The oil-and-gas industry is increasingly turning to ESG-linked financing to tap into the rapidly growing pool of capital. While not everyone is convinced by the companies' pledges to cut emissions, which underpin the loans, this type of financing is becoming increasingly popular.
Since 2021, a handful of North American fossil-fuel companies have issued sustainability-linked bonds and other instruments that are typically tied to certain environmental, social and governance metrics. These bonds and instruments are designed to help the companies meet their sustainability goals, and they typically come with financial incentives for meeting or exceeding those goals.
For example, pipeline giant Enbridge Inc. (ENB) is a major player in the energy sector. The company has a strong presence in North America and is involved in a number of high-profile energy projects.
Tamarack Valley Energy Ltd. is a Canadian oil and gas company with operations in Alberta and British Columbia. The company is listed on the Toronto Stock Exchange and has a market capitalization of approximately $2.3 billion.
Aris Water Solutions Inc. is a water services company that provides oil field water solutions. ARIS is down 3.23% today.
Presidio Petroleum and its partners have sold more than $3 billion in sustainability-linked bonds over the last two years. One of the latest offerings was closed by Diversified Energy Co.
The company that owns the most oil and gas wells in the United States received $215 million in October from an asset-backed security linked to emissions-reduction targets.
Sustainability-linked securities typically feature ESG goals set by borrowers, including cutting emissions intensity—emissions as a proportion of total energy produced—or increasing racial and ethnic representation in their workforce. Unlike with green bonds, companies can use deal proceeds for general funding and not only for projects that have a positive environmental impact.
Some analysts have said that loans for greenhouse gas emissions reductions can be risky because the market for these loans is still relatively new and standards and penalties for missed targets are not yet firmly established. In general, these securities are structured so that the interest rate (coupon rate) increases if the companies fail to reduce emissions, and in some cases, is reduced if they succeed.
This financial structure could encourage oil-and-gas companies to set ambitious climate goals, but issuers will need to implement those targets for the bonds to credibly qualify as sustainable, said Andrew Logan, senior director for oil and gas at sustainable-finance nonprofit Ceres.
He said that it will be up to the industry to show that they can meet a high standard.
Sustainability-linked financing is growing rapidly. Many industries have issued these securities, ranging from fashion to pharmaceuticals. According to financial-markets platform Dealogic, there were 42 issuances in the U.S. last year, totaling about $30 billion. That compares with just three in 2020 representing roughly $2 billion. S&P Global estimates that global issuance of all sustainable securities will reach $865 billion this year.
The bonds provide a much-needed funding mechanism for the oil and gas sector, which has seen oil-wary investors turn their backs on it in recent years, according to executives and industry experts.
According to Heather Lang, a principal at consulting firm ESG Global Advisors Inc., green bonds are a great opportunity for issuers to diversify their investor base and showcase their sustainability commitment.
Presidio, a Fort Worth, Texas-based oil and gas company, last year issued $430 million in securities tied to reducing greenhouse gas emissions by 50% over a five-year period, said Will Ulrich, Presidio's co-chief executive. If the company succeeds in meeting its emissions reduction targets, it will receive a small break in the interest rate on the bonds, Ulrich said.
"We thought that getting a sustainability-linked bond rating would be a way to differentiate ourselves from other companies," Mr. Ulrich said.
Presidio has retrofitted more than 1,200 pneumatic valves at well sites to reduce methane emissions, according to the climate targets attached to the bond. Methane is a major contributor to rising global temperatures, second only to carbon dioxide, according to the Environmental Protection Agency.
Oil-and-gas producers are attracted to ESG-linked loans because they can use the funds as they see fit, according to Erin Boeke Burke, a lead analyst at ratings firm S&P Global Ratings. Diversified Energy, which has issued four such loans this year, said it would use the latest one to finance general corporate purposes and repay previous borrowings.
"The new rules give companies more flexibility in how they use proceeds from asset sales, but they're still required to disclose any transition-related activities," said Ms. Burke.
Some investors have raised concerns that the issuers of climate bonds get to determine their own performance on attached climate targets, say analysts.
For example, Ceres' Mr. Logan said that Diversified Energy's issuance was problematic because there is debate over how to accurately measure reduction of methane emissions, which the company has set as a goal. He continued by saying that "there's a concern that Diversified has set targets before it has a true sense of what its actual emissions are."
A spokesman for Diversified said the company regularly checks well sites for emissions and that its efforts have been recognized by a methane emissions reduction initiative backed by the United Nations. The company's bond issuance was certified by ratings agency Sustainable Fitch, he said.
Some investors are also concerned that most issuers’ emissions targets don’t include those generated when consumers use their products, said Charlotte Edwards, an ESG analyst at Barclays PLC. Another factor affecting the perception of the bonds is that some companies set goals they would have achieved anyway or face insufficient penalties if they don’t achieve them, she said.
In February, Tamarack Valley Energy, an oil-and-gas producer based in Calgary, Alberta, sold debt securities worth $200 million. The securities are linked to a reduction in emissions intensity of 39% by 2025 in the company's operations and energy uses. If Tamarack Valley Energy fails to meet this target, the coupon rate on the securities will increase by 75 basis points.
S&P Global Ratings noted in a review that while meeting emissions targets would have some effect on reducing global emissions, it would not be as significant as if the company had pledged to reduce emissions from its products. The company is on track to substantially reduce its emissions thanks to a large investment in gas conservation, which will have a greater impact on reducing emissions.
June-Marie Innes, director of finance and sustainability at Tamarack Valley, said that S&P Global Ratings had approved of the sustainability component of the issuance. She added that the company has the greatest influence over its own operations and is committed to cleaning them up as much as possible.
"I think it's a good thing that there's a penalty if we don't do what we say we're going to do," she said.
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