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2 October 2020

Green financing – responding to the challenges of the energy transition for the Russian oil and gas sector

Green energy will not lead Russia’s oil and gas sector to poverty, but without it problems with access to external markets will become inevitable.

Source:  oilcapital.ru 

Florian Willershausen, Director of Creon Capital, managing company of the Creon Energy Fund (Luxembourg)

In the coming years Russian oil and gas companies will face serious institutional constraints in their most important European market. The reason for this is the forthcoming introduction of a carbon tax in the EU. However, this challenge is not yet fully realized in Russia. Their companies have to integrate now into the new reality of energy transition by offering European investors projects and attract financing with green bonds. Popularity of green finance will grow, and it is important for Russian companies not to miss the opportunity to demonstrate their potential by diversifying their portfolio of initiatives. Contrary to the known skepticism about the energy transition, green energy will not lead Russian oil and gas sector to poverty. But if its challenges will be ignored, problems with access to external markets and debt financing will become inevitable in current decade.

Rules of the game

Placing green bonds is similar to the usual procedure of raising borrowed funds by bond instruments. But in addition to the traditional description of the project for which funding is sought, it is necessary to assess its compliance with the green framework, which is carried out by the company itself or by independent entities, such as Creon Capital. Further, the application is checked by rating agencies – among them is the Russian RAEX, which has an office in Frankfurt. They provide a second party opinion, which is a “pass” to the financial platform.

The Sustainable Development Sector, which opened at the Moscow Stock Exchange last year and focused specifically on green bond issues, is still operating in a test mode. It is estimated that so far only five issuers in Russia have placed green bonds worth a total of 7.55 bln rubles and €500 million. For comparison, the global green finance market grew to $800 bln last year. So far, neither borrowers nor investors in Russia have enough motivation: they do not have a clear idea of how the green finance mechanism works, the rates of return on green bonds are not higher than usual bonds, and the infrastructure, necessary to develop this area has not yet been formed. Overall, green finance is perceived by companies more as an indication of strong brand.

However, within a few years the volume of the Russian market of green financing can reach hundreds billions of rubles thanks to its enormous potential and state support. Currently, the process of creating taxonomy for green financing, headed by Vneshekonombank, is under way. Its parameters are being coordinated with the relevant ministries and the business community. The creation of adopted green standard of finance is even more important, since the structure of the Russian economy is quite different from the European one.

Thus, due to the greater dependence of the Russian economy on the European terms, placing of green bonds should be more flexible. For example, in Russia the construction of LNG terminals can be considered as green projects, which is hardly acceptable in Europe. Potential western investors in Russian green bonds might also be interested in recycling projects, which are already trivial for Europe, since these problems were solved some 20 years ago, but remain highly topical for Russia.

Undoubtedly, the harmonization of Russian and European standards of green financing will still require a lot of work, but at the moment it is extremely important that the government is already involved in developing the rules of the game in this area. The banking sector is also not lagging behind; it acts as a service provider taking over the marketing component of the process when placing green bonds. Among the Russian banks that have already expressed interest in green financial products, include Sberbank, Gazprombank, Moscow Credit Bank and Center-Invest Bank from Rostov-on-Don, which was the first to place its green bonds on the Moscow Stock Exchange.

Two-way road

The development of green financing in Russia requires two main conditions – the feasibility of projects and effective format of state participation represented by institutional investors. The latter will prove to be key for liquidity of green financing market and will determine, along with its own taxonomy, the interest of foreign investors. The principled willingness of government regulators will become an incentive for the Russian green finance market.

At the same time, rates on green bonds in Russia will be higher than in Europe, which should be of interest to western investors who are looking for higher yields securities, regardless of the sanction factor. Russian bonds are still showing positive return, and European investors will be encouraged to do so. It would be a great success for a major placement of green bonds on the Moscow stock exchange with the participation of western investors, or double increase in volume of investments on this platform every quarter within one to two years.

At the same time, Russian companies should also seek to place their green bonds on global stock exchanges with a stricter taxonomy, but also with more attractive financing conditions.

As a whole, demand for green projects comes from the global market under the influence of global regulators. Since the Russian debt financing market is small, large Russian companies will inevitably have to go to western funds.

There are already successful examples in this area of work. In May last year the first Russian issuer of green Eurobonds was Russian Railways (RZD), placing €500 million with a yield of 2.2% and an eight-year maturity. The placement of RZD green bonds aimed at attracting financing for the purchase of energy-efficient locomotives proved to be very successful: the volume of applications amounted to almost €1.8 bln, and the coupon rate was the lowest in the history of the placement of Eurobonds by Russian issuers. Within the framework of bond placement RZD received official recognition of the “green” status of their projects, which is crucial for the Russian state-owned company located in the sanction risk zone.

Insurance against sanctions risks

Meantime, no major green finance projects have been announced by the Russian oil and gas sector, although in the future this may be the only way for them to raise funds on western platforms. Due to the sanctions, it will continue to be difficult for Russian oil and gas companies to raise cheap finance in Europe, and for “dirty” projects funding may not be available at all.

Green financing in this case can act not as a tool for avoiding sanctions, but as a signal to Western investors who fear political risks but seek good returns. Creation of Russian green projects seem to be the best way out of this dilemma.

In addition, it should be remembered that many investment funds have already declared a moratorium on investments in companies that do not implement green initiatives – this is a general trend that has been observed over the past few years. For example, the Norwegian pension fund excluded Russian assets, Norilsk Nickel from its portfolio. Danish pension funds have decided to get rid of the papers of European hydrocarbon companies. And last year the American world’s largest fund manager BlackRock announced a gradual decline in its share of investments in oil and gas companies.
Today, Russian oil and gas companies have great potential to be included in energy transition projects, for example in the field of hydrogen energy. The EU countries would like to receive green hydrogen using renewable energy sources, but there are limited opportunities to do so. Therefore, Russia, and primarily Gazprom and NOVATEK have a chance to develop the production of hydrogen from natural gas/LNG.

In this way, Russian oil and gas companies will be able to open up new markets where competitors are still not so active. At the same time, it is obvious that only international markets will be able to attract financing for such expensive projects, and here the green bond mechanism may be more useful than ever.

To begin with, the oil and gas sector should demonstrate to the financial markets its development potential toward new directions. Having at least one significant green finance project in a portfolio of major oil and gas companies would be a great case. The main thing is not to count on short-term success: it is far more important to make evident that Russian oil and gas companies understand the new challenges and are ready to provide relevant response to them.

To ignore means to be late

The German chemical giant BASF is one of the recent examples of the effective use of green financing, which directly involved in the oil and gas sector. In May, it placed bonds worth a total of €2 bln. In the second tranche, the company issued seven-year green bonds worth € 1 bln with an annual coupon yield of 0.25% (significantly lower than on other company’s projects) to finance the production of sustainable products and sustainable development projects. It is the first time in its 155-year history. BASF is known throughout the world as a petrochemical giant, but in recent years the company has invested heavily in the development of organic polymers, which can be produced, e.g. from garbage, without petroleum products.

The Norwegian national company Equinor’s papers are incredibly attractive to green finance-oriented investors. Equinor is one of the first European oil and gas majors who announced a large-scale development program for renewable energy. A few years ago, the company even abandoned its former name, Statoil, to pursue a zero-carbon strategy.

If we go back to Russian realities, the arguments of those who are skeptical about the energy transition are understandable. Russia has one of the lowest costs of oil and gas production in the world, and this advantage should be used to least not lose market share in the face of changes that are taking place in the world. Oil and gas will still be consumed in ten or twenty years, but forecasts of significant growth in demand do not seem justified. An increasing number of countries in the world are either actively developing renewable energy sources, improving energy efficiency, or changing the regulation of the energy industry so that fossil energy will become more expensive in the long run.

The result of these measures is an increasing shift away from hydrocarbons. This trend cannot be ignored – on the contrary, it needs to be actively involved in it, including growing risks to oil and gas companies. One of them is the introduction of a “carbon charge” in the EU, which is likely to take place as early as this decade. It will be a gradual process, but there are hardly any doubts about its inevitability, and preparations for an additional carbon tax are needed now.

The risks of this new regulation are not for mining companies but for oil and gas refining businesses, such as polymer producers.

Large and especially medium-sized Russian refiners are not as well known outside Russia as Rosneft and Gazprom, so they already need to proactively demonstrate their green strategy to international markets and assure investors that they are on the way to sustainable development. Certainly, this does not mean that the company should completely redesign its activities but adapting existing business models to the new reality is a task for absolutely all players in the Russian oil and gas sector and allied industries.