Energy is needed for the production of all industrial and consumer goods, and has traditionally been sourced mainly from oil, gas and coal. Renewable forms of energy, from solar, wind and hydropower, all the way to pioneering processes for the production of hydrogen by electrolysis, contribute to more sustainable energy generation. 

But according to the International Energy Agency’s (IEA’s) World Energy Outlook 2020 report, oil will still comprise a significant portion of the energy mix in 2040 (23%, versus today’s 33%), alongside other forms of energy. Despite the uncertainty brought on by Covid-19, the broader energy transition is taking place across the entire energy, resources and industrials sector. In order to meet the Paris Agreement’s 2°C target, upstream oil and gas production emissions need to decrease by 50% by 2040 compared to 2020 levels. 

The IEA explains: “For any pathway to net zero, companies will need clear long-term strategies backed by investment commitments and measurable impact. The finance sector will need to facilitate a dramatic scale up of clean technologies, aid the transitions of fossil fuel companies and energy-intensive businesses, and bring low-cost capital to the countries and communities that need it most. Engagement and choices made by citizens will also be crucial, for example in the way they heat or cool their homes, or how they travel.”¹

With around 7.8 billion people already on Earth, and the figure projected to be approaching 10 billion by 2050, such transformation will take years – and the right finance structures will be needed to support producers as they transition along this path. Transactions can support the use of renewable forms of energy for the extraction and processing of conventional raw materials, or the sustainable expansion of existing business models.

Sustainability is essential, and includes high environmental, social and governance (ESG) standards in the commodity sector,” says Deutsche Bank’s Head of Natural Resources Finance, Sandra Primiero. “On the environmental side, a reduction of CO₂ emissions is a key focus area and it is very positive to see how many corporates in the sector embrace their responsibility and work closely with financing partners who support them on their path.”

In other words, providers of natural resources finance are working towards getting their clients ‘Paris aligned’, and should not stop financing oil and gas, but rather support producers as they transition to cleaner energy production processes. “Continued financing of our commodity clients reflects our joint responsibility to form the energy transition, which will only happen hand in hand,” Primiero adds.

This article shares two Deutsche Bank ESG-linked commodity finance transactions where the margin paid by the client increases or decreases depending on their ESG performance to agreed metrics.

Both companies involved are examples of a new breed of agile, independent oil exploration and production (E&P) entities with a strategy of reaching once inaccessible or undiscovered reserves in a sustainable manner.

 “For the first time we are also including ESG KPIs in our debt framework”
Teitur Poulsen, Chief Financial Officer, Lundin Energy

Two years ago, in flow’s review of reserve-based lending in the North Sea,² we touched on Lundin’s reputation as one of the largest independent E&P companies operating in the Norwegian Continental Shelf (NCS). The company has grown from generating US$250m EBITDA in 2015 to around US$1.5bn in 2020. Lundin has enjoyed remarkable exploration success in the NCS, including in the giant Johan Sverdrup field, which has gross proven (2P) reserves of more than 2,650 million barrels of oil equivalent (MMboe). At its peak level of production (expected in 2022) its Johan Sverdrup asset alone will account for one-third of all petroleum production from Norway. 

Thanks to its solid management and exceptional oil discoveries, Lundin has grown nearly eightfold over the past five years, with Deutsche Bank’s Natural Resources Finance team having deployed reserve-based lending (RBL) transactions to support the development of the Edvard Grieg, Alvheim and Johan Sverdrup fields. Despite the pandemic, it has continued to perform well, and it was given an inaugural investment grade rating of BBB- by S&P in July 2020. As anticipated for a company that is investment grade and similar to its peers (Aker BP and DEA Erdoel), Lundin is moving towards a more corporate capital structure to provide greater flexibility. 

As a final step before completely moving from secured lending to unsecured debt issuance, the company refinanced its existing US$5bn RBL facility with secured multicurrency term and revolving facilities totalling US$5bn. The deal, involving 16 banks (including Deutsche Bank), was announced on 14 December 2020.³ Importantly, these facilities also include a margin grid based not only on Lundin’s external credit rating, but also the company’s performance in achieving its ESG target key performance indicators (KPIs) on carbon intensity and renewable electricity generation as a proportion of electricity consumption. This transaction was important in order for Lundin to continue to grow as an investment grade company with the appropriate level of flexibility in its capital structure.

23%
The proportion of oil in the global energy mix by 2040
(International Energy Agency)

Lundin has set itself a clear and ambitious target of achieving carbon neutrality by 2025. It is already off to a very good start, producing oil at around 4kg of CO₂ per barrel produced, compared with 24kg of CO2 per barrel for peers and 18kg of CO2 for the entire industry. It aims to halve this to 2kg per barrel by 2023. “If all oil in the world was produced this way, it would save two billion tonnes of CO2 per year, equivalent to removing over one billion passenger cars from the road,” states the company.⁴ 

Lundin is also aiming to have 100% of electricity consumption coming from renewables by 2025. In addition, it is the first company to provide a CarbonClear™ certification on barrels in one of its fields; the world’s first assured standard that certifies the full-life carbon footprint of a field, including emissions from exploration, development and production.  

As a testament to the company’s commitment, the refinancing transaction has ESG KPIs and a margin grid linked to renewable electricity generation and carbon intensity, making it one of the very first ESG-linked transactions in the oil and gas industry. In 2019, the group was rated highly by several ESG rating agencies, including some related to human rights. These include:

• Vigeo Eiris – Top 10 ESG in Europe, top five on human rights globally;
• ISS ESG – Prime status;
• MSCI – AA;
• Sustainalytics – Outperformer; and
• CDP – B.

The facility combines a five-year US$1.5bn revolving credit facility and US$3.5bn of term loans, split across two-, three-, four- and five-year maturities, replacing the current US$4.75bn RBL and US$500m of other credit facilities. Interest reduces to 1.6% above the London Interbank Offered Rate (Libor), from the current RBL rate of 2.5% above Libor. It also includes the option to bring in additional commitments in an accordion option of up to US$1bn. 

All facilities are secured through share pledges, asset security and security over collection accounts. Lundin’s medium-term plan is to issue unsecured bonds in the capital markets that will progressively replace the term loans upon issuance. Upon its first such issuance, all security will be released automatically, provided certain conditions related to credit rating and application of proceeds are met. Protective covenants will continue to apply. 

“For the first time we are also including ESG KPIs in our debt framework, which will serve to offer an economic incentive to continue improving our carbon emissions performance. This further demonstrates the financial value which can be realised from industry-leading sustainable operations,” said Lundin’s Chief Financial Officer, Teitur Poulsen, commenting at the announcement of the deal.

On 31 March 2021, Harbour Energy was born from a merger between Chrysaor, the UK’s leading North Sea independent oil and gas company and largest net producer, and Premier Oil plc, a UK-listed (FTSE) independent E&P company. The transaction was a reverse takeover under the Financial Conduct Authority’s (FCA’s) Listing Rules for Premier Oil.⁵

The new group has now become the largest independent oil and gas producer in UK North Sea waters with a pro forma production of 254 thousand barrels of oil equivalent per day (H1 2020), and reserves of 695MMboe (2P). 

Over the past few years, the former Chrysaor entity had consistently reduced greenhouse gas (GHG) emission intensity across its assets, and it has an additional target for further reductions. The new merged company has committed to continue Chrysaor’s legacy of industry-leading ESG objectives by reinforcing its health and safety standards, and taking part in ambitious projects on the path to a net zero UK economy in terms of GHG emissions by 2035. Measures to achieve this include pioneering blue hydrogen with carbon capture and storage using depleting North Sea fields. 

Combined group assets are located mainly in the UK (91%), as well as Indonesia (5%) and Vietnam (4%). The new group has a cash-generative diversified UK business and operates with a lower carbon intensity than the average UK oil and gas producer.

Deutsche Bank joined as a lender in a sustainability-linked seven-year US$4.5bn RBL refinancing transaction, which was signed in November 2020 in advance of the Chrysaor–Premier Oil merger. The RBL also includes a US$750m accordion, not pre-committed, to increase the facility size to US$5.25bn. 

As noted, the merger was, in fact, a reverse takeover under the FCA’s Listing Rules for Premier Oil, in which Premier’s US$2.7bn of gross debt and other liabilities had to be repaid and cancelled. In addition, the new RBL amends and increases Chrysaor’s existing US$3bn RBL, and funds capital and operational expenditure of the new merged Harbour Energy entity. 

Fully underwritten by Bank of Montreal, BNP Paribas, DNB Bank, and Lloyds Bank, this was very much a landmark deal, representing the first RBL to include ESG-linked KPIs in Europe. The structuring includes interest margin adjustments within a range of five basis points linked to pre-agreed carbon emissions and reductions targets – all verifiable by an independent ESG auditor.

"Lundin and Harbour are role models in their sector when it comes to environmental ambitions"
Yann Ropers, Head of London for Natural Resources Finance, with global responsibility for RBL finance, Deutsche Bank

Leveraging Chrysaor’s ESG legacy of pioneering in CO2 capture and storage solutions in UK projects and nature-based offsets in Southeast Asia, the new group’s strategy is to become a key energy player, with UK North Sea assets playing a pivotal role in its energy transition. It has announced a goal of 30% reduction in GHG emissions by 2025, with a further 20% reduction by 2028 and a net zero scope 1 and 2 emission by 2035. By way of background, the three scopes of GHG emissions, according to the leading GHG Protocol Corporate Standard,⁶ are:

• Scope 1 – Direct emissions from company-owned and controlled resources.
• Scope 2 – Indirect emissions from the generation of purchased energy from a utility provider.
• Scope 3 – Indirect emissions not included in scope 2 that occur in the value chain of the reporting company, including both upstream and downstream emissions.

Scope 1 and 2 are mandatory to report, whereas scope 3 is voluntary and the hardest to monitor. However, companies successfully reporting all three scopes will gain a sustainable competitive advantage. 

Before the merger, Chrysaor was a founding partner of the major Acorn CCS and Hydrogen Project at the St Fergus gas terminal in North East Scotland. This comprises a partnership with Shell and Total that is led by Pale Blue Dot Energy and supported by the UK and Scottish governments and the European Union. This North Sea based-project, now under the auspices of Harbour Energy, is essential for meeting the Scottish and UK governments’ net zero targets. The first phase of Acorn is targeting storage of 340,000 tonnes of carbon a year from the St Fergus gas terminal. A second phase, with the production of ‘blue’ hydrogen, could see the capture and storage of much larger volumes.

Harbour also has a foothold in the UK’s green energy plans through the Acorn project stake and the Humber Zero project. “We do have a focus on ESG and we have made a commitment to be net zero by 2035, we take that very seriously,” said CEO Linda Cook in an interview with the Financial Times on 1 April 2021.⁷ She confirmed that part of the plan is to snap up any assets the oil majors are offloading, as they streamline their portfolios and increase the focus on renewable energy. The newspaper noted that “since October, when Harbour and Premier first agreed their deal, oil has risen from about US$40 a barrel to US$65.”

Asset electrification projects are underway to assess low-carbon electricity supply options to power platforms. However, the company is mindful of its new shareholders, so the focus is on cash generation while ensuring investment is sustained for the long-term energy transition. 

“Despite the engaged energy transition, hundreds of billions of US$ per annum of investments continue to be required in the oil and gas upstream sector just to meet forecast demand over the next two decades,” says Yann Ropers, Deutsche Bank’s Head of London for Natural Resources Finance, with global responsibility for RBL finance.

He adds: “We remain committed to our North Sea clients in their ESG transition and development of long-term solutions for CO2 emissions reduction (such as carbon capturing and other carbon offset solutions). Lundin and Harbour are role models in their sector when it comes to environmental ambitions. The energy transition is a journey, and each step counts.”

Sources

¹ See https://bit.ly/3tyNKZg at iea.org
² See Sunset to sunrise at flow.db.com 
³ See https://bit.ly/3uzMIxt at lundin-energy.com
⁴ See https://bit.ly/3f2geoS at lundin-energy.com
⁵ See https://bit.ly/3f2gi86 at offshore-energy.biz
⁶ See https://bit.ly/2RFYuaO at ghgprotocol.org
⁷ See https://on.ft.com/3hgpqbN at ft.com