Energy companies face a dilemma. They recognise the imperative to decarbonise – and therefore to invest in renewable energy technologies and green solutions that reduce emissions. But the race to net zero is fraught with difficulty: move too aggressively and they may undermine their competitiveness today; move too slowly and they may face criticism – and even confrontation with groups such as regulators and activists – as well as other dangers.
New research from law firm White & Case underlines the delicate nature of this balancing act. While 59 per cent of energy companies regard the need to remain competitive during transition as one of the biggest risks they face in relation to decarbonisation, 44 per cent are anxious about the potential for challenges from activist shareholders.
Imagination required
It does not help that the pathway to decarbonisation remains unclear. Large parts of the energy sector are still trying to work out how financial and environmental sustainability can go hand in hand, says John Moon, Head of Morgan Stanley Energy Partners. “There are lots of things we can do to decarbonise without putting our shareholders’ financial welfare at risk,” he says. “But it takes real creativity and differentiation.”
Some investments will be targeted, Moon suggests. For example, he points to the case for investing in battery storage and microgrids, particularly given high levels of competition in the solar and wind sector. Others will be incremental: shifting from coal and diesel to cleaner natural gas might not represent complete decarbonisation, for example, but will still reduce emissions while generating financial returns.
Certainly, the risk of waiting until a fully plotted roadmap to net zero is clear is highly significant. Energy companies have already faced a series of activist investor campaigns, with high-profile confrontations at businesses including AGL, ExxonMobil, Royal Dutch Shell, Glencore and SSE. These shareholders are not demanding that companies turn their back on profitability and competitiveness, but they are pushing for more radical action on climate change.
In some cases, these disputes may evolve into full-blown litigation, warns Seth Kerschner, partner at White & Case. He points to the example of ClientEarth, an environmental advocacy organisation that, in February 2023, filed a derivative action against Shell’s board of directors, in which it holds shares, alleging that they failed to properly prepare the company for transition to net zero and mismanaged material and foreseeable climate risk. “It remains unclear whether ClientEarth will succeed with this type of claim” says Kerschner, but that, he adds, may be beside the point. “The main aim may be more the publicity surrounding the claim itself than any ultimate remedies.”
Inconsistent regulation
A related problem is the ongoing interventions from regulators and policymakers in the sector. Governments are offering incentives such as subsidies for those decarbonising quickly and penalties such as higher taxes for those moving more slowly. But while that increases the pressure on energy companies to step up the pace, consistency is in short supply. “Across the market, you can point to instances where instability in the regulatory regime is creating uncertainty, and uncertainty is bad for investment,” says Morgan Stanley’s John Moon. “As regulatory regimes go back and forth, it is very difficult to plan.”
The M&A arena provides one good example of where this issue is playing out in practice. While dealmaking in the energy sector has bounced back strongly from the Covid-19 lull – with many businesses seeing M&A as a potential route towards decarbonisation – some 40 per cent of firms in White & Case’s research study complain that regulatory uncertainty makes this a challenging strategy.
Technology investment is another tricky area. New technology may enable energy companies to explore greener solutions – both in the shift into renewable power and in mitigation of carbon-intensive activities through processes such as carbon capture – but innovation always brings risk. In White & Case’s research, 47 per cent of companies describe new technology risk as very challenging.
Investors are pushing the sector to be less risk-averse, says White & Case partner Carina Radford. “Most investors and financiers understand that the first-mover advantage could be significant, and they may just have to take a leap into the less-proven to capture real opportunity as the pace of change is so fast.”
One possibility is to share risk by pursuing more joint ventures. In Italy, for example, Enel Green Power is developing green hydrogen projects by working with partners such as ENI, Saras and AME. In the UK, the HyNet North West project is attempting to decarbonise an entire region’s industrial activity; a consortium of eight partners are developing the principal infrastructure, with support from businesses in the chemicals, glass and oil refining, food, paper and automotive sectors.
The bottom line, however, is that any transformation carries significant risk – and the decarbonisation of the energy sector is about as large a transformation as it is possible to imagine. Still, the biggest risk of all may be doing nothing. “Decarbonisation is a form of risk management in itself, given the transition risks associated with climate change and the increase in regulation that impacts our businesses globally,” says Mary Nicholson, Head of Responsible Investment at Macquarie Asset Management. “If we don’t work with our businesses to help them navigate that transition, we are at risk of having detrimental impacts on their valuations or finding it harder to sell them in the future.”
