‘Net zero’ oil firms sell dirty assets to private market

Divesting can take away the option of engaging high-carbon companies to do better

Asset managers pressuring oil and gas companies to transition to net zero are having to confront an emerging trend – some companies are selling dirtier parts of their businesses to the private market.

That practice, while making a public oil company look cleaner on paper, often leaves the planet in a worse position.

Smaller private companies that have been eager to snap up facilities from larger public ones usually have lower or no emissions-reductions goals and are more likely to regularly perform natural gas flaring or engage in other environmentally unfriendly practices, according to the Transferred Emissions: How Risks in Oil and Gas M&A Could Hamper the Energy Transition report from the Environmental Defense Fund (EDF).

Globally, mergers and acquisitions involving upstream oil and gas represented about $192bn across 498 deals in 2021, more money than in four of the past six years and a higher number of transactions than in three of them, according to EDF.

“Assets are flowing from public to private markets at a significant rate,” the report noted.

“Over the last five years, the number of public-to-private transfers exceeded the number of private-to public transfers by 64%. In every year during this period public-to-private transfers comprised the largest share of deals.”

This has led to more oil and gas assets being owned by less environmentally scrupulous firms, the authors noted.

Last year, for example, 62 deals moved assets from companies with flaring commitments to those without, while there were just 21 transactions in the opposite direction.

There were 34 sales from companies with net-zero targets to those without, and only nine sales from those without targets to those with them, according to EDF.

And 50 deals moved assets away from companies with methane goals, while 14 moved them toward ownership of companies with such targets.

“Mergers and acquisitions are an essential business tool for oil and gas companies, and that won’t change,” the authors of the report wrote.

“But how companies sell assets must change. The industry needs new tools to ensure sustained climate stewardship as assets change hands.”

For the report, the researchers analysed data on upstream oil and gas mergers and acquisitions from Refinitiv for 2017 through 2021.

Between those years, the top sellers of assets were Shell, Repsol, Chevron, ExxonMobil and Petrobras.

During that time, the banks that facilitated the most transactions by monetary value were Goldman Sachs, JP Morgan, Citi, Jefferies and Morgan Stanley, according to the report.

ESG analysis

“The significant increase in production by private oil and gas companies compared with the discipline we’re seeing from the publics, underscores the risk that a larger percentage of output could be moving toward private companies who are typically less transparent with their transition plans,” Wellington Management head of sustainable investment Wendy Cromwell commented. “M&A trends will accelerate this trajectory.”

In the US, the forthcoming final rule from the Securities and Exchange Commission on climate risk disclosure for public issuers will provide more information that will help managers evaluate climate plans and identify risks and opportunities, Cromwell said.

“Currently, the vast majority of oil and gas companies are not providing the market with the input needed to assess what portion of their reserves could be at risk of becoming stranded,” she said.

“Private companies that are purchasing these wells may not have a robust understanding of which assets could become stranded should we see acceleration of the energy transition, and may therefore be overpaying.”

That could also encourage private equity firms to invest more responsibility, she noted.

“We will continue to engage with the banks that are facilitating these transactions to ensure that climate targets are considered a package deal with the assets that are being sold.”

A recent paper from Columbia University’s Center on Global Energy Policy found that even while many public oil and gas companies have emissions-reductions targets, the data they choose to report is not provided in a consistent way that would help investors analyse them.

Further, companies’ emission-reduction goals and risk reporting are more likely to cover Scope 1 and 2 emissions than the much wider-ranging Scope 3 emissions, that report found.

Many oil companies, including Chevron, BP and ExxonMobil, have set some kinds of net-zero targets.

With some seeing less of a role for petroleum in the future, repositioning their firm as an energy company has been a popular way to reframe the business.

Recently, Phillips66 announced a project to convert its San Francisco Refinery in Rodeo, California to a renewable fuel facility, at an estimated cost of $850m.

Role in the energy transition

“The implications of holding energy companies in a portfolio that integrates ESG analysis may not be hugely impactful with regard to the timing of the transformation of the world’s energy infrastructure for a few reasons,” said Erika Karp, chief impact officer at Pathstone, in an email.

“First, the energy sector is not starved for financing, so the cost of capital to these companies may not increase. Second, the divesting of fossil fuel stocks may be truly in line with an investor’s values, but it also means that the ability to actively engage with the companies is less powerful.”

But ESG analysis can be used to identify the companies that are making the progress toward decarbonisation, she noted.

“Highlighting the companies that are moving most quickly and are the best-in-class can have a positive impact too,” she said.

“From the standpoint of an investor, the key is the extent to which they are willing to consider the magnitude and pace of the transformation.”