As Alberta Prepares for Drought, Investors Should Help Companies Manage Water Risk

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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Author

John McHughan

Vice-President, Climate Research, ESG Research and Engagement

TD Asset Management (TDAM)

As a Vice President with the ESG Research & Engagement team at the firm, John leads the team's efforts on managing climate risk and works closely with the investment teams to integrate climate-related risks and opportunities in the portfolio construction process. He began his career at TD through an enterprise-wide rotational program, giving him a diverse set of banking experiences, including spending time with the central Environment team. Prior to joining the firm, John spent five years working in Canadian politics as a lobbyist and as an assistant for a Member of Provincial Parliament. John holds an Honours Bachelor of Arts in Political Studies and an MBA, both from Queen's University.