As hydrocarbon exploration, development and production come under greater scrutiny, oil and gas companies are investing in the future. It is necessary to transform the way the global population generates, sources and uses energy. Investors, financiers, customers, businesses, governments, and other stakeholders agree that the oil and gas industry plays a significant role in that energy transition and will continue to do so in at least the short and medium term. In order even to come close to meeting the commitments reflected in the Paris Agreement and the UN Framework Convention on Climate Change, a significant shift from reliance on fossil fuels to renewable and sustainable energy sources is imperative. On the other hand, it is not realistic, at this point in time, to eradicate the production and use of hydrocarbons entirely, and there remains a conflict between global demand for energy (as well as refined products) and the need to meet net-zero commitments under time pressure. Until sustainable energy can be produced (and, in the case of renewable energy production, stored), at a scale that meets the demand, and at a price that is affordable to all, the world is not yet ready to face significant cuts in oil and gas investment and production.

Moreover, as we saw at the 2021 United Nations Climate Change Conference (COP 26), the transition will not move at the same pace across the world. E&P companies operating in developed jurisdictions, most of which have the benefit of increasingly supportive government policies, need to take the lead and accelerate action by moving towards clean and sustainable energy sources of power. By contrast, developing countries are in a very different position — in many of these countries oil and gas production is currently the major source of export revenue rather than simply a source of local power, and many of these local populations still lack access to affordable energy in sufficient quantities to meet demand from local populations. While there is pressure on these developing countries to move towards clean sources of power, such as solar and wind power, on an equivalent timetable to that being set by developed nations, the question of how these countries will generate much needed export revenues (including to fund the installation of renewable power infrastructure in the first place) in a world without oil and gas production remains largely unanswered. Much work is therefore needed to place developing nations on a level playing field with developed countries before they can embark on the energy transition in any meaningful way.

There is an obvious conflict between investor desire for E&P companies to focus on low carbon production and alternative energy sources, and the need to increase short-term investor returns. A key challenge for E&P companies seeking to access capital is how to address these competing pressures to reduce carbon footprints while, at the same time, remaining profitable and meeting consumer demand. E&P entities need to be savvy in their investment planning to ensure that sufficient resource (and capital) is allocated to alternative energy production strategies and in diversifying asset portfolios. Significant investments in expensive oil assets that will not come online in the near future are unlikely to be the norm, with E&P companies and their investors seeking to mitigate the risk of stranded assets and uncertain long-term returns. Alignment among all stakeholders is vital — the discussion must be informed, and alternative energy sources ultimately need to be affordable to all and capable of meeting the demand before conventional hydrocarbon production is shut down entirely.

Companies wishing to retain their dominant position in the energy sector are investing heavily in the energy transition and assuming a leadership role in the alternative energy conversation, including by deploying profits from their core hydrocarbons businesses into renewable energy production and research and development. Significant focus is being placed on new technologies (both aimed at making hydrocarbon production more sustainable and at generating “green” energy) that are required in a low carbon economy. Investors have made it clear that E&P companies need to accelerate expenditures on such technologies, as demonstrated by recent pressure from activist investors, including those who have positioned themselves on the boards of some of the supermajors. E&P companies that do not address environmental, social and governance (“ESG”) considerations imminently will see their credibility and reputations suffer as investors and financiers seek to deploy their capital elsewhere.

Disclosure and reporting of companies’ impacts on the environment has become increasingly important in the oil and gas sector, both at the micro and macro levels. This is against a backdrop in which there is no consistent set of ESG standards, resulting in a desire amongst E&P companies to implement parameters that apply universally to the sector in order to provide the industry with much-needed clarity. Financiers, in particular, want to work with their clients to help develop these ESG criteria and reporting requirements; a move which also seeks to manage the inherent climate-related and environmental risks faced by financial institutions. The real impact of Scope 3 disclosure requirements, the UK mandatory climate-related disclosure regulations which are due to be implemented during 2022, the disclosure requirements set by the Financial Conduct Authority that are already applicable to LSE premium listed companies in the UK, and the accounting requirements of the International Sustainability Standards Board (among others) remains to be seen, including whether these help forge a more uniform approach to disclosure and reporting, but there is no denying that investors and financiers are increasingly focused on implementing a set of minimum standards that must be met by E&P companies. In addition to regulations that are designed to police companies’ impacts on the environment, industry players are likely to rely heavily on government policy and regulation as a means of enabling them to further the climate agenda — for instance, through state subsidies and other financial supports and incentives, which could help E&P companies maintain the competitive edge as they move forward with the energy transition.

As financial institutions seek to limit their exposure to oil and gas holdings, liquidity will also need to be sought from alternative financing sources, which may include equity funds and private equity. The nature of the financial product available, and the ability to access capital, will depend on the size and financial health of the E&P company, as well as the quality and stage of production of the relevant assets, but the market is changing, and E&P companies will need to become more open-minded and consider a broader scope of financial products from a range of financiers in order to bridge any funding gap.

Following pressure from investors and financiers, a number of larger E&P companies are divesting non-core or high carbon/methane emitting assets, as well as acquiring and/or investing capital into the development of lower cost and less carbon intensive assets, as a means of diversifying their portfolios and/or returning cash to investors. There is appetite in the market from hedge funds, smaller E&P players and national oil companies from traditionally oil-dependent economies that seek to benefit from the favourable returns of those oil and gas assets (particularly when compared to the much lower returns generated by renewable projects). However, until ESG requirements are universally applied across the industry, there remains an inherent risk of a detrimental longer-term impact on the environment if E&P entities are forced to make fast asset sales, since those assets may ultimately be developed by less environmentally focused entities.

It is clear that, at present, E&P companies are under pressure to maintain sufficient production to meet current global hydrocarbon demand but are also required to continue to deliver meaningful returns to shareholders and demonstrate credible long-term business models, and all while working towards a sustainable and clean agenda, with a view to ultimately pushing hydrocarbon production and supply into decline once alternative energy sources can be produced at scale and at cost. This will require significant resource and swift action, as well as close alignment among governments, policymakers, capital-providers, and other stakeholders. Failure to respond accordingly will limit the capital available to E&P entities as investors and financiers seek to deploy capital elsewhere. The ability to attract talent in the workforce will also be impacted if a company does not actively seek to implement low carbon business models. Notwithstanding the tensions faced by the industry, the oil and gas sector has weathered many storms and, among other events, the 2008 global financial crisis, the 2015/16 oil price falls, and the COVID-19 pandemic have all demonstrated the resilience of an industry forced to adapt to ever-changing economic, political, and market pressures. E&P companies that do not accept the net zero challenge will simply risk being left behind.