Credit Ratings Downgrades From Growing Climate Risk Putting Further Stress On Oil and Gas Portfolios

S&P has just announced it is considering downgrading its credit ratings on a number of major oil and gas producers, including ExxonMobil, Shell, and Total to reflect a growing risk to their businesses from the energy transition.

Many oil and gas producers are already facing rising costs of capital due to the shift away from fossil fuels by large institutional investors.  Credit downgrades are likely to act as a catalyst for further increases in financing costs.  Higher financing costs drive down the value of oil and gas assets by making it more expensive for companies to develop their resource base.

Management teams have realized this. Their response has been to move to a “harvest” model. Return as much cash as possible to shareholders through dividends and buybacks, while only re-investing enough to continue to support those dividends.  As is evident in their market performance, this is a value neutral strategy. The only way to break out, and start to create real value is to “transition” towards less carbon intensive business lines so they can start to grow.

Transitioning the portfolio is not an easy task, and requires a dramatic rethink of how you evaluate opportunities and design the portfolio. Setting clear targets, as we’ve seen many players do (e.g. net zero by 2050), is one mechanism for helping with that transition, but unless the targets are supported by effective ways of “pricing in” in key externalities, then resolving the tensions between the way the organization traditionally thinks about value and the market linked targets will always be difficult.