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Investors and NGOs take tougher line on climate change

Fossil fuel projects in Africa often need international support to proceed and multilateral agencies and asset managers are strengthening their climate-related investment criteria, potentially leaving valuable resources stuck in limbo

It started with multilateral agencies and overseas development ministries removing support for coal projects. Now asset managers are enthusiastically leapfrogging each other’s climate pledges to secure their share of increasingly bountiful green dollars.

There is a possibility that oil and even relatively climate-friendly gas could face similar investment restrictions as coal in the not-too-distant future. African countries could be doubly hit if multilateral support and institutional investor cash dries up at the same time, leaving abundant resources in the ground.

It is already difficult to see where funding for coal projects could come from, outside of China, with institutions as diverse as the World Bank and Goldman Sachs having withdrawn from the scene.

To add to the chorus, at the UK-Africa Investment Summit, on 20 January, Britain’s Prime Minister Boris Johnson pledged that the UK would end “new direct official development assistance” to overseas thermal coal mining and power plants although it would continue to support African countries seeking to extract and use oil and gas resources, at least for now. “This is only stopping foreign aid to coal mines or coal power plants, not fossil fuels generally,” says Mitun Patel, energy consultant at QED Consulting.

Shifting focus

However, there was an immediate backlash against the UK government for presiding over a conference—which was billed as supporting African countries’ transition to cleaner energy—where 90pc of the £2bn energy deals done were based on fossil fuels. Green Party MP Caroline Lucas said the “hypocrisy… is breath-taking”. Greenpeace noted that UK Export Finance supported projects will emit 69mn t of carbon per year.

If it is seen as a vote-winner—especially following scrutiny brought by the UK hosting COP26 in Glasgow this November—it is not hard to imagine the UK’s populist prime minister changing tack and removing support for oil and gas.

“With commercial lenders increasingly coming under pressure to comply with green funding [initiatives], multilateral agencies may yet become a vital catalyst for the development of gas-related projects” Patel, QED Consulting

Multilateral agencies are already focused on emissions beyond those of coal and are ramping up their focus on climate change. Last September, nine development banks—The World Bank Group, New Development Bank, the Islamic Development Bank, IDB Group, European Investment Bank, the EBRD, AIIB, African Development Bank Group and ADB—agreed a five-point plan. It includes “helping our clients deliver on the goals of the Paris Agreement” and “support increased climate finance levels”. But also, more ominously, that “each institution will take actions to help clients move away from the use of fossil fuels”.

Plenty of people—not least African government ministers—point out that the continent’s citizens contribute the least amount of carbon emissions per capita globally. For context, it is responsible for just one-seventh of China’s emissions. Equatorial Guinea's minister of mines and hydrocarbons Gabriel Obiang Lima, at Africa Oil Week, clearly summed up his view of the perceived international attempt to keep the continent’s hydrocarbons in the ground: “Criminal.”

Competing for FID

While there are myriad reasons for projects not progressing past FID on such a diverse continent—not least abundant global supply and relatively low prices—Angola, Ghana, Gabon and Cameroon have all announced adjustments to licensing round terms with the aim of attracting IOC investment. Promising prospects are also apparently stalled in Kenya to Uganda.

After several years of declining oil production, Angolan politicians and regulators came to recognise the country was missing out on replenishment investment and decided it needed to enact reform. “It all boils down to flexibility… and having a more streamlined approval process,” says Belarmino Chitangueleca, executive board member of Angola’s recently constituted National Petroleum and Gas Agency (ANPG) at the start of February.

Many projects in the country had been close to FID but ultimately “failed to take off”, he says, due to requiring the front-end loading of payments and sticking too regulatory terms. “Now we have the result of new legislation… at least three projects already on board.”

Investor pressure

For decades, there has been an established niche for ESG fund managers serving, often public sector, pension funds. But recently the global investment titans have been making wholesale changes to their fund offerings. The UN Principles of Responsible Investing (UNPRI) initiative welcomed its 500th signatory at the end of January, continuing its 20pc in membership numbers growth rate. It now represents combined $90tn.

Morningstar, a financial services firm, describes the trend towards ESG funds as “record-shattering” with $120bn invested during 2019, with the trend accelerating towards the end of the year. Capital flows into ESG versions of exchange traded funds (ETFs) shot up from a then-record $2.1bn in 2018 to $8.1bn in 2019, according to Bloomberg data. ESG may be shaping up to be the investment mega-trend of the 2020s.

BlackRock, the world’s biggest asset manager with assets under management (AuM) of $7.43tn at end-2019, made a big media splash in January with its pledge to divest from thermal coal companies. Just a few days, later it publicly rebuked Siemens for its trivial involvement—a €18mn rail signalling system—in a controversial Australian coal project. Not so trivial is the fact that BlackRock is Siemens’ largest external shareholder.

Just as importantly, BlackRock is enjoying immediate success with the launch of new ESG ETFs; one was the most successful ETF debut this year according to Bloomberg. BlackRock has plans to double the number of ESG ETFs it offers to 150 and its success will be eyed jealously by its burgeoning number of competitors in the sector.

Likewise, Europe’s largest asset manager Amundi, with AuM of €1.65tn ($1.78tn), in mid-February announced that it is backing a shareholder motion to stop UK bank Barclays offering loans to all fossil fuel companies, not just for coal. If passed at the May AGM, admittedly a longshot, it would remove Europe’s biggest financier of fossil fuel companies—$85bn since the Paris Agreement, according to advocacy group ShareAction—from the market.

ShareAction, which is coordinating the Barclays move, is targeting large-scale emitters from all angles and is particularly scathing about perceived attempts at greenwashing. BP’s pledge for net-zero by 2050 is “a sign that recent shareholder pressure has paid off” and says it requires a lot more detail “or else this ambition is a mere pipedream”, according to project officer Joe Brooks.

“With commercial lenders increasingly coming under pressure to comply with green funding [initiatives], multilateral agencies (MLAs) may yet become a vital catalyst for the development of gas-related projects in South Africa,” says Patel.

Rush for gas

As gas is relatively low carbon, abundant and, while global supply exceeds demand, very cheap, it is a perfect fit for African power generation. But while the global focus is firmly on the lowest-hanging fruit of thermal coal, the same argument could easily be applied to fuels with lower but still significant carbon intensity. “This is increasing,” says Patel. “But it is less likely to impact Africa in the short-medium term especially given the timescales of alternative technological developments.”

Many African countries already focus on renewables, not least because in certain applications it is the lowest cost option. External support is only required where there are no creditworthy offtakers or where supply infrastructure, such as transmission and distribution lines, is required. Africa’s base load power requirements could be met through renewables to a large extent but there will still be a requirement for more flexible generation, of which gas will continue to be the best option.

$90tn - capital managed by signatories of the UN Principles of Responsible Investing

“African countries with small but growing power demand are already turning to a mix of renewables and gas, supported by multilateral agencies,” says Patel. “The challenge will be to ensure the low-cost availability of gas supply and the development of gas-fired power to provide stable power supply into the future. Currently, many countries are over-reliant on hydro or more expensive oil-fired power generation.”

In South Africa, the Integrated Resource Plan (IRP) announced in October adds a combination of additional renewables and gas-fired power (as well as some more fanciful plans). “Investment should come from the private sector supported by the government,” says Patel. “However, investment will only be made if investors have a clear understanding of, and solution to, payment risk. Right now, given [nationalised utility] Eskom’s creditworthiness, this is not the case.”

Demand is being held back by a lack of infrastructure in developing markets, and multilateral institutions are wary of pushing a country to increase its reliance on an imported fuel that could potentially shoot up in cost. There is a risk—recognised by the World bank’s IFC among others—of potentially locking a country into arrangements it cannot afford and expose it to damaging volatility.

Unintended consequences

Both multilateral banks and concerned investors should be mindful that withdrawing funding for gas is likely to be counterproductive from a climate point of view. “Without investment in reliable and flexible [gas] generation to match, there are likely to be brownouts and outages,” notes Patel, which will need to be resolved by one means or another depending on what is available. “Relying on oil-fired power generation is more costly, less environmentally friendly and raises the electricity tariff, especially if using diesel generators,” notes Patel.

The main alternatives to oil and gas in many countries is an increased reliance on hydroelectricity. However, the required investment can be huge, long-term and, obviously, dependent on rainfall. Climate Systems Analysis Group estimates that South Africa has been warming at approximately twice the global rate over the last 20-25 years and, in any case, it has been experiencing a prolonged drought since 2018.

In addition, the pullback of Western capital may not necessarily mean that funds be unavailable from any source. China, most prominently, is actively pursuing opportunities on the continent but this may come with unwelcome strings attached.

“The other downsides are that projects are developed individually without much consideration of how it fits in the wider market,” says Patel. “And, as observed in some African countries previously, China may insist on its preferential inclusion in other areas of economic development. This represents poor planning and will likely lead to operational challenges and potentially higher costs.”

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