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Hydrocarbons sector remains a lynchpin of bank financing

Despite some of the legal challenges taking place in the US, financiers can be expected to remain committed to the huge volume of hydrocarbons financing which will take place over the next couple of decades. Jonathan Bell examines the scene.

With ever increasing pressure from various directions, oil & gas companies are having to make significant changes to their operations and overall make-up in order to ensure continued production, growth and necessary investment returns. But, as the sustainability credentials get ramped up, the challenges they face are substantial and diverse.

And this pressure which oil & gas and other energy-related companies are facing also rebounds into the financing sector. Commercial banks financing these companies are now under more scrutiny than ever not only from third parties but also by their own credit risk and compliance departments. 

The ever-searching internal question of potential concentration risk in oil & gas is being whispered around banks more frequently than before. Some banks, which over recent years have significantly built up their energy-related portfolios, are now gently scaling back in certain parts of the sector. But this is a dangerous path to take for financiers as the upstream and downstream sectors are seeing significant new investments, many in emerging markets looking to capitalise on their natural resources and with many projects requiring financing this is expected to take place for many years to come. Like it or not, hydrocarbons have a long future ahead.

The whole issue of climate change, the state of the planet, and ESGs has already driven the financing of coal fired power stations away from most commercial banks, export credit agencies (ECAs), development banks (DFIs) and multilateral financing institutions (MFIs). Interestingly, one massive new coal-fired station sited in Vietnam has recently reached financial close – and this $1.9 billion project is financed with Chinese commercial bank debt and guaranteed by Sinosure. But as a so-called ‘legacy project’, this is an exception.

Of course, with around 60% of the world’s power still coming from coal, commodity coal financing remains an area where a number of banks and trading companies are highly active. Naturally, not too many want to advertise their activity.

But, just as coal has been in the spotlight, now it is the turn of oil & gas. So much so that some producers have sought to change their corporate name to take out the reference to ‘oil’. I kid you not!

Take the Norwegian company formerly known as Statoil. Last year it changed its name to Equinor and now describes itself as: “a broad energy company with a proud history. We are 20,000 committed colleagues developing oil, gas, wind and solar energy in more than 30 countries worldwide. We’re the largest operator in Norway, one of the world’s largest offshore operators, and a growing force in renewables”. To be fair, the company has for a long time been developing its wind portfolio – so a name change was probably on the cards anyway. Incidentally, the company had revenues of $79.6 billion in 2018.

Equinor also states in its literature: “Can an oil and gas company be part of a sustainable energy future? We’re working actively to reduce climate emissions, put a price on carbon, and benefit societies around the world. We aim to be the world's most carbon-efficient oil and gas producer and are investing actively in renewables.”

It is all very well for critics to sound off against big energy producers, but there has to be a degree of realism within all this and a sensible discussion. It cannot simply be an attack against corporations as ‘profit mongers regardless of the environmental and social cost’. Sure, there is much more all corporations can do to ‘clean-up’ their acts, and also be more considerate in particularly environmentally sensitive parts of the world such as the Arctic, offshore and ecologically diverse habitats onshore for instance. But then again, every single human could be making much more of an effort to be more sustainable too!

So, it was interesting to read an excellent article in the Financial Times (FT) in early June entitled ‘Energy groups to be sued over climate change’. The sub-header of this FT article also reads: ‘Activists hope oil and gas producers will be forced to make settlements similar to those of the tobacco industry.’ With so much attention on this front, it is no wonder that oil & gas companies and financiers working on projects in this industry are having increasing concerns.

The potential of litigation, of one form or another, is increasingly impacting much of industry and commerce of all types. This has been completely justified in some cases – particularly in relation to the impact of chemicals and pollutants on the health of people and the environment – and has acted as a check to the excesses of certain corporate groups. But some of the claims now taking place against ‘energy’ companies seem quite tenuous to say the least, and many have already been thrown out by the courts. The FT says there are currently more than a dozen climate liability cases taking place in the US. 

The FT article stated: “Over the past two years, a growing number of legal cases in the US – brought by cities, counties, and the state of Rhode Island – are seeking damages from energy companies for a litany of climate-related problems.

“Baltimore wants compensation for the cost of retrofitting storm drains to prepare for worsening storms. San Francisco says it will cost $5 billion to upgrade its sea wall to prepare for higher water levels. Meanwhile, Rhode Island expects coastal properties worth $3.6 billion to be under threat by the end of the century.”

The lawsuits name some of the biggest producers – such as Exxon, BP, ConocoPhillips, Royal Dutch Shell and Chevron – as defendants. The energy companies are of course having to fight each lawsuit brought. At the same time, some energy producers, says the FT, including Shell and BP, “ have poured millions of dollars into lobbying for a new carbon tax bill that would also include a liability waiver for fossil fuel products sold in the past, which would make most of these lawsuits vanish.” 

For most of the major oil & gas companies their investment in low carbon energy sectors (solar, wind, hydro, geothermal) still remains pathetically low. Many are putting on a good public relations front though. 

But such potential legal challenge activity and the increasing attention to this whole subject is having an impact – hence the concern with some of the commercial banks in trying to reduce their exposure to oil & gas. Currently, we still see ECAs, DFIs and MFIs coming into big oil & gas upstream projects, and commercial banks and other financiers riding along on the back of this institutional support. But, how long could it be before we see some of these institutions back out of these financings because of concern possibly related to this background of potential litigation?

Back in mid-2017, United Nations Development Programme (UNDP), International Finance Corporation (IFC) and IPIECA launched a new joint report, ‘Mapping the oil and gas industry to the Sustainable Development Goals (SDGs): An Atlas’. This ‘Atlas’ illustrates how the oil and gas industry can most effectively support and contribute to the achievement of the SDGs for sustainable development through the roles and responsibilities of key stakeholders, and by providing examples of good practices and existing knowledge and resources available in the industry on sustainable development.

At the time, Nik Sekhran, director for sustainable development, UNDP, said: “The private sector has a critical role to play in the achievement of the SDGs. This Atlas provides practical recommendations and examples of how the oil and gas industry can take action to ensure that the social and economic benefits are widely .shared and environmental impacts are minimised.”

From the MFI side, Bernard Sheahan, global director of infrastructure and natural resources, IFC, said: "The SDGs represent an ambitious, collective, international agenda. Achieving the Goals will require partnership and collaboration between and among all sectors and industries. By mapping the linkages between the oil and gas industry and the SDGs, we hope to encourage our clients and partners to further embed the Goals into their business and operations and seek out new, innovative ways to contribute to global development."

Moving this discussion on to the issue of transition, in a paper released last week by energy research consultancy Wood Mackenzie entitled: ‘How serious are oil and gas companies about the energy transition?’ chairman and chief analyst, Simon Flowers wrote: “New energy’s time has come. It’s less than four years since the Paris Agreement set the long-term goal to limit the rise in global temperature to well below 2°C. Back then, the oil and gas industry had zero appetite to invest in decarbonisation.” But Paris lit the fuse, he said. 

Flowers posed several questions to his colleague: Valentina Kretzschmar, research director, to find out how things were progressing. 

Who is doing most in the space? Kretzschmar responded: “European Majors are leading, though strategies vary. Total and Shell have gone further than the rest in increasing exposure to renewables and other clean technologies, but Shell is out on its own in laying out a net-carbon neutral ambition. But more and more IOCs [international  oil companies] and NOCs [national oil companies] recognise the need to signal clear intentions to shareholders and stakeholders.”

What are majors investing in? “They’ve bought into much of the zero-carbon value chain. Biofuels and carbon capture and storage have been in their portfolios for some time. The focus in the last four years has been on renewables (solar PV, onshore and offshore wind); battery storage and EV charging; and forestry (carbon sinks). There are similarities in scale and complexity between development of the biggest renewables and upstream projects.”

How much have they spent? “In time, it’s going to be big, but very little’s been spent so far – just $6 billion on M&A in four years, a tiny fraction of investment in the core business. But it’s in the formative stages. Right now, it's about positioning, trialling and testing. Companies are trying to assess technologies – and timing – and where they can create value. Both Total and Shell are planning to invest up to $2 billion a year and Total has committed to having 20% of assets in renewables by 2030.,” said Kretzschma.

And in an earlier Wood Mackenzie report entitled the ‘Energy View to 2035’ senior product manager David Brown looked at what's driving the anticipated energy transition.

He noted: “We've identified four key themes emerging as energy and natural resources markets move toward what seems like an inevitable paradigm shift.”

Demand for fossil fuels will peak. “Fossil fuel demands are divergent in the near term, but all markets will reach 'peak fossil' before 2035, as cleaner fuels such as renewables quickly become cheaper. Coal will be hit first and hardest, while oil and gas demand growth will continue. Despite the shift to come, hydrocarbons have a long future ahead.”

Global CO2 emissions will not peak before 2035. “Although the growth of CO2 emissions is slowing – due primarily to the evolution of China's energy demand – we don't foresee a peak in the next two decades. After power and transport, industry will be the biggest contributor to carbon emissions globally, accounting for 45% of oil and coal demand by 2035. Paris Agreement targets remain challenging long-term goals, but they appear more achievable than first thought.”

A trend toward electrification is clear. “Globally, we expect electricity demand to grow twice as fast as demand for fossil fuels to 2035 – rising to 27% of global energy supply. Africa and Asia Pacific will show the fastest power demand growth, with China and India surpassing 25% of end-use demand. But even outside emerging markets, in more mature regions such as Europe, there is scope for additional switching to power.”

Renewable energy will drive the shifting power market. “As the cost of renewable energy sources continues their rapid decline, their influence on the future energy landscape is compounded. Solar and wind power have extraordinary potential across numerous and diverse markets, and output for both will outpace demand. China, Europe and North America will dominate growth in wind, while emerging markets make better prospects for solar.”

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