Moving assets from pubic to private ownership risks global net zero targets, according to a report from the Environmental Defence Fund (EDF).
As M&A in the energy industry accelerates, the sale of assets from owners with targets and public oversight to owners with less interest is challenging not just the net zero commitments of stakeholders but also a possible increase in net global emissions. Holding key stakeholders like investor groups, bankers, energy companies, and policy makers responsible provides the best chance to mitigate this.
Upstream M&A risks sending net zero targets downhill
An analysis of the M&A activity in the oil and gas industry over the last five years reveals a majority sale of assets from public to private markets, with a greater shift away from operators with net zero commitments. Leaving the situation unchecked could risk the decarbonisation plans of all stakeholders in the oil and gas industry.
The IPCC has identified the move away from fossil fuels as imperative to meeting the 1.5°C goal, requiring drastic cuts in upstream oil and gas greenhouse gas emissions, and at the least no further increases. Meanwhile the International Energy Agency (IEA) has stated that there is no room for new oil and gas in a net zero future.
Clearly there is new investment going into oil and gas, which means that those assets operating in the market must lower their emissions. What the EDF analysis highlights is that traditional M&A methods of asset transfer may not be suitable for the climate stewardship demands of the energy sector in a net zero world.
Stranded assets should be everyone’s problem
The problem of ensuring assets transferred to private markets or operators with inadequate climate disclosures can be resolved by engagement with all the stakeholders involved in the M&A process, the EDF report concludes. Leadership from banks, energy companies and policy makers alike could alleviate the problem of stewardship-at-risk deals.
Traditionally asset sales have been part of corporate M&A strategies, helping raise cash to reduce debt and pay dividends, or optimise operations, but of late have also become ways for companies to invest in energy transition and reduce emissions. The latter reasons can result in a reduction in climate disclosure and jeopardise emissions targets. Five of the six largest banks in the US were involved in most of the transactions from 2017-2021, so its a mainstream problem.
Case studies highlight near- and long-term effects
The report includes case studies of asset transfers which risk near-term warming, and reduced long-term transition planning and climate disclosure. Transactions that moved assets from companies with methane and flaring targets to operators without them means that methane and flaring were no longer being addressed – or at the very least there was no transparency on what was being done.
The transfer of hundreds of assets from to companies without a net zero commitment risks a decline in strategic oversight, and could well hamper the global industry’s ability to meet long term climate expectations. Increased ownership of upstream operations by private owners also risks less scrutiny from investors, regulators and consumers. This is exactly the issue underlying the debate about stewardship versus divestment in the equity markets.
Obviously M&A in the energy sector isn’t going to go away, but the report’s authors are calling for a ‘new model of climate-aligned deal making’. There are a number of ways in which this can be done:
- Inclusion of climate safeguards into deal terms
- Buyer guarantee of enhanced climate disclosure
- Buyer guarantee of best of breed methane mitigation and flaring reduction
- Inclusion of funds for decommissioning in deal terms
Climate standards in transactions must be agreed
Investors can put pressure on asset owners to include climate standards in transactions, while sellers can make climate action a condition of sale. That may not be a standard approach today but as climate conditions worsen, failure to engage in the right sort of deal making could become a significant reputational drag on a seller.
The debate about whether a carbon-intensive assets should be improved or sold off is an extension of the debate about investment versus stewardship. There has to be a blunt discussion about the extent to which companies will be supported in transitioning those assets to a lower carbon status. Otherwise such assets will continue to be moved out of sight – and that is a danger to global net zero targets.
Energy is the sector hit first by transition and has struggled in its response to growing global demand for emissions reduction. Deal-making is going to evolve and market leaders need to get ahead of this challenge both to reputation and to emissions profile.