Is it better to engage with fossil fuel companies or to divest as part of a net zero strategy? Some banks apparently prefer the first option, and are financing fossil fuel companies that are in expansion mode
It’s almost eight years since 2015’s historic Paris Agreement – a legally binding international treaty on climate change – was signed by 196 parties, who agreed to pursue efforts to limit global warming to 1.5C above pre-industrial levels.
With fossil fuels such as coal, oil and gas being by far the largest contributors to global climate change, the International Energy Agency was pretty explicit about what needs to happen to fossil fuel investments if the world is to achieve a net zero carbon emissions energy system by 2050. “From today, no investment in new fossil fuel supply projects, and no further final investment decisions for new unabated coal plants,” it stated in its 2021 Net Zero Emissions by 2050 Scenario.
But fossil fuel companies do not appear to have received the memo. The IEA’s Oil 2023 report states: “Global upstream investments in oil and gas exploration, extraction and production are on course to reach their highest levels since 2015, growing 11 per cent year-on-year to $528bn in 2023.” It says if sustained, this level of investment would be adequate to meet forecast demand in the period (through to 2028) covered by the report, “however, it exceeds the amount that would be needed in a world that gets on track for net zero emissions”.
As demand for fossil fuels has surged, so too has financing. The 2023 “Banking on Climate Chaos Fossil Fuel Finance Report” published by Reclaim Finance, the Rainforest Action Network, BankTrack and other climate non-governmental organisations, tracks fossil fuel financing by the world’s 60 largest banks, 49 of which have committed to net zero emission targets. It found that fossil fuel financing reached $5.5tn in the seven years since the Paris Agreement was signed, with $669bn-worth in 2022 alone.
“Banks have taken steps to transition to net zero, but they’re still miles off where they need to be,” says Jeanne Martin, head of the banking programme at UK charity ShareAction, which promotes responsible investment. “What we’re really talking about here is whether new [fossil fuel] assets are needed – and an increasing pool of studies show that there is no space in the carbon budget for new oil and gas assets, and their associated infrastructure.”
Yet, according to the Banking on Climate Chaos report, 60 banks invested $150bn in 2022 into the top 100 companies expanding fossil fuels, including TC Energy, TotalEnergies, Venture Global LNG, ConocoPhillips and Saudi Aramco. Expansion and financing of fossil fuels is concentrated in just a handful of companies, says the report.
It names JPMorgan Chase “worst bank overall” since the Paris Agreement, for financing a total of $434bn of fossil fuels since 2016 and $39bn in 2022 alone. The Royal Bank of Canada topped the table in 2022, funnelling $40.6bn into fossil fuels – an increase of 0.5% over 2021’s figures – while Japan’s MUFG financed some $29.5bn in Asia, and French bank BNP Paribas financed $20.0bn in Europe.
Urgent action needed
Are banks just as addicted to fossil fuels as economies and the rest of society, or is it more nuanced than that? “The world is not on a 1.5C pathway today,” says Lindsay Patrick, head of strategic initiatives and environmental, social and governance at RBC Capital Markets in Canada. “We all need a greater sense of urgency to address climate change.”
Though RBC has long-standing relationships with fossil fuel companies, Patrick says when the company looks at these relationships today, it is not setting lending commitments based on the past but is “looking to the future”.
While everyone may profess to be working towards net zero by 2050, sometimes politics and other factors can hinder progress. When the IEA published its NZE, it did not anticipate a war in Ukraine – nor, perhaps, how much governments would place national interests and energy security ahead of the climate goal. Russia’s invasion pushed EU member states to further develop their liquefied natural gas infrastructure, despite environmental groups warning that Europe’s growing reliance on LNG could mean “a very long lock-in effect for these fossil fuels”.
Furthermore, despite fierce opposition, Canada’s controversial Trans Mountain Pipeline expansion project – a 1,000-mile-long oil pipeline from Edmonton, Alberta to the coast of British Columbia – was first approved in 2016, then again in 2019, as the government deemed it to be in the national interest. Last year, Stand.earth revealed that Canadian banks RBC Capital Markets, TD Securities, BMO Capital Markets, CIBC, National Bank Financial and Bank of Nova Scotia had “stepped in” to finance the next stage of construction of the controversial pipeline, which will transport increased production from the oil sands in Alberta.
Fossil fuels remain closely intertwined with the economy, and banks are the engine of the economy, says Patrick. “The issue for banks is what to do if government policies and economic actors aren’t moving as fast as required to get to a 1.5C world,” she adds.
So what does the pathway to net zero look like for fossil fuels? The headline in the IEA’s NZE may be no new oil and gas production, but some banks say this scenario makes all sorts of conditions around changes to demand and government policy, and that in some industrial processes, the shift to renewable energy and electrification may not be simple.
“We can’t have an immediate cessation of all reliance on fossil fuels. What we need to be focusing on is the transition from where we are now, to an economy that is much less dependent on fossil fuels,” says Tracey McDermott, steering group chair of the Net-Zero Banking Alliance and group head of conduct, financial crime and compliance at Standard Chartered.
“There has to be a glide path,” she adds. “If you look at the scenarios that are used – whether that be the IEA’s NZE or the Network for Greening the Financial System scenarios – there’s going to be a fossil fuel requirement for some considerable time to come. And the NZE, even in 2050, does see some dependence on fossil fuels.”
In the short term, carbon reduction will be driven by increasing the efficiency of existing fossil fuels output, says McDermott. But over the long term, it will be achieved by reducing fossil fuel output altogether.
The question is, when will fossil fuel financing change course? “In 2030, I think we’ll start to see the curve bend and a shift in the mix of energy solutions being financed compared to what we are seeing today,” says RBC’s Patrick.
Ehsan Khoman, head of commodities, ESG and emerging markets research at MUFG, says: “Of the $1.9tn in bank financing that went to the energy sector in 2022, $840bn went to low carbon energy projects and $1.1tn to fossil fuels.” While the pace of scaling low carbon energy supply is impressive, he says, its models suggest that the transition supply to fossil fuel investment ratio needs to rise to 6:1 – that is, $6 of low carbon supply to $1 of fossil fuels – this decade, to ensure net zero.
“Although investments in green energy have grown, the green ‘new economy’ revolution is too nascent for green capital expenditure alone to drive global growth without carbon-intensive investment,” he adds.
A matter of perspective
For their part, NGOs say they are not expecting banks to switch off all fossil fuel investment tomorrow. “What we’re asking is for them to stop financing new activities, and to have a plan to gradually phase out their financing of fossil fuels in line with those 1.5C pathways,” says ShareAction’s Martin.
Will van de Pol, acting CEO of Australian NGO Market Forces, says the IEA is clear on which types of fossil fuel projects are incompatible with a NZE that gives just a 50 per cent chance of limiting global warming to 1.5C. “New oil and gas fields, LNG terminals, new and expanded coal mines – both thermal and metallurgical – are incompatible with that net zero pathway,” he says.
Some banks say they are not really financing fossil fuel companies because they don’t provide project finance for new oil and gas fields. While a lot of fossil fuel financing is moving more towards general purpose corporate financing, rather than dedicated project finance, van de Pol rejects that claim. “There are certainly plenty of occasions where that is still happening. Even banks that say they won’t lend to a new oil and gas field might lend to an LNG terminal that would unlock a new gas field,” he says.
However, according to Farnam Bidgoli, HSBC global head of ESG solutions, there seems to be more of a limited appetite, particularly from European banks, for financing new development of oil and gas. “That’s been reflected in the policies that we’ve seen over the course of the past 18 months,” she adds.
Oil and gas companies have also made progress on their journey towards net zero. “People often forget that five years ago, there wasn’t a single oil and gas company that had a net zero target,” she says. “We now have an expectation across European oil and gas companies and large energy companies to have set net zero as a target. You’ve also seen time-bound targets across the next decade and very clear capex plans, which to me is the most important part of this equation.”
Europe’s 25 largest banks now all have a commitment in place to reach net zero by 2050, according to a ShareAction report published in December 2022. “No major European bank had made such a commitment when we first conducted that assessment [in 2020], so that’s positive progress,” says Martin.
The same report also found that 75 per cent of Europe’s 25 largest banks had committed to phasing out their financing of thermal coal by 2030 in Organization for Economic Co-operation and Development countries, and 2040 at the latest globally.
This is a considerable improvement since the 2020 survey, where less than half of Europe’s largest banks had committed to exiting coal. But in many cases, Martin says, banks’ coal policies are tailored to their client base. “That means there are several exceptions or loopholes that allow the continued financing of some of their core clients,” she adds.
Engage or divest?
Fiona Melrose, head of group strategy and ESG at UniCredit, makes the distinction between coal developers and those companies that show a willingness to transition. “Our policy is no support for coal developers,” she says. “So when we talk about helping companies in their energy transition, we’re talking about the companies that still use fossil fuels to generate power but are trying to diversify away from them.”
UniCredit has a ‘phase-out by 2028’ policy for coal, but Melrose says the bank is present in some eastern European countries that are moving more slowly than Italy or Austria. Where countries are still heavily reliant on coal, she says the reality is they need help transitioning to net zero. “That is a process that will require finance and green lending, which allows power companies to invest in producing renewable energy,” she adds.
Fast-growing economies that are heavily coal dependent, such as Indonesia or Vietnam, cannot end coal tomorrow because it is unjust to their populations and development, McDermott says. “But what you can do – as has been the case with NZBA banks as part of the Glasgow Financial Alliance for Net Zero – is look at how to incentivise the transition by making sure that you are retiring coal plants earlier than they would otherwise have been retired, and at the same time, investing in the alternative infrastructure to ensure that those countries can continue to grow, and that people can continue to have improvements in their standard of living,” she adds.
According to Stephen Jennings, managing director and head of energy in MUFG’s structured finance office for Europe, the Middle East and Africa, divestment from fossil fuels is a blunt tool. “It doesn’t achieve what you want to achieve, as you lose engagement with clients and can’t influence what happens,” he says. “Open and direct access to liquidity to transition is a more responsible approach, and asking clients to continue to disclose their progress throughout will give us a better view.”
Over time, he says, banks will adopt a stricter approach with customers; he believes if all institutions had adopted a ‘stick’ rather than a ‘carrot’ over the past 12 to 18 months, it would have impacted security of supply.
Jennings also expects eventually to see greater clarity for individual sectors such as coal, oil and gas. “If we hadn’t joined the NZBA, I don’t think we would be where we are in terms of commitments that have been made and progress reported,” he says. Within 18 months of joining, NZBA member banks are expected to publish interim targets for 2030 or sooner for the most greenhouse gas-intensive and emitting sectors.
McDermott says it is not the NZBA’s role to order every single bank to act in exactly the same way: “There are guidelines about the sectors you must cover, the proportion of your portfolio and the manner in which those targets are set.” Banks have to publish these targets and report on them annually, as well as reporting on their emissions and emissions intensity.
But Martin at ShareAction says the quality of targets differ significantly from one bank to another. “Emission reduction targets give a direction of travel, but they’re not enough on their own because they tend to be set at the sector level and don’t distinguish between companies,” she adds.
“Banks need to introduce robust sectoral policies, making it clear what kind of activities and clients they will finance, and under what conditions to avoid a scenario where a bank might have a coal target, but will also be financing companies with coal expansion plans.”
However, van de Pol says many banks rely on initiatives such as the NZBA to imply they are taking action, when really they are not taking sufficient or fast enough action. “At the end of the day, it’s incumbent on the alliance, and civil society, to ensure it holds its members accountable to its principles,” he says.
Capital markets question
Meanwhile, Reclaim Finance founder and executive director Lucie Pinson says targets face several methodological issues and would, even if fixed, remain insufficient to mitigate the biggest impact on climate as they do not guarantee the immediate end of new capital flowing to the development of fossil fuels.
At the moment, most banks have set targets that only cover their lending activities. However, grassroots environmental organisation the Sierra Club describes capital markets financing – bond and equity underwriting – as “the hidden pipeline for fossil fuel financing”. A report it issued in July reveals that from 2016 to 2022, nearly two thirds (61 per cent) of the financing for fossil fuel expansion companies from JPMorgan Chase, Citi, Bank of America, Wells Fargo, Morgan Stanley, and Goldman Sachs came via capital markets, as opposed to direct lending.
The Partnership for Carbon Accounting Financials is trying to develop guidelines for banks to disclose their “facilitated emissions”. While it has set up a working group of banks, Martin says they have found it difficult to agree on various elements of the methodology.
But whatever banks facilitate in capital markets ultimately is distributed to investors, says HSBC’s Bidgoli. “And there is still demand for issuance from oil and gas across capital markets. Part of that is reflective of asset managers having the same debate that we’re having, which is around engagement versus divestment.”
Remco Fischer, programme officer and climate change lead at the UN Environment Programme Finance Initiative, says there is an element of ‘wait and see’ that does not align with the urgency needed. “Yet all of this is a big shift in paradigm,” he says.“When before have we ever seen companies or financial institutions setting environmental targets for a significant majority of their business or their portfolio? ‘Never’ is the answer.”
This article first appeared in The Banker