French oil and gas major Total will only raise funds in the bond market using sustainability-linked bonds from now on, in a development that will test the sustainable debt market in 2021 as the energy transition accelerates.
Total’s confirmation that SLBs will be its only route to the bond market as it transforms into a broad energy company is being seen by ESG bankers as a highly significant sign of an acceleration in the oil and gas sector’s transformation, and the most important ESG announcement of the year so far. But financing one of the world’s most polluting sectors remains highly controversial with investors, and is certain to provoke fierce debate.
“In one single sentence Total sent the signal that they are going to shift quite rapidly. Total coming to the ESG bond market is a landmark moment,” an ESG banker said.
Total’s executives had hinted about raising a transition bond, but a formal statement in its results presentation on February 9 that SLBs would be the "new normal" took the market by surprise. At the same time, Total proposed changing its name to TotalEnergies.
All new bond issues will be linked to KPI climate targets, and will have long maturities and measurable targets, the company said, as Total seeks to combine its climate goals and financing policy.
“The board has decided that from now, all new bond issues will be climate KPI-linked,” a Total spokesperson said.
These KPIs include scope 1 and 2 oil and gas emissions, which cover its own operations, and indirect scope 3 emissions related to customers’ use of Total’s energy products and net carbon intensity objectives. The KPIs will also be verified by external auditors annually.
“This is a strong commitment from the group to demonstrate that Total is integrating its net-zero ambition into its financing strategy,” the spokesperson said.
Details of timing were not available, but a transaction is now seen as imminent, and could prompt billions of dollars of SLB issuance from the sector.
No oil and gas companies have tapped the sustainable bond markets since a green bond for Spanish oil major Repsol in 2017 was accused of "greenwashing", although Shell raised a US$10bn sustainability-linked loan in December 2019.
“It could very well be that SLBs serve a great role in incentivising decarbonisation,” said Mitch Reznick, head of research and sustainable fixed income at investment manager Federated Hermes.
However, the oil and gas sector remains under pressure despite net-zero pledges from some companies. At the end of January, S&P warned several companies of potentially negative ratings actions due to rising ESG risks, and HSBC analysts recommended that investors reduce exposure to oil and gas issuers to avoid potential capital losses.
Credibility
The prospect of SLBs for an oil and gas company raises key questions around credibility – in particular how robust emissions targets will be. Total is a good candidate to test the market as it is the most highly rated company in the oil and gas sector by the ESG raters.
Total's transformation strategy is also well advanced compared to its peers, and it is seen as one of the front-runners among the oil majors to move from a traditional oil and gas producer to a diversified energy company. (See story on page 11 for more on oil companies' efforts to move into renewables.)
It has made strategic investments in energy storage, energy efficiency, wind, and electricity retailing, and its strategy is less reliant on carbon sequestration, which remains highly controversial and expensive, and other nature-based solutions. Shell's pathway to meet the Paris Agreement targets of limiting warming to 1.5 degrees relies on planting a forest the size of Brazil, for example.
Total raised a €3bn dual-tranche hybrid in mid-January to finance its €1.7bn purchase of a 20% stake in Adani Green Energy, which operates one of the world's biggest solar plants and is Total's biggest investment in renewables to date. While that deal had ESG-friendly use of proceeds, it did not have an ESG label, but saw €6.8bn of demand.
Renewables aside, oil and gas companies clearly face the uphill task of radical transformation as their products have fundamental problems from an ESG perspective, but will still be in demand for decades to come.
"Do we need to think that oil will be part of the global energy mix for many decades to come? Yes we do," said Simon Redmond, a senior director and commodities sector lead at S&P.
Structuring issues
Third-party verification on companies’ transition pathways and KPIs is seen as essential to get investors comfortable, but the appropriate level of penalties and coupon step-ups for missing targets is likely to be key, as investors push for higher rates to finance more polluting companies.
“It's hard to quantify exactly how much we'd need [for a suitable coupon step-up], but the higher the better," said Scott Freedman, a fixed-income portfolio manager at Newton Investment Management.
Investors have been calling for greater variation on the standard 25bp increase, but industry body ICMA's SLB principles say that a step-up has to be commensurate with the overall remuneration on the transaction, which points to a penalty more in line with market precedent as the oil majors still carry high investment-grade ratings.
Additionally Total's commitment to issue only SLBs will cover billions of euros of issuance, which would create significant reputational risk if it missed targets.
All six major European oil and gas producers have in the past 12 months pledged to deliver some form of net-zero emissions by 2050, but investors are calling for more detail, particularly around scope 3 emissions in supply chains, which many see as the leading indicator of the pace of change and how quickly companies can change their business models and move to renewable energy.
“To really have distinction, decarbonisation or carbon-neutral commitments from the sector need to encompass scope 3 emissions as well as scope 1 and 2. We want companies to demonstrate to us what they will look like in 2050,” said Navindu Katugampola, head of sustainable investing at Morgan Stanley Investment Management Fixed Income.
For now, the jury is out on the sector’s ability to adapt amid declining markets, reduced profitability and lower and more volatile oil prices.
“Ultimately, investors will clearly have to make up their minds whether that's the best use of their funds, both from a returns perspective and also from an ESG risk-adjusted perspective," Redmond at S&P said.
While "dark green" ESG investors may choose to steer clear of oil and gas SLBs, and some leading investors are still formulating energy transition policies, they may prove more attractive to more mainstream capital that is increasingly adopting ESG considerations.
"SLBs are a very attractive way to reinforce the sustainability credentials of a typical mainstream bond fund," Reznick said.