Turning challenges into opportunities: how well are oil and gas companies navigating the move to net zero?

To successfully navigate the energy transition, the oil and gas industry must continue a proactive dialogue with investors, banks and regulators.

The oil and gas industry is weathering a turbulent period. Rattled by the COVID-19 pandemic, a slump in oil prices and a push to net zero, the world’s largest oil and gas companies are facing an existential crisis.

As pressure from climate and investor activism heightens and investment patterns transform with a keen eye on sustainable and resilient assets, the sector is reassessing its business model and striving for a new balance between net zero and net profits. Today’s investors expect to see companies with clear strategies for expanding their renewable energy capacity and well thought-through roadmaps outlining achievable emissions-reduction targets.

To successfully navigate these changes, turn them into opportunities and future-proof itself, the oil and gas industry must continue an open and proactive dialogue with investors, banks and regulators.

“The energy transition brings challenges to the oil and gas sector, but huge business opportunities as well,” says Clare Francis, Regional Head, Client Coverage, Europe at Standard Chartered. “We’re all on the journey to net zero, so working together to develop clear transition strategies and articulate those to investors, will be key to keeping capital flowing.”

Demonstrating success

According to the International Energy Agency (IEA), no energy company will be unaffected by the transition1 to net zero. A report from CMS Legal Services points out that there’s already evidence in Asia that access to financing for coal and oil companies has fallen2. This trend is likely to continue.

The impetus for change comes after the COVID-19 crisis3 pushed oil prices to 30-year lows, underscoring the need for an industry-wide shift and diversification. Less business travel and more working from home will continue to dimmish the demand for oil, forcing companies to revisit their business models. The issue is no longer when oil will run out, but rather when the transition to other forms of more sustainable energy will take over4. Against this backdrop, shoring up balance sheets and cash positions has taken on increasing importance, with all companies facing questions about how and when they can deliver climate solutions.

And it’s not just about the high-profile names you see making headlines. While seven large integrated oil and gas companies dominate much of the dialogue, the IEA says, the wider industry also needs to respond. The seven majors account for just 12 per cent of oil and gas reserves, 15 per cent of production and 10 per cent of estimated emissions from operations, underscoring the share made up by other players.

For oil majors caught between climate goals and shareholder returns, forging a path to transition has become a question of survival. A failure to demonstrate a clear strategy to embrace other forms of energy generation risks capital drying up and investors seeking opportunities elsewhere. Oil and gas companies − from the smallest to the largest − are now vying against one another for capital and need to demonstrate how and why they deserve it.

The solution is a mix of innovation − thinking more broadly about attracting investors; creativity − including looking at alternative markets and different sources of capital; and strategy − educating potential investors and presenting a roadmap with targets to get to net zero.

Financing the transition

Financing these shifts requires skill, as investors focus on the global transition to more sustainable sources and companies must work harder to prove they are meeting environmental, social and governance (ESG) criteria. Strong relationships and collaboration between investors, banks and company management is critical.

Standard Chartered is working on the financing side to support and manage the transition of companies from oil and gas to lower carbon companies, which presents an ongoing challenge to corporate treasurers in the sector.

Thriving in this tricky environment requires adequate liquidity management structures. For example, oil major BP raised USD12 billion of hybrid bonds5 last year to help shore up its balance sheet. The instruments, which have equity-like features, place less strain on the balance sheet, and were issued in a year where BP also agreed a two-year credit facility6 to help its liquidity management.

It is important for corporate treasurers in this sector to keep options open and evaluate them on a continuous basis − harnessing the power of market fundraising. Exploring different structures, like convertible bonds and hybrid bonds, is also central to success, as well as understanding how best to incorporate the focus on ESG into assets and what this means for investor education.

Turning challenges into opportunities

A three-pronged approach should be considered, according to consultancy firm McKinsey & Co. Firstly, making the core hydrocarbon businesses more resilient; secondly, finding ways to expand the low-carbon businesses; and thirdly, changing the operating model to survive in a low-carbon future.

Traditional business models in this sector have been under pressure for some time, McKinsey says, as evidenced by a lag in total returns. The average oil and gas company lagged the S&P 500 by seven percentage points in the past 15 years, in terms of annual total returns to shareholders, its research shows.

Even so, the sector is vital, since oil and gas are set to remain an important part of the energy mix, particularly for developing countries. And while decarbonisation is top of the global agenda, a smooth transition means oil and gas companies will continue to play a central role for decades to come.

But the pace of change needs to accelerate, according to the IEA, which calculates that, so far, investment by oil and gas companies outside their core business areas has been less than 1 per cent of total capital expenditure. Among the major oil and gas companies, the figures are slightly better, with investment in the energy transition jumping to 3.6 per cent of capex in 2020, from 2.9 per cent in 2019, according to CMS Legal Services.

“Maintaining reliable funding flows to allow this sector to transition towards a lower-carbon future is going to require us to scale our strategy and of course, our relationships,” concluded Standard Chartered’s Clare Francis. “After the significant price volatility we’ve seen, net zero will continue to shape the future of the oil and gas industry for many years to come. We are committed to partnering with the sector and support this transition.”

This article is based on themes discussed during a panel discussion at Standard Chartered’s recent Global Credit Conference – Opportunities from Disruption. View the recording.

1 https://www.iea.org/reports/the-oil-and-gas-industry-in-energy-transitions

2 https://www.euractiv.com/wp-content/uploads/sites/2/2021/06/Energy-Transition_The-evolving-role-of-oil-and-gas-companies-in-a-net-zero-future.pdf

3 https://www.mckinsey.com/industries/oil-and-gas/our-insights/oil-and-gas-after-covid-19-the-day-of-reckoning-or-a-new-age-of-opportunity

4 https://www.euractiv.com/wp-content/uploads/sites/2/2021/06/Energy-Transition_The-evolving-role-of-oil-and-gas-companies-in-a-net-zero-future.pdf

5 https://www.ft.com/content/6213ac92-9d7b-41da-9353-a2be17a37a96

6 https://www.reuters.com/article/bp-secures-further-us10bn-of-headroom-idUKL8N2BU5MI

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