In this week’s energy industry analysis, we take a look at the jet fuel demand landscape, fourth-quarter earnings reports for oil and gas companies, and the first oil and gas producer in North America to issue a sustainability-linked bond.
Aviation energy demand to rise in 2022
Global air travel rose last week for the first time in 2022, prompting questions about what energy demand from the aviation industry will look like in the near future. While global airline capacity is still well below 2019 levels, it is expected to increase in 2022 despite ongoing fluctuations, and the energy sector should be ready for a spike in demand.
First, jet fuel demand remains extremely vulnerable to shifts in the pandemic. Air travel, especially international air travel, is the first thing to get nixed when a new variant emerges. January saw countless flights canceled as omicron spread.
And the impact of a COVID-19 wave is long-lasting. In Canada, for instance, WestJet cut 15% of its flights in January and made another cut of 20% in February, well after omicron’s peak, for flights this month and next, as Canada requires international passengers to have a negative PCR test both before departure and some upon landing. Canada has some of the strictest COVID-19 restrictions for air travel, which in turn discourage people from flying and depress demand.
Nonetheless, 2022 will see more countries open to international visitors and adapting to life with COVID-19, increasing demand for long-haul air travel. While we should expect periodic drops when new variants spread, none will be as dramatic as the pre-vaccine era.
In addition, airlines are under intense pressure to decarbonize, as aviation currently makes up 3% of worldwide carbon emissions. Right now, airlines’ plans to decarbonize focus on purchasing carbon offsets. But carbon prices are set to keep rising, and there aren’t simply enough forests in the world to offset current emissions.
Therefore, for the rest of 2022, global aviation demand for jet fuel will rise. In the longer run, however, airlines will be looking to switch to sustainable aviation fuels, hydrogen, and developing electric aircraft in an effort to decarbonize, reducing their overall demand on jet fuel.
Oil and gas profits up
Earnings reports for the fourth quarter of 2021 are coming in, and the results in the oil and gas space are largely encouraging. ExxonMobil, Shell, Chevron, Marathon Petroleum, Schlumberger, Plains All American, and many others posted Q4 results that beat Wall Street expectations. These earnings results, coupled with extreme cost cutting across the sector during the pandemic, have resulted in rising free cash flow, which sector investors have been demanding.
Cost cutting aside, the positive results for many companies can be attributed to stronger commodity prices, which are expected to continue in the near term based on rising demand, low oil inventories, persistent OPEC+ production shortfalls, and the ongoing geopolitical situation with Russia and Ukraine.
West Texas Intermediate and Brent crude are both trading at eight-week highs around $90 to $95 per barrel, despite some softness early this week. This strong price environment and extremely tight supply and demand balance has several producers announcing production increases, especially in the Permian Basin. The Energy Information Administration bumped up its production forecast from an average of 11.9 million barrels per day to an average of 12 million bpd in 2022, and 12.6 million bpd in 2023.
As supplies increase, the market will come back into balance, putting some downward pressure on oil prices. Nevertheless, the price environment will still be supportive of continued investment, production increases, mergers and acquisitions, share buybacks, and dividend/distribution raises. Market participants should continue to monitor the supply and demand balance, prices, and active geopolitical situations.
Sustainability-linked bonds and ESG metrics
Calgary-based oil and gas producer Tamarack Valley Energy announced last week that it became the first oil and gas producer in North America to issue a sustainability-linked bond (SLB), marking a significant milestone for the sector as the importance of environmental, social and governance targets gains prominence. Similar to sustainability-linked revolving credit facilities, SLBs raise financing with the interest rates linked to the company’s ability to meet such ESG targets.
A growing alternative to green bonds, SLBs are favorable to companies because the funds can be used for any regular business operations, while the proceeds from green bonds are restricted for exclusive use toward projects that have a positive environmental impact. Investors and stakeholders prefer SLBs due to their near-term maturity; 20- to-30-year green bonds can often raise suspicions around greenwashing, where the bonds are issued to earn favorable ESG press without the company outlining concrete steps to achieve distant targets.
Tamarack Valley Energy is issuing a CA$200 million aggregate principal amount of 7.25% senior unsecured sustainability-linked notes maturing May 2027, with the proceeds intended to repay a portion of the amounts outstanding from their recent acquisition of Crestwynd Exploration. The yield on the bonds can increase as much as 100 basis points if the company misses its ESG targets. A failure to achieve a 39% reduction in Scope 1 and Scope 2 emissions by 2025 will result in an increase of the interest rate payable by 75 basis points, and if Tamarack is unable to increase its Indigenous workforce participation by 6% or greater over the same timeframe, the interest rate payable will increase by 25 basis points.
These targets are in line with broader industry goals, and also align to some extent with government agency goals. Canada’s federal government announced last week that it is launching a call for proposals for Indigenous-led clean fuel projects, such as the production of hydrogen and advanced biofuels. Funding is provided as a part of the CA$1.5 billion Clean Fuels Fund and is intended to benefit Indigenous communities and encourage participation in the industry. Additionally, Canada’s environment minister is expected to strengthen national criteria for reducing emissions from large emitters starting in 2023, and may require provinces that opted into their own policies to overhaul their emissions reduction systems and comply.
Whether it’s to raise capital in the current environment or to keep up with escalating regulation, energy companies will need to demonstrate a commitment to improving ESG metrics to remain successful moving forward.