Financing the transition to net zero with green finance in the oil & gas industry

With COP26 taking place and the North Sea Transition Deal announced, it is clear that the UK Oil & Gas industry has committed to the Green Energy Transition. This year's Offshore Europe conference has also decided to focus upon how we fuel the transition to net zero. There are many things still to be considered in terms of how we achieve a total transition to a renewable energy society, but there is one thing that is certain - funding will be required to effect this global change. The pressure to address the Climate Emergency has also led providers of finance to show that they take their responsibilities to the climate seriously, and as a result "Green" loans are increasingly common in the UK loan market across all sectors of the UK economy. But what does Green Financing mean for those borrowers who continue to work in the Oil & Gas industry, and can it really be used to achieve net zero?

What is Green Financing?

There has been a real focus in the loan market in recent years on "Green Financing". Green Financing can be made available through any of the traditional methods of finance, with loans and bond issues the most usual. In order for a loan to be classed as "Green", it must include conditions and/or provides benefits which aim to ensure that the borrower is taking responsibility for their impact upon the climate, and operating an environmentally sustainable business model.

What does a Green Loan look like?

In terms of Green Financing, there are a couple of different types of lending which we regularly see:

1. Green Purpose Loans

These are loans which are made available exclusively to finance or refinance a project which is recognised as being "Green". The Loan Market Association have published a non-exhaustive list of categories which would be considered "Green". These could vary from upgrading equipment in workshops and refineries, to investing in electric vehicles and renewing the UK's fleet of lorries and supply vessels.

2. Sustainability-Linked Loans

Sustainability-linked loans are based upon the expectation that a borrower can take increasing steps to move their business towards "net zero", while recognising that the primary purpose of the loan is not yet "Green". Within these loan agreements certain Key Performance Indicators (KPIs) are identified which the borrower commits to achieving. Examples might include:

(a) a reduction in emissions; or

(b) an increase in use of renewable technology; or

(c) an increase in the energy efficiency of a production process.

Targets around these KPIs are set, and meeting the targets could be required for lending to be extended or increased. Alternatively a more attractive interest rate could be given where targets are met. These loans can be made available for usual business purposes but can also be used for "Green" purposes. Unlike traditional "green purpose loans" however, sustainability-linked loans can be used where the project which may not have a direct or definite "Green" benefit, such as to acquire new equipment in contemplation of a diversification into green industries or to finance R&D in relation to green improvements or greentech.

It is possible to see both green purpose loans and sustainability-linked loans within a single lending package, with certain tranches of debt earmarked for designated purposes and the remaining tranches attracting a margin which is affected by success on certain environmental KPIs. An example might be a specified tranche for use in replacing equipment with more environmentally sustainable alternatives and another tranche used for general corporate purposes with a margin ratchet based upon the overall reduction in carbon emissions of the borrowing business.

How does Green Financing apply in the context of Oil & Gas companies?

Sustainability-linked loans are currently the most common type of Green Financing in the UK energy industry. While there is a general understanding in the UK and European energy market that a transition to cleaner forms of fuel is inevitable (for more on this, please see The Cleantech Evolution by Martin Ewen), sustainability-linked loans focus on the positive steps which can be taken in the short term to make improvements while the Energy Transition is achieved.

KPIs may be linked to specific assets or to the borrower's business as a whole. For example, in a reserve based loan, the KPIs might focus particularly on the carbon intensity per barrel of oil equivalent of a particular asset or assets. In contrast, when providing financing to an oil services provider, the KPI could refer to the overall carbon output of the business including any output from production, transport, buildings, IT and business travel. KPIs can also encompass only direct environmental impacts from a particular business, or it could be expanded to record environmental impacts of the business' wider supply chain. This is particularly relevant for the Oil & Gas industry, where including the impact of contractors and suppliers could have a significant impact on results. Shell, for example, entered into a $10 billion revolving credit facility in December 2019 which has a KPI based upon its short-term Net Carbon Footprint, which includes the carbon footprint generated in the ultimate consumption of its products by third parties (source: Shell).

.How do you demonstrate green credentials to a lender?

Lenders are understandably concerned that any financing of an enterprise involved in the Oil & Gas industry can be seen as hostile towards the Climate Emergency, and reputationally they will want to make sure any borrower under Green Financing is committed to reducing their environmental impact. It is important that lenders are not unwittingly party to an "ESG (environmental, social and governance)whitewash", where there may be paperwork showing an intention to improve their impact by those benefiting from green loans, but no real underlying action taken. If seeking green financing, it is therefore important to have a well thought-out ESG policy, with KPIs which are relevant to your business and which can realistically be improved. It is also important to note particular markers showing how the targets will be met. As part of ESG reporting under a Green Financing loan, it is likely that a regular report will be required, setting out evidence as to how the KPIs are being met and progressed. You will want to be sure that your successes can be measured and will be capable of being evidenced in this report. In larger loans it may also be the case that a specialist ESG coordinator is appointed to the loan to oversee this work, and accordingly a fee may be charged for this service.

If you have any questions about Green Finance, please contact us.