was below average at the two sites surveyed , and as of measurements on February 13, the Athabasca River flow was measured to be 151 m³/s, the ninth lowest winter measurement in the last 25 years.

At least one regional water agency has already suspended its water from being used for fracking – a particularly water-intensive form of oil production, where large volumes of water get injected below the surface of the earth to help fracture rocks and unleash the oil trapped within them. Importantly, water used for fracking cannot be recycled, unlike much of the water used in oil sands operations. Once water is used for fracking, it is out of the water system forever. For oil sands production, while there is variance, it generally requires about three or four barrels of water to produce a barrel of oil. For most of the oil production in the province, the industry has a great ability to process, treat and eventually return the water back to the system. While progress on water treatment efficiency is important, risks will still emerge during serious drought conditions, when the possibility to take the time required to treat and return the water has disappeared, and companies may have to reduce the amount of water they extract from the system in the first place. Ultimately this may result in impacts to operations through curtailing production or to rising expenses through sourcing alternative sources of water, such as trucking it in.

Engagement strategies

As investors in companies with operations in the province, how can we work with those companies to better understand the water risks they face? Ensuring companies have prudent water management strategies and the ability to continue operating without disruption will be essential as we head into this summer. Engaging with companies in advance of the summer on the five items below will help investors evaluate the water risks their investee companies are exposed to.

Management and contingency planning: First, investors must establish a baseline understanding of how effectively the company is managing water when it isn’t exposed to risk of drought. Does the company disclose water management policies? How does its water withdrawal and consumption compare to industry and geographical peers? Investors should find out if the company has ever dealt with water restrictions in the past and what type of contingency plan it has if water withdrawals are limited.

Monitoring conditions: In a dynamic ecosystem, does the company have systems to monitor the conditions of the water systems it relies on and does it have procedures to adapt quickly to changing conditions?

Understanding the license: Companies need to understand where they are in the FITFIR line and how their position in line may impact their ability to withdraw surface water this summer. Companies further back in line may be at a greater risk of not having enough water this summer, but proactive water license negotiation should mitigate some of this risk.

Participating in the system: As active members in a water management ecosystem, as well as having a long history of innovating and finding new ways to efficiently manage water, oil and gas companies should be at the table with the government and other members of the water-use community to develop strategies for managing the drought, whereby all players in the system can benefit.

Disclosing risks: Beyond the immediate water needs of the summer ahead, long-term engagement strategies should focus on water disclosures and management strategies. For companies with minimal disclosure related to water, encouraging participation in the CDP Water Disclosure program can be a useful starting point.

Conclusion

As we head towards a potentially challenging summer for water management in Alberta, we should remember that while Canada has an abundance of water resources, there are still limits to what the natural world can produce. Drought risks to water- intensive companies can disrupt operations or necessitate costly alternatives to water procurement. As temperatures rise, populations increase and commercial needs increase, drought-laden summers may become a more common occurrence, and with that water stress will become a more important investment risk. Companies that are significant players in the water management system should be encouraged by their investors to proactively implement water management strategies, plan for a time where water withdrawal may be limited, and produce disclosures that allow investors to effectively evaluate operations that are exposed to water-stressed areas.

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