Last year was certainly eventful for the energy industry. As predicted, global efforts to work towards Net Zero have gained huge momentum. While COP26 may not have achieved consensus in all areas, it did result in some important commitments and concessions. Moreover, independently of government policy frameworks, many large industry players have embraced progress to Net Zero, thereby marking an easier pathway for others. This is in part down to their corporate goals/aspirations, but in many cases also due to pressure to diversify from public and private investors as well as funders.
It is against this background that, as we begin the New Year, we set out below our predictions for different sub-sectors within the energy industry: upstream, midstream infrastructure, LNG, downstream, renewables, hydrogen, nuclear, energy from waste and energy disputes.
Recovery of mergers and acquisitions activity continues
- After a hiatus of activity in 2020, the second half of 2021 saw a resurgence of M&A activity in the upstream oil and gas sector, driven by the recovery in both oil and gas prices resulting from an actual and forecast increase in demand together with a recognition that companies are likely going to need to combine to be effective businesses going forward.
- We expect this trend to continue into 2022 as industry players consolidate, companies rebalance portfolios and/or exit non-core assets. We are seeing a significant number of full country exits (especially Sub-Saharan Africa) which provides opportunities for those that see upside, particularly from a yield perspective, in acquiring upstream assets (particularly gas).
- To address the volatility of hydrocarbon prices, we expect contingent consideration to form a key element of deals to bridge gaps in expectations between sellers and buyers.
Upstream financing continues to transform
- Banks have continued to shift their focus away from lending to fossil fuels businesses, meaning that they are less willing to lend to some oil and gas companies, even in developed markets around the North Sea, with a particular sensitivity over further financing of upstream crude (as opposed to gas) production.
- In some parts of the world, we are likely to see alternative lenders (such as traders, contractors, debt funds, and private investors) stepping in to syndicates or to plug funding gaps where traditional banks are not prepared to lend. This will likely drive changes in the traditional reserve based lending (RBL) structure and will drive more multi-tiered structures involving mezzanine and other forms of junior lending or quasi-equity.
Midstream oil and gas infrastructure
Continued deal activity for the "right assets"
- Energy companies will continue to divest non-core midstream infrastructure assets, with infrastructure and pension funds the likely buyers. NOCs (especially in the Middle East), may seek to replicate the recent pipeline infrastructure divestments seen in Saudi Arabia and Abu Dhabi over the past 18 months. The challenge for the less developed markets will be ensuring creditworthy customers, which is a hallmark of the earlier IOC and NOC transactions.
- There is the potential for an uptick in demand for mothballed infrastructure for re-use as part of planned carbon capture and storage (CCUS) projects.
Growing interest in green LNG
- The fact that countries that are major buyers of LNG (such as the UK, EU, Japan and South Korea) have net carbon zero goals, means that there will be growing appetite from buyers for "green" LNG – that is Carbon-neutral LNG. While LNG production is still in the early stages of emission reduction strategies and in 2021 only a very small percentage of LNG cargoes were green LNG, growing demand and increased scope for using onsite renewable electricity generation and/or CCUS means that the pace of green LNG uptake will accelerate. However, we also expect that carbon neutral cargoes will be subject to greater scrutiny of their green credentials.
Increased use of ullage in production facilities
- The use of ullage in liquefaction capacity using tolling service arrangements appears likely to continue and to accelerate as upstream fields come off plateau. This trend started in 2017 and is continuing, in particular to allow the development of more marginal upstream fields.
LNG a transition fuel
- The need to electrify means that natural gas will continue to be seen as a transition fuel in Africa, East and South East Asia. The high prices natural gas experienced at various points during 2021 were a function of many things, including supply side tightness. It seems to us that a number of countries will embrace natural gas and LNG as a transition fuel, and seek to provide a clear matching of supply and demand side, providing certainty to one, security to the other.
Downstream oil and gas
Petrochemicals industry looks to sustainability
- While the demand for petrochemicals and petrochemical products is set to grow, the industry will increasingly look to implement measures to improve sustainability and reduce carbon emissions. There will be a particular focus on ways to adapt to a circular economy.
- It is to be expected that the focus of the petrochemical industry will be carbon capture and storage, and increasingly carbon capture and use, in particular the use of CO2 and hydrogen to produce methanol.
A shift in thinking around downstream gas infrastructure
- While natural gas is an important transition fuel (see above), in some countries (such as the UK) there is a shift away from natural gas, with the expectation that existing gas infrastructure may be used to carry natural gas blended with hydrogen or pure hydrogen. Longer-term this will result in the repurposing of gas infrastructure. This is underway in the UK and the EU. However, in emerging markets blessed with access to gas resources, the continued development of gas networks and a consumer market for gas will be an important trend as these economies mature.
Established technologies remain the "ones everyone wants"
- While new decarbonisation technologies are making headlines, established technologies such as solar PV, and onshore and offshore wind will continue to play an important role as an easy to access renewable power source and build-out will continue to increase.
Increasing role for renewables in energy security
- Western European countries will need to find ways to reduce dependency on Russian gas and this will provide additional impetus to push into hydrogen and electrification and related technologies such as battery storage.
Carbon capture, usage and storage is taking off
- After many stops and starts, carbon capture, usage and storage (CCUS) is finally being implemented (and at pace). In the UK, for example, the UK Government's CCUS programme achieved a significant milestone in 2021, with the selection of the first CCUS "cluster" projects and this is to be followed by applications from potential users of the transport and storage networks. The UK experience illustrates the key role of government in CCUS.
- The Global CCS Institute has reported that as of September 2021, the CO2 capture capacity of all CCS facilities under development across the globe has grown from 73 million tonnes per annum to 111 million tonnes per annum – a 48 per cent increase over 2020.
- We see innovations around capture technology developing quickly in 2022 as key stakeholders get behind the sector.
Other emerging technologies set to benefit from tailwinds
- Technologies that have found it difficult to gain the same starring roles as others, are finally moving forward. In the UK, support for tidal energy projects through the Contracts for Difference regime is finally coming to fruition, as well as material progress on the first tidal lagoon projects.
- Nascent technology of this kind will inevitably encounter teething problems in initial implementation, meaning an enhanced risk of disputes in the construction, commissioning and operation phases of these projects.
- Meaningful progress is expected to be made on support from governments for projects producing sustainable/synthetic aviation fuels (SAFs) from renewable sources.
- Regulatory reform looks here to stay as regulators/governments look to update the regulatory framework to adapt to emerging technologies and changing consumer behaviour (e.g. the increasing role of distributed energy).
- 2022 will push forward the illumination of the price differential between traditional energy and green energy, and will show whether people are willing to pay the green price.
Offshore wind keeps surging forward
- Offshore wind has continued to play a key role in decarbonising the electricity sector but, plans for the development of green hydrogen, as well as the electrification of sectors such as transport, means that the demand for low-carbon electricity will continue to grow and has guaranteed a starring role for offshore wind.
- This technology has rapidly progressed from being a high-risk developing technology to an established technology. In the UK, for example, the fourth Contracts for Difference allocation round, where a large portion of the overall budget is dedicated to offshore wind, is expected to yet again achieve record-low strike prices for offshore wind in the auction process.
But some supply chain challenges to overcome
- There will be increasing (but short-term) supply chain constraints on renewables projects that will impact via higher EPC prices, leading to an increase in PPA prices for renewables projects.
- There will also be higher battery prices with similar constraint issues on battery and rare earth minerals and processing backlogs, but at the same time, there will be many announcements of new battery manufacturing (aka gigafactories) increasingly outside of China, especially in Europe.
Energy sector central to the circular economy
- With growing recognition that decarbonisation technologies must be sustainable to be fully green, the energy sector is poised to become central to the circular economy.
Hydrogen is accelerating
- There will be more concrete steps taken to take forward hydrogen. There is an increasing consensus that the acceleration is required, and that governments need to take a leading role in this.
- In Europe, we are starting to see a material amount of activity with companies looking at blue and green hydrogen as a business model and forming joint ventures with complementary business partners, but until the regulation and incentive regime is published by governments, we are unlikely to see FID on large-scale projects.
- Investor appetite for this sector is increasing, with interest from strategic corporates, infrastructure investors and traditional private equity, although some are wary of taking the technology risk.
- We also expect potential market participation by "complementary" players such as midstream and downstream infrastructure players (including shippers) and traders (of produced commodities) will increase in 2022 as hydrogen projects are progressed.
- The role of "captive offtakers" to underpin projects is likely to play a key part in the sector in the near-term as the wider market develops.
Small modular reactor growth
- We will see continuing growing interest in advanced small modular reactors as an alternative to larger projects.
Energy from Waste
EfW will gain boost from BECCS
- Plans for retrofitting of BECCS technology on existing energy from waste schemes get closer to being a reality. In the UK, at least two new EfW projects are expected to be awarded contracts offering financial support for projects with carbon abatement, allowing the incorporation of BECCS technology in their schemes.
Investments in energy transition technologies will generate disputes
- Investment in the energy transition will produce opportunities, but also commercial disputes, driven by new entrants to the market (investors, operators and EPC contractors), new and scaled up technology, and an evolving regulatory landscape.
- Further changes to renewables subsidies may prompt more investment treaty claims by cross-border investors, similar to those faced in the past by Spain and Italy.
ESG-inspired disputes will increase
- Climate change inspired litigation will generate headlines, but there will be an increasing focus on other elements of ESG including human rights and supply chain liability (as relevant to renewables companies, as it is to fossil fuel producers).
- Decarbonisation statements will be increasingly scrutinised and an increased litigation risk because regulators and investors will take action where green statements are not credible or are misleading. NGOs and claimant law firms will pore over companies' public statements for evidence of "greenwashing", with a particular focus on carbon offsets, and whether they live up to their stated environmental benefits. Litigation funders, keen to invest in ESG-inspired disputes, will actively seek opportunities.
More disputes in the upstream space
- Although upstream production will not precipitously decline in the short term, we will see more disputes arising from decommissioning, asset retirement obligations and country exits.
More investment treaty reform
- There will be continued focus on investment treaty reform which is likely to cause energy sector investors to consider/reconsider whether their projects are structured adequately to attract investment treaty protection.
You can read more from our London dispute resolution team about the prospects for energy disputes in 2022 here.
Authors: Matthew Blycha (Partner), Justyna Bremen (Senior Expertise Lawyer), Michael Burns (Partner), Tom Cummins (Partner), Paul Curnow (Partner), Julia Derrick (Partner), Michael Harrison (Partner), Emma Johnson (Partner), Caroline Lindsey (Partner), Chris Redden (Partner), Quentin Robinson (Senior Associate), Luke Robottom (Partner), Antony Skinner (Partner), Cameron Smith (Partner), Huw Thomas (Partner), Maximilian Uibeleisen (Partner), Michael Weatherley (Partner), Matthew Wood (Partner).