Green reserve based lending facilities?

The evolution of green/sustainable finance in the oil and gas sector

The market in green and sustainable finance as it has developed distinguishes between, on the one hand, green bonds and loans, where the proceeds are to be applied to fund eligible green projects (e.g. renewable energy projects, energy efficiency processes and low carbon transport) and on the other hand, sustainability linked loans, where the terms of the loan are in some way linked to performance under sustainability criteria or third party assessments of "greenness". 

In October last year, Teekay Shuttle Tankers issued a Green High Yield Bond in the Norwegian bond market.  The green bond market is well established in Europe, but the unusual thing about this bond issue is that the company owns one of the world's largest fleets of tankers transporting oil from offshore fields.  The bond was classified as "light green" by Cicero, a sustainability analytics company, on the basis that, although the proceeds are to be used to finance the construction of four new tankers, these will be highly fuel-efficient tankers, or "e-tankers", which will substantially reduce the carbon intensity of the company's operations. 

As for sustainability linked loans, while electricity utilities have been leading the way in the energy and resources sector, the trend is spreading to oil and gas companies, including offshore services companies.

In early 2019, SBM Offshore, a leading provider of floating production storage and offloading vessels, signed a new five-year sustainable revolving credit facility (RCF) which provides for a link between the company's sustainability performance and the interest rate margin on the RCF.  This was the first RCF linked to sustainability performance in the oil and gas services industry.

Then in December last year, Shell announced it had signed a US$10 billion RCF under which, in a first for Shell, the interest and commitment fees paid on the facility are linked to Shell's progress towards reaching its short-term Net Carbon Footprint intensity target, as published in its Sustainability Report.

There has been a steady stream of E&P companies announcing a net-zero carbon strategy, sometimes along with changing their names to drop reference to petroleum.  One of the latest to do so is Lundin Petroleum (soon to be Lundin Energy), one of Europe's largest independent E&P companies with a US$5 billion RBL.  Is it possible we will see the emergence of "green" or "sustainability linked" RBLs consistent with these developments?

Lenders are increasingly coming under pressure from regulators, investors and the wider public to justify their continued lending to fossil fuel businesses.  We have already witnessed some banks which were traditional participants in the RBL market withdrawing from the oil and gas sector, or at least seeking to reduce their exposure over time, for "policy" reasons.  The recently appointed CEO of RBS, Alison Rose, has said that RBS will stop lending and offering underwriting services to major oil and gas producers that do not have credible transition plans in line with Paris climate agreement targets.  Regulators have for a while been considering giving a nudge to the market by providing for cost of capital benefits for lenders under loans in both the green and sustainability criteria linked categories.  There is in reality still no shortage of banks keen to lend to E&P companies, but it is likely the market will need to evolve in some way to keep the liquidity flowing.

A product for E&P companies that could potentially cut the pricing of loans compared to other pricing available in a changing market, broaden the pool of lenders and chime with their corporate net-zero carbon goals would obviously be appealing in principle.  That appeal may have its limits if the product came with disproportionate increased ancillary costs for setting up the facility and for any continued monitoring, or with very restrictive use of proceeds limitations, cumbersome bank account controls and onerous covenants.

Common sense says that it may be challenging to convince lenders and others that an RBL used to fund the development and operation of oil and gas fields, even in the least carbon intensive manner, could fall within the "green loan" bucket.

But, as the RCFs for SBM Offshore and Shell have indicated, there could be scope to go down the sustainability linked loan route.  This has the advantage (compared to green bonds or loans) that loan proceeds can be applied to general corporate purposes, rather than being tied up in a controlled bank account to be applied only for specific limited green purposes, which realistically are likely to be a relatively small part of the funding requirements of an E&P company even with the best of decarbonisation intentions.  As a word of caution, it should be noted that Shell, in particular, has a high investment grade credit rating, which no doubt is helpful for banks in deciding to be part of what will probably be an undrawn liquidity backstop facility.

The documentation process need not be daunting.  For companies with an existing RBL, rather than starting from fresh it should be easily possible to amend and restate the existing loan agreement to turn it into a sustainability linked facility.  Adding a green tranche to a current facility would require more replumbing but could be done.  In another sector heavily involved with fossil fuels, the airline industry, JetBlue Airways has just closed a sustainability linked loan with BNP Paribas, amending its existing $550 million RCF.  The amended facility now includes a pricing mechanism linked to JetBlue's Environmental, Social and Governance (ESG) score provided by Vigeo Eiris, an independent provider of ESG research and services.  RBLs are more complicated than straight RCFs, but the same approach with amendments to existing documentation could be taken.

Features of a sustainability linked RBL

A sustainability linked RBL may have all or some of the following features:

• interest rate margin (and commitment fee) linked to reported average asset portfolio carbon intensity to below "x" kg CO2 per boe of production, possibly with a grid for further step-downs in the margin as the carbon intensity reduces to below fixed trigger points, and possibly with a step back up in the margin if those trigger points are no longer achieved.  Alternatively the margin could be linked to an overall ESG score of the borrower, taking account of net carbon produced across the whole of the borrower's business, involving for example the purchase of carbon credits to offset business travel.  The scale of the margin variation is likely to be limited to a few basis points, though even that could be significant for a larger RBL in the context of a possibly changing market where loan pricing for E&P companies generally may be on an upward trajectory;
• an annual or semi-annual report may be required from an independent sustainability analytics company or other suitable expert alongside the RBL borrowing base redetermination, so there could be some additional cost for borrowers.  If the borrower is a publicly listed company which reports on the relevant sustainability criteria, independent monitoring may not be required;
• an ESG co-ordinator and agent appointed by the borrower (from among the lender group) to help identify, set up and monitor compliance with any sustainable finance-specific provisions in the RBL.  A fee is likely to be charged by the bank assuming such a role;
•  a separate "green" tranche could possibly be included, to be used only for green purposes, for example, for investing in renewable assets to decarbonise the borrowers "net" electricity consumption, which is particularly relevant given the push for electrification of offshore production.  The proceeds of the green tranche would be paid into a separate project account and would be subject to covenants relating to the use of those funds for the specified green purposes. As an upside for the borrower the pricing on the green tranche may be lower.  Some form of independent reporting on the application of the funds is likely to be required, except perhaps for listed companies where that information is publicly available.

A future necessity?

The direct cost benefits of such a facility may be relatively small, or possibly even non-existent if outweighed by set-up and monitoring costs.  It is increasingly common in any case for any pricing savings to be donated to sustainability charities.  The greatest benefits of a sustainable finance RBL are likely to be as part of an overall corporate strategy of carbon intensity reduction in order to keep regulators, equity investors, potential lenders and the wider public on-side with the continued "licence to operate" of the oil and gas industry.

It would make a lot of sense for banks which are keen to keep lending to fossil fuel intensive industries to prioritise moving customers in those industries to sustainable finance products ahead even of customers in other sectors.  Indeed we are likely to see many such deals among E&P companies over the next couple of years as facilities come up for refinancing in the normal course.  Something that would hardly have occurred to E&P executives undertaking refinancing exercises six months ago is now front of mind.

This article was first published in Project Finance International on 11 March 2020.