Energy Expert Commentary: Azimuth Capital Management

The recent United Nations Climate Change Conference (COP21) in Paris has focused attention on both climate change policy and investor responsibility through its international agreement to keep global temperature increases to below two degrees Celsius.

Delivering on this commitment will require a transition to a lower carbon economy. At the core of this obligation lies energy production and use which accounts for two-thirds of man-made emissions.

In recent years, significant progress has been made. Wind and solar power generation, for example, has grown more than four-fold in the last decade, although it still provides less than 2 percent of global energy needs. Despite impressive growth in renewables, fossil fuels account for more than 80 percent of global energy needs, and will still provide between 60 percent and 75 percent in 2040, according to the International Energy Agency. In particular, natural gas, which plays a role as a bridge fuel, will see demand increase over this period in all IEA projections.

It is not possible to meet current energy demand using renewables alone. The IEA projects that increasing renewables (including hydro and biofuels) from 13 percent to 18 percent of total energy demand by 2040 will cost $7.8 trillion, reflecting the massive scale required to supplant just a small portion of fossil fuel energy. In addition, the intermittency issues surrounding renewable energy require a level of energy storage not achievable with current technologies and global lithium reserves.

It is clear that even in a post-COP21 world, oil and gas will require significant investment – as much as $25 trillion through 2040, according to the IEA’s current projections.

Fortunately, investment in oil and gas is consistent with the Paris temperature targets. By pairing hydrocarbon investment with further increases in renewable energy and gains in energy efficiency, the two degree goal can be met. In many instances hydrocarbon development can directly result in reduced emissions. In the US, for example, energy-related CO2 emissions have dropped to 1995 levels, declining 10 percent since their peak in 2007. The shift from coal-fired power generation to clean-burning natural gas made possible by the development of shale gas accounts for almost half of this reduction.

The decarbonisation of transportation will take even longer, and almost 20 percent of primary energy consumption is related to transport. This is not to say that the goal of a world powered primarily by renewable energy is not attainable, but rather that it will take a long time to achieve. During this long transition period fossil fuel investment will still be required.

So how should a responsible energy investor allocate their capital today? The Paris agreement has led some investors to reconsider their allocations, but most recognise the need for hydrocarbons and know it is most effective to work with companies as engaged participants.

As a Calgary-based energy-focused private equity manager, most of our investment at Azimuth Capital Management is in Canada, which offers some intriguing opportunities.
Canada is the world’s fifth largest oil and gas producer, ranking third in oil and fourth in natural gas resources. Although best known for its oil sands, many investors today are focusing on Canada’s unconventional light oil and natural gas resources where technological advances have substantially reduced capital and production costs. The best of these projects deliver globally competitive rates of return.

Sustainability is a key issue post-COP21, and Canada consistently ranks as a global leader across a number of environmental, social and governance (ESG) metrics including democratic freedom, transparency, environmental protection, gender equality and worker rights. The Environmental Performance Index, compiled by Yale and Columbia Universities, ranked Canada number one among the top 10 oil producing countries that together hold 80 percent of the world’s oil reserves.

Azimuth recognises the need for sustainability by balancing the potential costs of climate change with the economic benefits of energy. As a signatory to the UN Principles for Responsible Investment, sustainable energy development and impact are among the key drivers of our investment strategy. Our primary focus is on upstream oil and gas investing but over our 15-year history we have invested in numerous companies across the energy value chain.

Today we are primarily focused on lower carbon intensity hydrocarbons such as light oil and liquids-rich natural gas. In addition, we seek to partner with management teams that limit environmental risk through activities such as pad drilling, carbon capture and sequestration, sustainable use of water, and reduced flaring and methane venting.

Our investments reflect this strategy. We are a founding investor in Canadian oil and gas producer Seven Generations Energy, which is an industry leader in ESG. Their policies require them to conduct business in a way that protects the natural beauty of the environment and preserves the earth to meet the needs of future generations. As an example, they drill more than 30 wells from a single location. This innovate technique disturbs less than 1 percent of the land above the reservoir resulting in minimal wildlife and habitat disturbance.

Azimuth also targets 25 percent of its portfolio towards broader energy opportunities including early-stage energy infrastructure, services and technology. We have identified opportunities where companies can benefit their upstream customers, reduce greenhouse gas emissions, and generate attractive returns without relying on government subsidies.

Azimuth is one of the original investors in Steelhead LNG, a Vancouver-based LNG developer that provides Canadian natural gas to Asia. This has substantial environmental benefits because it provides Asia with an alternative to coal that produces half as much CO2, one tenth the levels of NOx and just one percent of the SOx and micro-particulate levels. Over the next 30 years, Steelhead’s projects could reduce overall global greenhouse gas emissions by as much as 1.2 billion tonnes.

Another example is Monolith Materials Inc., where Azimuth is also a founding investor. Monolith upgrades natural gas to produce hydrogen and a high-value petrochemical product known as carbon black. Relative to current industry standards, Monolith’s upgrading process produces 70 percent less CO2, 90 percent less NOx and 95 percent less SOx. In addition, Monolith’s process is cost competitive with traditional means of production allowing for investor returns, again without the need for subsidies.

There is no doubt that COP21 has focussed governments, corporations and the public on reducing greenhouse gas emissions. Its goals will be attained through investment in both renewable and non-renewable energy. Thoughtful energy development is fully compatible with improving quality of life worldwide while accomplishing important environmental objectives. For investors aligned in achieving these goals, investment jurisdiction and manager selection are critical.

As we transition to a lower carbon intensity world, it is important to recognise the improvements to quality of life that access to energy affords. Much of our world remains impoverished. The IEA forecasts that most of the projected growth in global energy demand over the next two decades will come from non-OECD Asia, the Middle East and Africa. Globally, 1.2 billion people are without access to electricity and more than 2.7 billion people lack clean cooking facilities. Meeting energy demand growth in places like Africa and India improves the quality of life of billions of disadvantaged people by rebalancing systematic inequality.

Azimuth Capital Management is one of the leading energy-focused private equity managers in Canada. Jeff van Steenbergen, co-founder and managing partner, Travis Smith, principal, and Ryan Sapieha, senior analyst, all contributed to this article.

This article is sponsored by Azimuth. It first appeared in the 2016 Investing in Energy supplement of the July/August 2016 edition of Private Equity International.