WECA Advisory Board #1: Key Takeaways

In anticipation for the Energy Council’s World Energy Capital Assembly (WECA) to take place in December, an advisory board of the industry’s leading figures was held to inform the agenda. Among the attendees were representatives from INEOS Energy, Standard Chartered, Kerogen Capital, Lloyds Banking Group, ADNOC, Mizuho, Morgan Stanley, BP IST, Bluewater Energy, Wentworth Resources, Sector Investment Managers, Harbour Energy, NEO Energy and Jersey Oil and Gas.

Chief among the concerns was the lack of clarity around ESG criteria, the state of traditional oil and gas financing structures and the role of private equity in a changing energy landscape. As the world begins to achieve some control over the Covid pandemic, the consequences from a succession of sectoral downturns has led to a level of uncertainty rarely encountered.

The divergence between the “O” and the “G” is growing as ESG influence grows. Gas is viewed as a transitionary fuel that facilitates moves away from oil, and the view of actors in the sector is to increasingly separate the two from the one another. This view was consistent across both advisory boards, with gas being viewed far more favourably than oil.

State of ESG Across the Globe

From the perspective of oil and gas producers, lenders, investors and regulators alike – there is a distinct lack of clarity to what constitutes action toward ESG. Without measurable, data-driven targets the path to decarbonisation becomes increasingly unclear, creating bottlenecks within the sector as financiers and investors become hesitant to lend or invest without knowing how the assets comply to ESG criteria – and if they may have to divest if the asset is exposed to high carbon emissions.

A concern emerged that there may be a production void in several years time as these market bottlenecks have delayed 5 years’ worth of production projects.

For companies seeking finance, they will need to produce evidence of action and develop a decarbonisation story to accompany their operations. This entails actively measuring their reductions and offsets, however the lack of conformity across jurisdictions inhibits market activity.

Financing and investment decisions are increasingly constrained by the implementation of ESG trends, typically aligned to the policy decisions of Europe and the United States of America. These criteria cannot be enforced across the globe with the role of developed states needing to be enlarged in comparison to the developing world.

The Decline of Reserve-Based Lending?

To this end, there is a need to reconsider the financial structures typically relied on by lenders to mitigate the high-risk exploration, particularly the viability of reserve-based lending (RBL). Traditionally, RBL has provided producers with the opportunity to repay debt via the profits made from successful explorations and accompanied by mechanisms that will adapt to market shocks.

As the international finance institutions begin to limit their lending exposure away from projects with high emissions and step back from the complexities of regional ESG differences – a financing vacuum may appear that can be filled by regional banks. Regional banks will have the advantages of understanding the local regulatory environment and of reduced ESG pressure from the European finance sector.

RBL has traditionally helped banks to shift down their diligence and provide bond investors with comfort, typically giving space for independent producers to grow. As they market shrinks this will become inviable and may inhibit production activities by independents, or they will have to look elsewhere for capital.

Likewise debt markets will have to make adjustments and become more flexible with their offerings; with green bonds, sustainable link bonds and the like becoming more prominent as ESG becomes more pronounced.

Investor Sentiments Expect O&G Rebound

The investor landscape has shifted dramatically for the oil and gas sector, with the successive shocks in 2015, the Russia-Saudi price war of 2019, shortly followed by the Covid pandemic – ensured that prices fell far below expectations, resulting in reduced or withheld dividends. However, the environment has shifted with the rise of ESG, with Private Equity funds and international energy funds stepping in to fill the void left by the more risk-averse financiers.

The panelists noted that there had been a clear division presented to the public between; environmental evangelists and oil zealots. Within this advisory board there was a relief to find like-minded “Middle of the Road” pragmatists seeking concrete measures that will both aid the energy transition and ensure growing energy demand is met.

This approach recognizes the need for the oil and gas sector to make material changes to the way in which operations are conducted, and the capacity for the investment community to influence and further the energy transition by seeking to acquire assets less exposed to GHG emissions.

There is an expectation that, as Private Equity firms and investment funds come to terms with ESG, there will be a significant increase in M&A activity to fill the void of more cautious financiers. The North Sea E&P sector is enjoying some of the early benefits of their decarbonisation efforts – implementing EOR, powering platforms with renewables and creating efficiencies through digitalization. All actions that speak to having “an ESG story”.

Elsewhere in Asia and Africa, where the ESG concerns may be seen as a barrier to development more so than an opportunity to decarbonize – NOCs, PE and the energy funds may step into the void of IOCs divesting their positions from higher risk assets. This opportunity to fill the void left by traditional finance, could yet prove highly beneficial for private investors willing to assume the risk of high-emissions assets.

The Role of IOCs & Oil Majors in the Energy Transition

There needs to be conversation about the role of the oil and gas industry in the paths they are taking to decarbonize, and if their presentation as “energy” companies is an honest representation of their business. IOCs have rebranded and made loud declarations about their move away from oil and gas, and to many inside and outside the industry – are simply not convinced.

Demand for oil and gas is growing, not declining, and the world requires an affordable and consistent supply of this energy. This is what IOCs know best, where they can make the greatest difference to decarbonize and lead decarbonisation efforts that will impact smaller producers.

The concerns herein are born out of a belief that IOCs are not Energy companies, as their portfolios would reflect 1-2% annual divesture and fewer than 5% of operations outside of O&G. Their expertise lies within oil and gas, where they have proven capacity to develop new technologies and create efficiencies – this is where they should make the impact while leaving Renewable Energy development to the market leaders.

There was a feeling IOCs, oil majors and independents can acquire strong social capital by seeking more effective decarbonisation methods within oil and gas, rather than token efforts at carbon offset programmes or carbon leakage through divesture of high-emissions assets. Solutions such as CCUS, EOR and carbon-neutral gas flaring, all have the capacity to significantly reduce the GHG emissions impact of fossil fuel production.

• Our second advisory board, looking at the evolving strategies and digitalisation of the sector – can be read here.