Oil firms need a new covenant with investors

The prospect of a lower-carbon future has left oil and gas firms struggling for investment as they try to adapt, writes Tom Fowler

With many years of poor financial performance behind them and the early phases of the energy transition suddenly at their feet, oil and gas producers need to build a new covenant with investors to regain their trust.

The crude demand and price crash that started this spring, combined with an unsure outlook for a return in demand, has many energy investors and lenders "literally heading for the exit", US private-equity firm Carlyle Group's managing director, Bob Maguire, told the Energy Intelligence Forum. Investors were souring on the oil and gas industry as early as 2017, but the past two years have seen a combined $700bn in market capitalisation destroyed, leaving bankers with non-performing loans and investors with sizeable losses, French bank Natixis' managing director, Marianne Daryabegui, told the conference.

That performance, combined with growing signs that society wants to move towards a lower-carbon future, has raised the cost of capital for even fiscally responsible oil and gas producers.

But while the timeframe for the energy transition has been sped up by Covid-19, global demand for energy will grow as the world economy recovers, and oil's role in meeting that demand will continue to be significant.

"On one hand, the energy transition is real and here to stay," Maguire says. "On the other hand, there are 280mn cars on the road in the US today, 279mn of them running on oil, and the average lifespan of a vehicle is 12 years."

So hydrocarbon projects will be around for years to come, meaning that someone will have to own, operate and finance them — and do it in a way that is sustainable both economically and environmentally. Every investment will have to have an environmental, social and corporate governance element to it, Daryabegui says. What used to be standalone oil and gas business groups in banks are now lumped in with power, renewables and infrastructure, the "new energy bucket". Business groups looking at energy transition and environmental issues now have the power to veto transactions.

Even smaller oil and gas producers that lack the balance sheets of the majors to invest or research renewables will have to show they are making efforts to reduce their greenhouse gas emissions. Success in those efforts could be quantified and translated into financial terms, says the World Benchmarking Alliance's engagement director, Pauliina Murphy. Debt could be issued or loan terms adjusted based on how a producer reduces the carbon intensity of their operations, for example.

Cost of capital

The oil and gas sector finds itself in a similar situation to that which the utility sector faced a decade ago, says US investment firm BlackRock's head of global energy equity funds, Alastair Bishop. Utilities were seen as flailing amid the challenge of renewable energy undercutting their costs while they buried their heads in the sand. What they should have done — and what the oil and gas sector should now do — is see low-carbon energy not as a competitor but as an opportunity, Bishop says. Those utilities that successfully embraced renewables saw themselves re-rated, and their cost of capital came down.

That does not mean oil and gas producers should suddenly pivot from oil wells to wind farms. But meeting the goals of the Paris climate agreement and other environmental pacts will require heavy lifting from all parts of society. And there are skill sets those firms have that will be necessary for meeting climate goals, such as managing geopolitical risk, logistics and supply chain expertise.

"So it does not make sense to leave energy companies out of the conversation," Bishop says.

By Tom Fowler