Key issues for energy companies amid the energy transition: A financial perspective
Mizuho Industry Research
April 22, 2021
As the trend toward decarbonization grows worldwide, efforts in the European Union to become carbon neutral at the corporate level are progressing. While the burden on companies to deal urgently with decarbonization varies from industry to industry, the burden on integrated oil and gas companies is particularly high.
As energy companies transform their business portfolios for decarbonization, a variety of key financial issues are emerging in two phases: the transformation phase and the post-transformation phase. During the transformation phase, a period when the companies are shifting from their existing business to low-carbon and decarbonized business, securing the necessary funds to invest in new business expansion is paramount. During the post-transformation phase, the focus will shift to optimizing the capital structure in response to changes in the expected rate of return on assets due to the business portfolio's transformation.
For energy companies to manage the transition effectively, it would be a useful to develop a medium- to long-term strategy in collaboration with financial institutions that takes into account the key financial issues mentioned above. It is also important to consider the use of transition financing when considering the funding of each phase.
The trend toward decarbonization is growing worldwide. In the year 2020, many countries around the world announced their decarbonization goals. In line with these developments, European companies have announced various decarbonization aims. The burden on companies to respond to the decarbonization varies from industry to industry, but it is a particularly heavy burden for oil and gas companies that have developed multiple businesses related to fossil fuels.
Long term business plans can mitigate financial market concerns about the uncertainty surrounding energy companies. As the trend toward decarbonization accelerates, and the uncertainty of the future business environment increases, the viability of long-term strategies announced by companies is becoming increasingly important for investors. At the same time, in the short term, uncertainty about the companies’ ability to generate cash flow during the energy transition process will increase. Firms need to demonstrate successful track records and their financial management efforts must be sound and in line with their financial policies.
A firm’s financial strategy is one of the fundamental elements for successfully implementing an energy transition. The key issues to be addressed in this strategy differ depending on the stage of a firm’s portfolio transformation. First, during the business portfolio transformation period, securing the necessary funds to invest in new business areas should be a primary focus. However, during the post-transformation phase, the focus should shift to optimizing the capital structure in response to changes in the expected return due to the portfolio’s transformation.
To successfully fund the transformation of business portfolios, it will be important for firms to formulate medium- to long-term plans that directly address important financial issues. In particular, developing those plans with financial institutions, taking into account future funding issues, is a prudent path forward.
Finally, when considering the financing for each phase of a project, it is important to look at sustainable financing. Transition finance is a framework that allows companies with a large GHG emissions volume to obtain certification of reduction efforts by meeting certain requirements in line with the goals of the 2015 Paris Agreement. In the future, it is expected that investors, as the providers of funds, will have a preference for this type of financing. In order to meet these certification requirements, it will be necessary for firms to disclose their transition strategy and governance structures, highlighting environmental significance, scientific evidence, and transparency. Considering them at the same time will lead to the development of comprehensive financial strategies that take into account the possibility of benefiting from future funding.