Why we need leadership to close the transferred emissions loophole

By Andrew Baxter and Gabriel Malek

Investors and climate experts are increasingly concerned about one of the energy transition’s biggest loopholes – the transferred emissions problem. As larger oil and gas companies strive to accommodate stakeholder climate expectations, many are offloading underperforming oil and gas facilities to other companies, often smaller or privately held. The result? Emissions reduction for the seller leads to an emissions increase for the buyer, leaving global emissions constant, or potentially worse. As BlackRock CEO Larry Fink noted, “Divesting…might move an individual company closer to net zero, but it does nothing to move the world closer to net zero.”

Securing large-scale emissions reductions in the real economy – not through accounting exercises – is core to a successful energy transition. With methane emissions driving near-term warming at an alarming rate, it is critical that oil and gas transactions incorporate ambitious standards for CO2 and methane management to ensure effective environmental stewardship in line with climate science. Regardless of whether the climate community sees disinvestment as a viable decarbonization strategy, we must agree that when asset transfers take place, transactions must feature strong climate safeguards.

Solving this complex challenge will require collaboration and leadership from oil and gas companies and the finance community. As the urgency to act increases, there are three groups whose engagement is crucial.  

How can the oil and gas industry drive progress?

Addressing the transferred emissions problem must include leadership from the oil and gas sector. Corporate management teams shape methane mitigation, flaring reduction, and emissions reporting across oil and gas assets. The extent to which companies embed carbon management principles in sales and acquisitions will heavily dictate the ability of the oil and gas sector to meet international climate goals. With more industry players committing to high integrity climate standards like the Oil and Gas Methane Partnership 2.0, momentum has begun to build for corporate progress on transferred emissions. However, key questions remain:

• What steps can a seller take to monitor, mitigate, and disclose climate and environmental impacts before a sale?
• What commitments can a buyer make to provide assurance that low-hanging fruit like methane emissions and flaring will be eliminated?
• Do accounting rules, norms, or practices need to change to make sellers accountable for residual emissions post asset sale?

Advisory services for mergers, acquisitions, and other deals are big business for Wall Street. In Q3 of 2021 alone, US oil and gas mergers and acquisitions activity totaled $18.5 billion. Many of these transactions are facilitated by banks with net zero pledges. And oftentimes, private equity firms benefit from these transactions on the buy side, even as their limited partners call for more ambitious climate standards.

Meanwhile, finance sector commitments on climate have snowballed, with hundreds of investors that manage tens of trillions of dollars pledging net zero in their portfolios by 2050. Resolving this tension between heightened climate pledges and business-as-usual in oil and gas deals must become a chief priority for the years ahead.

• How can asset managers, private equity firms, and influential investor groups like the Climate Action 100+, Net Zero Asset Manager Initiative, and IIGCC integrate solutions to the transferred emissions problem into their investment stewardship and asset allocation strategies?
• How can limited partners like public pension funds and university endowments leverage their influence to help private equity raise the bar for climate responsibility on the buy side?
• How can banks, many of whom recently committed to the Net Zero Banking Alliance, anticipate client demand and prepare to support first-of-kind transactions with climate-aligned due diligence, deal terms, and advisory support?

How can policymakers accelerate action?

Public policy can help combat the transferred emissions problem by applying strict emission control standards to all actors in the industry, public and private alike. That is why regulations like the newly proposed EPA methane rules are so important, and why they must be strengthened to include leak inspection and repair at older facilities – assets with disproportionately high emissions primed for disinvestment. Leveraging public policy to drive responsible oil and gas mergers and acquisitions will involve the following considerations:

• What mechanisms can ensure sufficient industry funding to responsibly decommission currently operational assets and to remedy assets that were improperly abandoned in the past?
• How can enhanced disclosure requirements raise the bar for climate transparency on oil and gas deals?  

Aligning net zero finance with a net zero future

As stakeholder demands grow for accelerating the energy transition, asset transfers will only increase in importance. We need the right financial and legal safeguards in place to ensure that these transfers elicit more confidence than consternation.

We look forward to meeting this challenge in collaboration with investors, oil and gas companies, banks, policymakers, and other partners.