As banks taper lending to oil and gas projects amid a wider push for “sustainable investments”, Fieldfisher energy specialists Paul Stockley, Oliver Abel Smith and Dougall Molson consider how fossil fuel companies can contribute to the sustainability agenda.
Moves by big banks to slash financing for oil and gas developments have recently garnered considerable press commentary, and refocused attention on where fossil fuel businesses fit into the energy transition.
Banks are unlikely to cut off their exposure to oil and gas entirely, however there is a clear trend towards shrinking that exposure.
Central bank, regulator and investor pressure are all factors influencing banks to move away from fossil fuels, in favour of focusing on climate-related risks and mobilising capital to support the energy transition and emissions reduction goals set out in the 2015 Paris Agreement.
In Europe, the trend is being partly driven by the EU’s ‘Disclosure Regulation’ (EU – Regulation 2019/2088), which will enter into force on 29 December and apply from 10 March 2021.
Under this regulation, in scope entities (Alternative Investment Fund Managers (AIFMs) and Undertakings for the Collective Investment in Transferable Securities (UCITS) management companies; investment firms carrying out portfolio management and financial advisers) will be required to provide investors with certain ESG-related information for financial products to enable investors to make informed investment decisions based on ESG factors.
As things stand, the draft technical standards under the Disclosure Regulation on how they relate to oil and gas, do not make it impossible for specific oil and gas financings to be labelled “sustainable” (although this was hotly debated during the consultation period on the regulation, which closed on 1 September 2020).
Only hard fossil fuels such as coal are banned from benefitting from any financing that purports to be sustainable or ‘green’.
But there is a gap to be bridged between being outright banned from using the term “sustainable”, on the one hand, and being able to satisfy all of the other criteria that need to be satisfied to use the sustainability label in connection with a specific financing, on the other.
The regulation’s use of proceeds criteria will probably mean that oil and gas developments will not be compatible with a sustainable label, however this is subject to the outcomes of the consultation and subsequent interpretation.
What is certain is that the Disclosure Regulation (which under current law/government policy will either come into effect in the UK, or be onshored in the event of a ‘no deal’ Brexit) will materially affect access to capital if it is disregarded by the industry.
Why backing out is going backwards
It has been suggested that the burden of complying with the Disclosure Regulation as well as wider regulatory, societal and other ESG pressures might tempt banks to shun oil and gas altogether.
But banks that decide to turn their back on oil and gas risk losing out on business opportunities, including the energy transition opportunities, if they base lending decisions on a sector, rather than technology.
Even if banks decide not to support further exploration and development for oil and gas – a topic which has proved particularly controversial in areas such as the Arctic National Wildlife Refuge in Alaska, which US president Donald Trump is eager to open up to oil companies – the industry is much wider than its E&P footprint.
In the UK, for instance, according to Oil and Gas UK (OGUK), spending on decommissioning redundant oil and gas infrastructure alone currently amounts to around £1.5 billion per annum, meaning decommissioning in itself is big business for the UK oil and gas supply chain.
Decommissioning investment represents a big chunk of spending – around 10% of overall annual UK expenditure on oil and gas – that banks are set to miss out on if they turn their back on the sector completely.
The energy transition is rightly attracting considerable attention and commitment, however this transition will not happen overnight, and the role oil and gas companies will play in switching to more sustainable energy generation should not be overlooked.
Big Oil’s energy transition has been underway for some time, albeit at a slightly slower pace than many climate change campaigners had hoped.
Banks are now seriously starting to respond to this shift and are reflecting it in their lending policies and this has perhaps caused some undue concerns about a flight of finance from oil and gas.
If banks do tighten lending significantly, this could mean less competitive financing for oil and gas companies, which is a worry for the sector – especially as it tries to modernise and invest in new technology and approaches that will make the industry more sustainable.
Alternative sources of debt capital are likely to come from trading companies, private debt funds and family offices and alternative markets such as the Nordic bond market – most of which (with the arguable exception of the Nordic bond market) are under less scrutiny for sustainability than banks.
The retreat of bank lending from oil and gas therefore risks leaving the industry to be funded by investors with less incentive to drive the sustainability agenda forward – at least in the short term.
To date, there does not appear to have been a “sustainability-linked RBL” (reserve based lending loan) done in the debt instruments market, but this seems a likely and natural development.
What next for bank lending for oil and gas
While it is certainly true that market sentiment has moved against oil and gas, this ignores the fact that the world will need oil and gas for decades to come and that some fossil fuels – particularly natural gas – will remain a key part of the energy mix in any credible future energy scenarios analysis.
Oil and gas companies are also likely to help lead and drive the energy transition (including through CCS and the hydrogen economy), and should not be barred from access to competitive bank finance if they can prove their intention to invest in demonstrably sustainable projects.
It may be that there is more talk than action by banks when it comes to deserting oil and gas. Banks after all are pragmatic institutions capable of assessing how much oil and gas can potentially contribute to energy transition objectives.
Oil and gas companies of all sizes should take note, however, and get to work on their sustainable investment cases, which will increasingly be required by lenders.
This article was written by Paul Stockley, Head of Oil and Gas at Fieldfisher; Oliver Abel Smith, banking partner, and Dougall Molson, derivatives and structured finance partner at Fieldfisher.