As commercial bank lending to oil and gas shrinks, other sources of capital fill the gap

May 22, 2024|Written by Peter McKillop

An oil rig at sea

The newly released Banking on Climate Chaos report for 2023 should have been good news to climate activists. Banks are lending significantly less money to fossil fuel companies, according to the annual report by a group of environmental organisations led by Rainforest Action Network.

Commercial banks lent US$632bn in 2023, down from $802bn the previous year. At least seven major oil companies, including ExxonMobil and Shell, sought no financing last year after borrowing more than $50bn annually over the previous six years. Overall, loans in 2023 comprised only 58% of the financing, down from 65% in 2022.

Peak fossil fuel lending?

The decline of traditional fossil fuel lending shows public pressure and tightening disclosure regulations are beginning to bite. However, the drop is also the clearest signal that fossil fuel exclusion policies are accelerating the shift of oil, gas, and coal assets to less transparent corners of the capital market, which means climate-conscious regulators will need to play catch-up to meet globally agreed net-zero targets.

Global financiers are offering a growing menu of alternative sources of financing to their capital-starved fossil fuel clients. These include private equity firms and insurance companies lending, issuing asset-backed securities and bonds, asset sales through mergers and acquisitions, and increased incentives from fossil-fuel-friendly governments like Japan.

Last year alone, according to Climate & Capital Media calculations, more than $300bn of private lending, bond issuance, and mergers and acquisition activity helped oil and gas majors get bigger and fund key projects, including boosting exports of liquified natural gas or offshore oil development.

Oil and gas mergers and acquisitions doubled in 2023, fueled by a mix of bank financing and profits made since the Ukraine crisis.  “Financiers and investors of fossil fuels continue to light the flame of the climate crisis,” warned Tom Goldtooth, executive director of Indigenous Environmental Network and a report co-author.

Private credit financing soars

While the new forms of funding are more expensive for the oil and gas industry, they do offer an added attraction of less transparency and fewer financial regulations. In recent years, the private equity industry has drawn criticism for snapping up billions in fossil fuel assets as energy firms transfer oil and gas assets from public markets into private markets. Since 2021, private equity firms have acquired over $25bn of oil and gas assets from the public markets.

But the latest trend sweeping Wall Street is lending by private equity firms. As commercial banks step back from fossil fuel lending, private equity firms have offered record amounts of so-called “private credit” to the fossil fuel industry. Last year, PE firms lent the industry $9bn, up from only $450mn in the preceding two years, according to data provided by Preqin, an analytics company that tracks the alternative investment industry. The shift is particularly pronounced among European banks, where climate regulations are stricter.

While loans decreased by $97.1bn last year, fossil fuel bond issuance enjoyed a robust year, increasing by $24.3bn. Since 2019, banks have turned to so-called proved developed producing securitisation, in which an oil or gas producer issues bonds in an asset-backed securitization transaction, using the cash from oil and gas production as collateral for the notes placed with investors.

Particularly popular are so-called 144A bonds, which are debt securities that are privately placed and can be traded among qualified institutional buyers in the US without being registered with the Securities and Exchange Commission.

“Securitizations backed by oil and gas assets help diversify funding sources for companies that would typically access capital from more traditional sources, such as reserve-based lending facilities, high-yield bond issuance or equity investment,” Fitch Rating said in a recent report.

Mergers and acquisitions have always been a big part of the oil and gas business, but the sector is amid a particularly intense consolidation. S&P Global Market Intelligence reports the value of oil and gas deals topped $271bn in 2023, double the previous year, including Exxon’s $60bn acquisition of Pioneer Natural Resources and Chevron’s purchase of Hess Corp for $53bn.

Historically, the reason is simple. As a company’s reserves decline, there are only two ways to replenish: new exploration or buying the reserves discovered by someone else. But now there is a new reason: the huge cost of monitoring and capping methane gas. Mergers will allow the large gas players to scale their methane operations by offering efficiencies in deploying the best technology and practices, says EDF. Analysts say one reason Exxon purchased Pioneer is that Pioneer has less carbon-intensive gas fields.

Other new forms of finance

Banks are also getting creative in developing new funding products that allow them to shoehorn high-carbon assets into their ESG strategies. HSBC and Standard Chartered, for example, are currently exploring so-called transition credits, financial instruments issued by the owners of coal plants to generate the funds needed to cover the cost of closing down operations early. Other models currently being explored include capital-relief products. Newmarket Capital, a Philadelphia-based alternative asset manager specialising in structured credit, is pitching so-called emissions-weighted risk transfers to banks.

Countries like Japan, which is urging its commercial lenders to increase loans to the fossil fuel industry, are helping all lenders. Last year, three Japanese banks were the largest financiers of ultra-deepwater extraction, while Mizuho and MUFG were the top financiers of methane gas. Their increased lending reflected increased public financing and other policy support offered by the Japanese government. The Japanese government is the world’s second-largest provider of international public finance for fossil fuels and the world’s largest provider of international public finance for gas.

The challenge of global capital is that it is fungible. As long as there is demand, new ways will emerge to fund oil, gas and coal exploration, development, and production. “It’s hard to say no to short-term opportunity,” says April Merleaux, co-author of the RAN report. The surging demand for new forms of capital, she says, is “proof positive that the only way to shift capital away from the industry is through regulation that makes it harder and more expensive for the fossil fuel industry to fund itself”.

This article first appeared on Climate & Capital Media.

This page was last updated May 23, 2024

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