Behind headlines of price spikes, the oil and gas sector faces multiple long-term challenges to operating models with investors increasingly vocal about their expectations.
The business models of oil and gas firms and the structure of energy supply are increasingly in focus for institutional investors, as short-term supply and demand issues heighten concerns over the long-term difficulties of low-carbon transition.
Energy ministers across Europe have been considering a range of measures, with fuel price spikes leading to a range of challenges, including the collapse of a plethora of small energy suppliers and queues at UK petrol stations.
The UK has been particularly badly hit as high petrol prices – reaching their highest level since 2013 as economies crank up after the pandemic and supply chains – have coincided an ongoing shortage of UK HGV drivers.
European benchmark futures for gas delivery in January 2022, when heating demand is expected to peak, have hit a record €66 (US$78) per megawatt-hour, up from €16 a year ago.
That’s largely down to multiple factors, including low gas storage levels, decreased Russian supplies, growing demand from Asia particularly China, lower renewables output and nuclear maintenance outages.
Fossil fuel dependency
Although short-term factors will continue to play a key role in the resolution of current challenges, including winter weather, the crisis highlights how dependent consumers, businesses and industry remain on fossil fuel and how much further there is to go to hit net-zero targets for greenhouse gas emissions.
NGOs stepped up the gas last week with a series of reports and initiatives on what fossil fuel and its financial backers need to do next. According to Reclaim Finance, this includes further pressure on the finance sector to cut the links that supply finance to oil and gas firms to prevent Arctic exploration.
It said that oil and gas companies such as Gazprom, Total and ConocoPhillips are set to ramp up production in the Arctic by 20% in the next five years. They are being backed by hundreds of billions of dollars from banks and investors, despite many of them holding commitments to restrict fossil financing in the region.
The report detailed US$314 billion of loans and underwriting from commercial banks to Arctic oil and gas expansionists between 2016 and 2020, noting also that investors are also “facilitating the deadly oil and gas boom” by holding around US$272 billion in Arctic fossil developers as of March 2021.
“Financial institutions have bankrolled these companies, making a mockery of their own climate commitments. Since the oil and gas tigers won’t change their stripes, the likes of BNP Paribas, BlackRock and JPMorgan Chase must heed the instruction of the International Energy Agency and cut off the taps,” said report author Alix Mazounie.
A report by Moody’s Investors Service last week flagged the risks to investors of continuing to invest in oil and gas firms with inadequate plans to transition to low-carbon business models.
Moody’s gave the exploration and production sector a median Carbon Transition Assessment score of CT-8 at the high-end of risk on its 10-point scale. The median score of the integrated oil and gas companies rated by Moody’s is CT-7, indicating material exposure to carbon transition.
This, Moody’s said, showed that both sectors face material and increasing risks from the transition to a low carbon future, despite limited adjustment steps taken by some companies. Neither sector is strongly positioned for the carbon transition it warned.
“Independent exploration and production companies are particularly vulnerable to the growing risk of a weakened demand scenario over the long term,” said James Leaton, Senior Vice President at Moody’s Investors Service.
“Companies face daunting challenges in strengthening their resilience to a low carbon future, because doing so will require a capital-intensive diversification of their business to adapt to shifts in the energy system, and strategic cost management to ensure the economic viability of current and future assets.”
A recent report from UK-based think tank Carbon Tracker warned investors that oil and companies have failed to grasp the “seismic implications” of the International Energy Agency’s (IEA) roadmap, saying they would by exposed to trillion-dollar losses from stranded assets and heightened insolvency risks if oil firms continue to ignore climate change.
Institutional investors are already increasing their scrutiny of the transition plans of oil and gas firms in their portfolios, partly driven by regulatory changes which are making it clearer what can be considered a green investment.
The EU’s Taxonomy Regulation creates a list of economic activities that can be regarded as sustainable and fit for investment by funds regulated under the Sustainable Finance Disclosure Regulation.
So far the European Commission has not yet ruled conclusively on the inclusion of gas, but a recent report by WWF and over 150 civil society groups including Greenpeace warned this would turn the taxonomy into a greenwashing tool, “completely undermining its credibility and sending a disastrous global signal”.
An open letter from the groups to European institutions, notably the Commission, urged it not to label fossil gas as a green investment.
The Commission proposed the inclusion of fossil gas in the Taxonomy in March but postponed the decision to a Delegated Act due this Autumn.
Henry Eviston, sustainable finance spokesman at WWF European Policy Office, said: “The expert evidence just keeps piling up: fossil gas is not and never will be green.”
Raising investor expectations
Investors have become increasingly vocal in their expectations of oil and gas firms, asserting the need for detail evidence of a commitment to transition and diversification in turn for continued support.
This saw a number of high-profile developments during the proxy voting season, with several firms subject to shareholder resolutions on climate-related transition plans, including ExxonMobil, which saw three of its directors replaced.
But investor networks have also launched more sustained engagement campaigns with the sector. These include efforts by Climate Action 100+ to work with heavy emitting firms across a variety of sectors, while US-based network Ceres launched this month an Ambition 2030 initiative targeting firms in sex sectors, including oil and gas.
Also this month, the European-focused Institutional Investors Group on Climate Change (IIGCC) released its ‘Net Zero Standard for Oil and Gas’, which outlined the actions that oil and gas companies should be taking and how these should be reported to enable investors to effectively evaluate their progress and assess the credibility of their net-zero transition plans.
Options outlined in the standard include: diversifying into new areas of business, particularly renewable energy; working with customers to transition to low carbon energy; developing technology and solutions to reduce emissions; and ceasing exploration and running existing assets down to return cash to investors.
“This net zero standard offers a reset moment for investors and oil and gas companies alike to get behind a shared understanding of what needs to be included in a transition plan within the oil and gas sector in order to allow for effective comparisons of investor evaluations,” said Stephanie Pfeifer, Chief Executive, IIGCC.