Transition risk becomes more real for oil and gas companies
May 24, 2021 | Bayani S. Cruz
The risk of transition is becoming increasingly real for the world’s largest oil and gas (O&G) companies, as they face increasing pressure from investors, including their shareholders, to take shares. more short-term measures to combat climate change.
Failure to do so on the part of these companies could result in divestment by existing shareholders, leading to increased transition risk, particularly in the form of “stranded assets”. These are physical assets whose investment value cannot be recovered and must be written off.
In the case of Royal Dutch Shell, the calculation could take place as early as 2023 when the Pensions Board of the Church of England (CEPB), a major shareholder, plans to sell its stake in the company if it does not reach its emissions target by then. year, according to a statement by CEPB Ethics Director Adam Matthews at Shell’s Annual General Meeting (AGM) on May 18.
At Shell’s annual general meeting on May 18 and BP’s on May 13, the two oil majors had to push back separate resolutions presented by FollowThis, a group of climate activists representing minority shareholders, which demanded that companies are setting stricter emissions standards to fight climate change.
The resolutions were the result of a general perception that the two companies effectively covered up putting in place stricter company policies to reduce carbon emissions, while claiming otherwise, and continuing to grow their businesses highly. carbon pollutants.
In February last year, BP announced that it had set itself a goal of achieving a net zero carbon goal by 2050, but since then it has not disclosed any details on how she plans to do so. In February of this year, Shell made a similar pledge while saying it would continue to grow its gas business by more than 20% over the next few years.
Although both FollowThis resolutions were defeated, the number of shareholders voting in favor of them increased significantly, from 8.4% a year earlier to 20.6% in the case of BP and from 14.4% a year earlier. year earlier to nearly 30% in the case of Shell, indicating that there is increasing pressure on oil companies to take their carbon reduction promises more seriously.
If anything, the recent BP and Shell AGMs seem to indicate that the O&G majors still don’t know how to strike a balance between how they transition to renewables while still maintaining their still hugely lucrative fossil fuel businesses.
But the longer they delay the transition to renewables, the greater the risk that their fossil fuel business will end up with stranded assets, as investors are rapidly moving away from these types of assets for renewables.
“We believe that the risk associated with stranded assets will remain at the center of the energy transition, with a particular focus on more carbon-intensive fossil fuels, although the timetable is not yet clear,” says Nick Moller, group manager Global Infrastructure Investment at JP Morgan Asset Management. “Valuations represent an additional risk for investors.”
The fact that investor interest in green infrastructure has increased and significantly boosted the share prices of some publicly traded infrastructure assets may also increase the risk of stranded assets for the O&G sector.
In terms of infrastructure, one thing that can work for O&G majors is the fact that the supply of green or renewable investments has not grown as quickly as investor demand. However, given the growing investor appetite for green infrastructure, these companies may not have much time to switch from their traditional carbon-based assets to renewables without risking breaking. end up with stranded assets.
“Given the length of new development cycles, which could impact forward-looking returns, the sustainable management of critical infrastructure, with an emphasis on governance, is essential for risk-adjusted returns,” notes Moller. .
It’s not just the O&G majors that risk ending up with stranded assets. Even the oil-producing countries of the Middle East, also known as the Gulf Cooperation Council (GCC) countries, face a transition risk from a global shift to renewables, which will have an impact. on their credit ratings.
As demand for fossil fuels declines, major exporters will experience a loss in GDP, government revenues and export earnings in the absence of offsetting trends, such as economic diversification, according to a report by Fitch Ratings. “The solvency of large fossil fuel-producing sovereigns who can diversify their economies away from hydrocarbons will be less affected by stranded assets,” he said. “Many, like those at the GCC, already have diversification plans and still have time to make changes.”