Expect GFANZ to crystallise the climate threshold for financing as Sharm el-Sheikh approaches
If COP26 was all about creating the mechanisms to make the energy transition possible, COP27 promises to be the catalyst to start implementing decarbonisation in earnest. But with governments struggling to allocate the trillions required in capital, tying private financing to climate criteria will be vital to asserting the new normal.
Established at COP26, the Glasgow Financial Alliance for Net Zero (GFANZ) aims to use the next UN Climate Change Conference in Sharm el-Sheikh as a catalyst to standardise and implement its transition financing plans. As one of the highest emitting sectors, oil and gas can expect to feel the consequences. So, what exactly is GFANZ and what are the implications for future oil and gas funding?
What is GFANZ?
Launched in April 2021 by Mark Carney, UN Special Envoy for Climate Action and Finance, GFANZ brought together the world’s largest banks, asset managers, asset owners and insurers into a single financial sector-wide alliance. Prior to COP26 they were functioning under separate subsector groups. GFANZ has been a force amplifier for synergy between these groups, greater than a sum of the parts, uniting the sector behind a central mission to mobilise capital to lower greenhouse gas emissions.
The central mission of GFANZ is to mobilise the financial sector to accelerate the transition to a net zero economy. That inevitably means a smaller role for oil and gas as part of the transition. However, recent geopolitical events have highlighted that economies are fragile to price shocks, and supply and demand have to move in sync. And GFANZ has been clear that members can continue to finance oil and gas companies if these are taking appropriate steps to enable the transition.
To ensure credibility, GFANZ is grounded in the UN’s Race to Zero campaign, which prescribes ambitious criteria for participation – a 50% carbon reduction by 2030 and net zero by 2050. Science-based criteria as a starting point add rigour and transparency, addressing the credibility gap and concerns around greenwashing.
How will it affect oil and gas companies?
Despite higher oil and gas prices, the oil and gas industry remains exposed to financial sector capital allocation. By bringing together financial subsectors, GFANZ has many levers – from bank lending to security selection by asset managers – through which it can materially impact oil and gas companies.
Financial institutions will redirect capital towards companies with robust and credible plans to reduce emissions. To stay investable, oil and gas companies will have to demonstrate that they are taking steps to align with the Race to Zero criteria and will be under increasing pressure to cover all scopes of emissions.
Between now and COP27 in November, GFANZ will deliver guidance and frameworks that provide sector-level granularity on what is expected of oil and gas companies. Recent strengthening of GFANZ climate criteria implies that the alliance will set the bar high.
What does that mean in practice?
There will be a greater emphasis on visible and measurable emissions reduction. GFANZ members will expect oil and gas companies to have a strategy that sets out how they will reach net zero, along with targets and metrics that enable external stakeholders to track their progress. They will also need to show an understanding of the risks and opportunities involved and demonstrate good governance that inspires confidence in their ability to deliver.
Though companies are investing to reduce emissions, decarbonise and diversify into renewables, this must increase to levels that trigger a declining trend in absolute company emissions, including Scope 3. At present there are only a handful of oil and gas companies that show a reduction in total emissions over time.
As GFANZ membership continues to grow and its work program increasingly informs policymaking, the pressure on companies to align will only increase. Financing with no climate strings attached will largely be assigned to history.
Is there any alternative for oil and gas companies?
Finance will still be available from non-GFANZ sources, but over time the pool of lenders and investors without climate criteria will shrink. Those willing to ignore ESG risks will expect to be compensated, making funding more expensive. They are also likely to have shorter time horizons and be fewer stable shareholders.
Is the industry ready?
Despite the looming threat, production growth remains the key focus for most resource holders. Some of the largest emitters have been able to use recent high prices to rapidly deleverage, reducing their exposure to the issue, while a select few companies are diversifying into renewables. However, in general there is limited capital allocated to decarbonisation.
With greenhouse gas emissions at their highest level and energy security in sharp focus thanks to Russia’s invasion of Ukraine, momentum is building behind the energy transition. As pressure increases on financial sub-sectors such as private equity to align in the run-up to COP27, GFANZ membership is expected to grow further. Given the emerging situation, oil and gas companies need to be ready for a rapid shift in the funding landscape.
Source: Wood Mackenzie