Shift in funding looms over oil & gas industry as COP27 approaches, says WoodMac

Energy intelligence group Wood Mackenzie is wondering whether COP27 could be a turning point for oil and gas funding as the Glasgow Financial Alliance for Net Zero (GFANZ) intends to use it to crystallise the climate threshold for financing.

As a legacy of COP26, many governments intensified efforts to align with their pledges concerning net-zero aspirations, however, the Ukraine crisis has resulted in inflation, which is increasing costs across the energy sector and affecting the implementation of the energy transition roadmap.

If COP26 was seen as a way of creating the mechanisms to make the energy transition possible, COP27 promises to be the catalyst to start implementing decarbonisation in earnest, according to the energy intelligence firm. Due to governments struggling to allocate the trillions required in capital, Wood Mackenzie believes that tying private financing to climate criteria will be vital to asserting the new normal.

Due to Russia’s attack on Ukraine, the outlook for the supply, demand, and price of hydrocarbons is constantly changing, which is leading to a rewriting of energy trade flows, thus, against this backdrop and with coal currently more resilient, further advancing the energy transition could be more expensive and potentially prove more carbon-intensive.

This is where GFANZ comes into play. Established at COP26 and launched in April 2021 by Mark Carney, UN Special Envoy for Climate Action and Finance, GFANZ brought together the world’s largest banks, asset managers, asset owners and insurers functioning under separate subsector groups into a single financial sector-wide alliance. Wood Mackenzie says that GFANZ has been “a force amplifier for synergy between these groups, greater than a sum of the parts, uniting the sector behind a central mission to mobilise capital to lower greenhouse gas emissions.”

As the central mission of GFANZ is to mobilise the financial sector to accelerate the transition to a net-zero economy, which inevitably means a smaller role for oil and gas as part of the transition, since, it is one of the highest emitting sectors.

While GFANZ aims to use the next UN Climate Change Conference in Sharm el-Sheikh as a catalyst to standardise and implement its transition financing plans, recent geopolitical events have highlighted that economies are fragile to price shocks, and supply and demand have to move in sync. With this in mind, GFANZ has been clear that members can continue to finance oil and gas companies if these firms are taking appropriate steps to enable the energy transition. 

Furthermore, GFANZ is grounded in the UN’s Race to Zero campaign to ensure credibility. The campaign prescribes ambitious criteria for participation which entails a 50 per cent carbon reduction by 2030 and net-zero by 2050. Wood Mackenzie explains that science-based criteria as a starting point add rigour and transparency, addressing the credibility gap and concerns around greenwashing.

The energy intelligence provider elaborates that the oil and gas industry remains exposed to financial sector capital allocation despite higher oil and gas prices. Due to this, GFANZ has many levers – from bank lending to security selection by asset managers – through which it can materially impact oil and gas companies by bringing together financial subsectors.

Wood Mackenzie states that financial institutions will redirect capital towards companies with “robust and credible plans” to reduce emissions, therefore, oil and gas companies will have to demonstrate that they are taking steps to align with the Race to Zero criteria to stay investable. In addition, these firms will be under increasing pressure to cover all scopes of emissions.

While GFANZ is expected to deliver guidance and frameworks that provide sector-level granularity on what is expected of oil and gas companies between now and COP27 in November, the recent strengthening of GFANZ climate criteria implies that the alliance will set the bar high.

As a result of this, there will be a greater emphasis on visible and measurable emissions reduction and GFANZ members will expect oil and gas companies to have a strategy that sets out how they will reach net-zero, along with targets and metrics that enable external stakeholders to track their progress. Additionally, they will need to show an understanding of the risks and opportunities involved and demonstrate good governance that inspires confidence in their ability to deliver.

Even though companies are investing to reduce emissions, decarbonise and diversify into renewables, Wood Mackenzie claims that this must increase to levels that trigger a declining trend in absolute company emissions, including Scope 3. Currently, only a handful of oil and gas companies show a reduction in total emissions over time.

The energy intelligence group informs that financing with no climate strings attached will largely be assigned to history, as GFANZ membership continues to grow and its work program increasingly informs policymaking. It is anticipated that the pressure on companies to align will only increase as time goes by.

While finance will still be available from non-GFANZ sources, the pool of lenders and investors without climate criteria is expected to shrink over time as those willing to ignore ESG risks will expect to be compensated, making funding more expensive. Wood Mackenzie also adds that these are likely to have shorter time horizons and be fewer stable shareholders.

Meanwhile, production growth remains the key focus for most resource holders despite the looming threat, as underlined by Wood Mackenzie. The company further confirms that some of the largest emitters have been able to use recent high prices to rapidly deleverage, reducing their exposure to the issue, while a select few companies are diversifying into renewables. However, the energy intelligence firm says that there is limited capital allocated to decarbonisation.

Wood Mackenzie further states that the momentum is building behind the energy transition with greenhouse gas emissions at their highest level and energy security in sharp focus thanks to Russia’s invasion of Ukraine. GFANZ membership is expected to grow further as pressure increases on financial sub-sectors such as private equity to align in the run-up to COP27.

Taking this into consideration and given the emerging situation, Wood Mackenzie concludes that oil and gas companies need to be ready for a rapid shift in the funding landscape.