The availability of cheaper capitals

But here, the writer would argue that if you have a deep pocket, sustainable financing could help propel you to a more future-proof business. While the capex requirement is high, the cost of financing is sharp.

In May 2023, 23 banks closed a USD 6.24 billion project finance for the Neom Green Hydrogen Project (NGHP) in Saudi Arabia. The project seeks to build a plant that produces carbon-free hydrogen in the form of green ammonia by the end of 2026.

One of its shareholders, Air Products, is the exclusive off-taker of its 600 tons/day of carbon-free hydrogen. The firm will bring the hydrogen, in the form of green ammonia, to the United Kingdom, Germany, and the Netherlands.

Public filings showed that the US dollar tranche for the project’s loan was priced at 131 basis points (bps) premiums to the daily compounded Secured Overnight Financing Rate (SOFR) for a 30-year tenor and 93 bps for an 18-year tenor. At the point of signing in May 2023, the 30-year tranche would translate to 41 bps premiums against the Kingdom of Saudi Arabia’s 30-year bond yield issued just five months before. This means the lenders to the Neom project were willing to take a mere USD 4.10 premium of interest income than the Saudi government bond yield per USD 1,000 of loan they disburse. This was a major example that showed the benefit of cheaper capitals for sustainable projects.

ADNOC Distribution is another beneficiary of sustainable financing. The firm managed to sharpen the costs of its term loan from 87.5 bps above USD LIBOR to 85 bps above SOFR in 2023 by turning it into a sustainability-linked loan.

Lower your bankability risks

The Covid-19 pandemic provided a much-needed pause to reassess what is good for the world. It sent us to explore an energy source that could be both sustainable and abundant. It sent people to explore ways to solve the consistency issues that could prevent new energies from fulfilling base loads. It marked the start of another energy transition.

Major banks subsequently charted and made public their net zero pathways. DBS, Southeast Asia’s largest lender by assets, in 2020 set targets for 47% and 57% decreases in emissions intensity for its power and automotive portfolio, as well as a 28% drop in absolute financed emissions for its oil and gas exposures. Standard Chartered, another bank that holds significant oil and gas loan assets, is setting a net zero target to be achieved by 2050.

And this is not a trend prevalent only outside the Middle East. According to its 2023 pathway to net zero report, First Abu Dhabi Bank is targeting a 7-15% drop in financed scope 1, 2, and 3 emissions from its oil and gas portfolio between 2021-2030. The bank is also targeting a 64% drop in scope 1 and 2 emissions in their power exposures in the same period. This would risk the bankability of a good proportion of companies, let alone those carbon intensive ones.

Banks do take reference from the pathways set by the International Energy Agency when they set their guidelines. The most ambitious guidelines by the agency are currently imposed on road transportation, bunkering, and the aviation sector as of 2021. The IEA’s roadmap showed that the proportion of oil-powered ships and planes needs to be below 20% by 2050. This respectively would require more than a two-third drop in carbon emissions between 2021 and 2050.

Until 2030, the pathways set for chemicals, steel, and cement are still rather forgiving. The IEA targets conventional production routes for chemicals, steel, and cement to drop from 100% to above 75% in 2030. By 2050, however, the agency targets a further drop to below 25% for the three industries.

This could mean that while chemicals, steel, and cement are still largely spared from banks’ ambitious targets, there could be a shift in the coming years. Therefore chemical, steel, and cement companies that have made changes by 2030 would face lower bankability risks when the goal posts move. And these changes could be made with cheaper capitals now.

“Mastery itself was the prize of the venture.”

That was the justification Winston Spencer Churchill, then the First Lord of the Admiralty, gave when he recommended to change the power source of the British navy to oil from coal. This happened three years before the first world war. Owning tanks, planes, and warships that were powered by crude oil was pivotal to having state-of-the art militaries.

And the justification Churchill gave in 1911 rings truer than ever, more than a century later. We are in the midst of another round of energy transition. While “drill, baby, drill” echoes through, the move toward greener, more sustainable businesses still charges ahead in many parts of the world.

Hitting the targets set by the guidelines is by no means an easy feat. Apart from the initial capex spending, operational and technical excellence need time to be built. Long-term budget needs to be set aside to build numerous tracking mechanisms. Time and effort need to be spent to engage third-party consultants and auditors to certify the target achievements

But mastery itself was the prize of the venture. Accumulating technical and operational expertise, setting the targets, building the tracking mechanisms, and engaging the third-party consultants and auditors in the early stage of the development are certainly easier than doing so when the bandwagon has moved fast.

Since the first industrial revolution, few factors have shaped the course of power dynamics more than the mastery of energy sources. Churchill, who successfully led the shift of the British navy’s power source from Welsh coal to Persian oil, would have been vindicated to see Japan and South Korea becoming manufacturing powerhouses despite owning minimal energy assets within their territorial borders. And much of this success was the result of their oil and gas-driven energy policies in the mid-to-late 1900s.

It would perhaps be with much chagrin and amazement that he would see China’s mastery of green energies that has helped provide its current abundance of electricity supplies. History has proven that the first to claim mastery of the next energy transition will potentially become the dominant power for decades to come.