Capital MarketsESG

Extra Credit: Energy Companies Issuing Debt from Green Subsidiaries

By November 10, 2021No Comments

Bonds issued by energy company transition business units are preferred by debt investors who screen for green.

Bonds issued by entities within energy companies that are focused on low- or no carbon emission projects and technology are far more likely to appeal to some asset managers than debt issued by the holding company.

  • That takeaway emerged at a recent meeting of NeuGroup for Oil & Gas Treasury sponsored by Societe Generale during a session that featured two debt investors, one representing a traditional credit mandate and one with an ESG mandate.
  • Both expressed a preference for debt issued by subsidiaries engaged in businesses largely unrelated to oil and gas. “I would love it if your industry started issuing out of their renewable subsidiaries,” one investor told members of the group.

Here are some of the points made by the investors about this preference that energy companies should consider:

  • Keep more investors who are leaning toward excluding fossil fuel issuers. Both asset managers noted that there is a cohort of investors committed to reducing the carbon footprint of their portfolios who will be far more likely to invest in bonds issued directly from the parts of a corporation shifting away from carbon.
  • Good marketing for little-to-no capital cost. This approach provides corporates with a marketing benefit while the cost of capital difference is likely to be trivial and can be avoided by structuring the offering with a parent guarantee. It also signals to investors that the transition/low carbon business is a viable enterprise that can support its own debt.
    • “That provides the talking point about how you are addressing transition. It’s the way that makes it the most obvious and clear that you are approaching this from a longer-run perspective and you’re shifting your focus in the long run,” one asset manager said.
  • Show a balance sheet and financial reporting not reliant on E&P. While cash is fungible, fixed-income investors want to see a transition that is not wholly reliant on oil and gas cash flows to fund energy transition. “The E&P balance sheet is a challenge to transition, so it helps to have a separate balance sheet and reporting entity to show consistent progress,” one investor said.
  • Positioning for a longer-run technology payoffs. Investment in renewables and low carbon energy has similarities to investing in technology. Like Moore’s law in technology, each investment in renewable technology, such as solar, helps the next generation produce more energy at less cost.
    • Fossil fuels investment payoffs, on the other hand, are much more dependent on the future fuel cost, which will be declining long-term as alternatives evolve, than the efficiency of getting that fuel out of the ground.
    • It is a different risk profile and payoff duration. The same can be said for investment in carbon capture/storage technology. Aligning the bond and duration to the longer-run technology payoff can thus makes sense.

Reasons for resistance. In a follow-up email, one of the investors told NeuGroup Insights he has heard that some large energy companies are “evaluating” the idea but said he has not yet seen any issue debt directly out of their greener entities. Asked why, he wrote: “Based on my interactions with the energy companies I believe there are a few different reasons, and not necessarily in this order:

  1. Concern over cost of financing (assuming that [holding company] capital is cheaper).
  2. Lack of knowledge over requirements of issuing a green bond.
  3. Concern over potential claims of greenwashing given their core fossil fuel operations.
  4. Concern over valuation impact on core fossil fuel operations by highlighting and focusing on greener businesses.”
Justin Jones

Author Justin Jones

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