CalSTRS investor: Access to capital will tighten for oil and gas companies sidestepping climate

We’re back with the last in a two-part series on prospects for ESG and climate investing between EDF’s Ben Ratner and Brian Rice, a portfolio manager at California State Teachers’ Retirement Systems, the world’s largest educator-only pension fund with roughly $243 billion under management.

After exploring the importance of climate policy and net-zero corporate planning in the first Q&A, the discussion turns to oil and gas. The experts examine this historic moment for the industry, and how escalating climate pressures will profoundly affect energy markets and the companies that power them.

Ben: The outlook for oil and gas looks challenging — what’s an investor to do?

Brian: We are living in an interesting time. Certainly, as a major index investor we will continue to have exposure to the sector, but over time this will likely evolve as low-carbon indexes become more common. We are seeing movement away from cap-weighted funds into more climate and ESG indexes. There is rising concern around oil and gas, though the majors still have decent cash flows and balance sheets. Beyond that, I think you need to be very strategic in how you invest in oil and gas. Choose the companies that are most aligned with a low-carbon economy transition.

Ben: What kinds of opportunities and barriers exist for today’s oil and gas companies to become tomorrow’s energy companies?

Brian: I have always thought the ideal energy situation is to generate, store and use your own power. Is this scenario really going to happen everywhere? No, but the model for delivering energy is changing. I can’t help but think these companies want to rebuild themselves and drive out the utilities and create their own renewable energy center. Imagine pulling into an energy station to fill up your electric vehicle while accessing that same energy that electrifies the neighborhood.

Ben: Will COVID-19 and oil supply issues, on top of climate pressures, accelerate big changes in oil and gas?

Brian: Electric vehicles, renewable energy and supporting infrastructure don’t have a large enough foothold to push out oil and gas right now. There are still too many internal combustion engine vehicles. I do think current dynamics will go a long way to accelerate the transition, but there is uncertainty. Five or 10 years from now, we might be looking back saying, ‘well, that was it.’ From my perspective, oil and gas is still abundant, and might be getting cheaper. If anything, if we’re not careful the current environment could hinder the evolution to renewables because the market may decide it needs to go with the cheaper known quantity. That’s one reason that strong government action, including a price on carbon, is essential for helping build back better to a more resilient economy.

Ben: What companies have been navigating the energy transition most effectively?

Brian: The European oil and gas companies, but maybe that is because of the regulatory environment and regional stakeholder viewpoints. Companies like Shell, BP, Total and Eni — they seem to be far more committed to the transition than U.S. operators.

Ben: The irony is some of the U.S. companies have the balance sheet to go big on investing in cleaner forms of energy, but they are not.

Brian: Companies need to be thinking long-term and reimagining what gas stations of the future look like. Who are the customers and what are the products?

Ben: As a growing number of asset owners embrace ESG and climate, is there a threat that access to capital will dry up for oil and gas companies not undertaking the low-carbon transition, or asset managers not financing them?

Brian: Yes. Within my 15 years in the market, I have seen a real big push on financial institutions that provide capital to oil and gas companies for ground projects. Pressure on financiers to disclose the risks associated with financing oil and gas companies or develop a plan to reduce exposure to oil and gas projects is only going to grow. Investors like CalSTRS, who understand the low-carbon movement, are asking financiers how they are approaching the transition in terms of financing strategy. Investors are asking questions such as ‘shouldn’t you be providing more capital to projects that are part of the transition?’ At some point, access to capital will become limited — it’s just a matter of when.

Ben: You said earlier that some oil and gas companies are contemplating new business models. Arguably, the good news for the energy industry is global energy demand is still expected to rise. What about opportunities in the developing world? Are developing markets an opportunity for oil and gas companies with capital, technical and infrastructure expertise to work collaboratively with local governments and people to help develop clean energy?

Brian: Yes, but do oil and gas companies have the expertise to develop renewables at that scale? They need to build, acquire or partner for expertise, and is that something they want? Then there is the issue of risk. Can oil and gas companies deploy the experience, network and geopolitical knowledge to handle these types of projects? Our role as investors is to be talking to companies about these types of new opportunities.

Ben: Many oil and gas executives keep talking about the dual challenge — meeting growing energy needs while addressing the climate. What we want to see is dual solutions —in practice and at scale.

Brian: Exactly. Investors, majors and governments need to come together and find ways to align everyone’s interest while also realizing some sacrifices need to be made by everyone to successfully evolve with the current energy transformation.

Follow Ben on Twitter: @RatnerBen