Energy Transition: The Premise Without a Payoff

LONDON—Banks, private equity providers and consultants continue to see a disconnect between energy companies making concerted efforts to shift from performative ESG efforts to demonstrative progress.

The payoff for those efforts remains elusive, panelists said at a recent energy conference.

The invasion of Ukraine has laid bare that fossil fuels will remain a vital part of the energy mix for years, even as the impetus to replace them with renewable energy sources falls far short of actual need.

The more direct disconnect between the mandate for energy transition and marketplace appreciation continues. While ESG has become a rallying cry and a mandate in C-suites, strenuous efforts to produce carbon-neutral fuels still aren’t meaningfully rewarded—even as companies upend their businesses to meet ESG ethos and push toward net-zero emission targets.

Bob Maguire, managing director for The Carlyle Group, said society has been clear it wants progress toward energy transition but simultaneously, as investors, “society is making it difficult to get it to happen.”

“I keep wondering … given how hard it is to achieve what everyone wants to happen, when do we start seeing the market giving a premium for this?” he said at the Energy Intelligence Forum 2022. “If somebody has gone green … is there a sustainable premium? Do we see evidence of that?”

The consensus among the panel is that investor appreciation is hit-and-miss.

Julian Mylchreest, executive vice chairman, global corporate and investment banking, Bank of America, said the market appears to have become more sophisticated at “looking at what really counts and what really matters.”

Nevertheless, in the case of bond markets, for instance, “they just want to see the cash flow right? So actually, they don’t care about the transition, ironically… They just want to enjoy the cash.”

Meg Starr, global head of impact for The Carlyle Group, who oversees the firm’s carbon footprint and that of its portfolio companies, said she has seen some instances of market premiums either through equity multiples, exit liquidity or financing costs. She said the firm saves millions of dollars in interest expenses tied to certain ESG targets.

“We see glimmers of that premium in capital markets,” she said. “I think the bigger point from the private side is we are avoiding a significant drawdown. And I think we have seen that with some very carbon-intensive assets where there are not buyers in the market for them anymore.

“And so, I actually think in the private side, we’re not just thinking about the investment thesis over our whole period anymore, but there is a much stronger focus on who’s buying it after us and what premium or discount do they apply to the trajectory that we’re on?”

Starr said Carlyle’s portfolio companies are also not trying to fully decarbonize, which is an unrealistic goal in the three to five years they are backed by the firm. Rather they are demonstrating capex, science-based targets and showing a “delta” in the reduction of carbon emissions.

“I think we’re just in the early innings of people actually creating a structure in corporate entities to drive decision-making based on auditable data and clear decision-making hierarchy that is tied to capex and long-term business planning,” she said.

Michael Birshan, global co-leader, strategy and corporate finance practice, McKinsey & Co., said his clients are focused on core aspects of the energy transition. While he acknowledged that wealth stewardship is most important, that includes decarbonizing.

“It’s lower-carbon intensity, lower-methane intensity, you know, flaring, running the business safely of course,” he said. “But it also means running it productively and the next generation of efficiency and technology.”

He added that all transitions leave some behind.

“If you look across sectors, whether it’s technology or many other transitions, not everybody survives a transition, right?”

Birshan said companies need to demonstrate a competitive edge showing they are making meaningful progress that is fast and relevant enough to make it part of a company’s equity story.

“If you look at, for example, when … re-ratings come … when you get to more like 30% share of EBITDA,” he said.” So smaller things are insufficient to get to the sort of true transition.”

And investors also want to see that companies are committed to capital disciple and “robust stewards of capital.”

He noted that the McKinsey Global Institute analyzed total energy supply capex—fossil fuel and renewables—from 2000 to 2014, when it skyrocketed from $700 billion to about $2 trillion. During the period, capex increased about 8% each year. Since then, capex has fallen 2.4% a year, he said.

“Some of that is obviously the decline of fossil fuel investment. Some of that is renewables not ramping up as fast as some might have planned,” he said. “And so, I think there is real opportunity for that investment and real need for that investment. But I think investors do look for that sort of robust capital discipline.”

Whatever the market’s reaction, as geopolitical turmoil continues—such as Russia’s invasion of Ukraine—the lesson learned is that fossil fuels, and not renewables remain the key to energy security, Maguire said.

“Mostly we’ve learned that we aren’t as far along with Plan B as we thought we were,” he said. “That’s not entirely the fault of plan B. It’s the fact that we still use 82%, in the energy mix, … fossil fuels and that’s a huge number and that’s just a fact and that’s what we have to deal with.”

The conclusion he drew is that with fossil fuels part of the mix, the preference is to have owners that are accountable and responsible.

“I think we’ve learned that managing the supply of fossil fuel through the energy transition is as much a part of the energy transition,” he said. “That’s where we’ve got to now relative to where we were six or nine months ago.”