‘Funding’ the way: navigating the investment maze

Despite some fundamental similarities, financing of Australian energy and resources projects looks very different depending on whether the project is a renewables or resources project.

The resources industry continues to finance and fund in unconventional ways from within, while the renewable energy sector continues to seek conventional debt financing to fund their projects. As funding continues to mean different things for each industry, we have highlighted key considerations for each in playing its role in Australia’s energy transition.

When unusual lending becomes commonplace

Financing for resource projects has been undergoing a transformation for some years now, this evolution being a consequence of shifting environmental priorities and a trickle down effect from stakeholder pressure on banks and private equity funds alike. Without the ‘usual’ sources of finance, projects have been required to avail themselves of an array of unconventional financing models such as private investment within the industry, prepayment agreements or royalties. Previously, the unwillingness to fund traditional energy and commodity resource projects was unspoken, now one only has to read CBA’s 2023 Climate Report to see it clearly.

Take, for example, CBA’s Environmental and Social (E&S) Framework in the 2023 Climate Report. It outlines strict criteria (see below) in respect of the provision of project finance for oil and gas extraction projects and sets limits on financing for coal-fired power generation. Unlikely to meet this criteria, most traditional energy and resource companies will need to seek alternative financing.

CBA’s Environmental and Social (E&S) Framework

• No project finance for new or expanded oil or gas extraction projects.
• No project finance for floating production storage and offloading infrastructure solely dedicated to new oil projects, new transmission pipelines for new oil and gas, or new oil ships or gas vessels.
• No corporate or trade finance, or bond facilitation for power generation clients expanding coal-fired capacity if they generate 25% or more of their electricity from coal.
• No corporate trade finance or bond facilitation for new clients deriving 25% or more of their revenue from the sale of thermal coal.
• Only offer corporate or trade finance or bond facilitation to existing oil and gas producing or metallurgical coal mining clients that derive 15% or more of their revenue from the sale of oil, gas, or metallurgical coal after assessing ESG impacts (based on published Transition Plans, including Scope 1, 2, and 3 emissions).

Despite the shifting availability of funding, M&A continued in the resource sector in 2023 asa number of the blockbuster resource sector transactions completed with funding. For example, BHP and Mitsubishi’s sale of Daunia and Blackwater to Whitehaven and more recently Stanmore’s commitment to acquire of Eagle Downs and Aquila. These transactions are increasingly funded with the arrangements such as those set out below. Once considered unusual, these arrangements are increasingly commonplace:

• Off-take and prepayment arrangements, known as prepayment facilities or production-based facilities, these involve the off-taker (financier) procuring the product in advance. In turn, the borrower (project owner) fulfills their repayment obligation by delivering the product to the off-taker. This practice has become prevalent in the mining industry, especially for critical minerals and coal.
• Streaming arrangements, another contractual arrangement that functions similarly to a prepayment arrangement. In a streaming agreement, the buyer (financier) remits the purchase price upfront or through a series of instalments to the project owner (borrower). In return, the buyer secures a lasting entitlement to acquire a defined quantity or percentage of the streamed product, typically silver or gold. This product, often a by-product of the project owner’s primary operations, can complement other financing structures in place especially where the streaming product does not compete with the other primary product.
• Royalty financing another funding method where the royalty holder (financier) typically provides an initial payment. This payment is exchanged for the right to receive royalties tied to the future revenue generated by the project, as granted by the project owner (borrower). Various methods exist for calculating the royalty, typically being a percentage of the net revenue in this context (often a ‘net smelter return’).

While these arrangements are often unavoidably complex and tailored than a typical facility seen in debt-financing, they do provide enhanced flexibility, and the industry is now well accustomed to these arrangements. Often, these arrangements require broad legal input given the intersection of considerations such as FIRB, regulatory approvals and permits and project finance.

Measure twice, fund once

At first glance policies like the CBA E&S Framework appear clear, objective, and qualitative for renewables projects – however, in the case of the CBA E&S Framework at least, it also highlights a continuing point of frustration in obtaining project finance for renewables projects. The devil is in the (reported) detail.

While there is willingness from conventional lenders like CBA to invest in renewables, the lack of standardised emissions reporting creates a significant hurdle. Not having clear criteria and benchmarks hampers investor confidence and limits the availability of funding for renewable projects due to the difficulty in demonstrating compliance with lending protocols – such as the 25% thresholds set out in the CBA E&S Framework above. The Vanguard and Mercer Superannuation examples in our article ‘Combatting greenwashing in the race to net zero’ are prime examples of how greenwashing and greenhushing can hamper investor confidence in green products or projects.

Further, the continued delay until the start of in commercial production for most projects creates an uncertainty which weighs heavily on the ability to obtain appropriate (and efficient) project financing.

In the absence of a comprehensive sustainable finance taxonomy, investors broadly struggle to assess the environmental impact of renewable projects due to inconsistent reporting. We’re seeing this hinder the sector’s ability to attract sustainable investments.

Navigating the maze

A good taxonomy should set clear criteria for what constitutes a sustainable project, providing investors with a reliable framework to assess environmental impact and compliance. However, this is not the only solution to encourage investment in renewable projects and a number of initiatives continue to foster demand. Other suggested areas of focus include:

• Government incentives for renewable innovation – Governments can incentivise sustainable practices in the renewable sector by introducing financial incentives for companies adopting environmentally friendly technologies. This could include tax breaks, subsidies, or grants for projects that align with long-term sustainability goals. Of course, eligibility for such schemes will require confidence and transparency that the applicant meets the requirements – such as a sustainable finance taxonomy.
• Stable regulatory environment – Both sectors would benefit from a stable regulatory environment. Governments can provide reassurance to investors by committing to long-term policies that support sustainable practices and provide a predictable framework for project development. For example, following the introduction of the Queensland 2022 coal royalties, much was said about the lack of transparency and forecasting of that policy and the resulting impact on international investment.
• Legal advocacy for regulatory standards – Clear and consistent standards for emissions reporting will enhance investor confidence. We have a role to play in progressing this initiative including by contributing to the development of frameworks that provide clarity while safeguarding stakeholder interests.

Collaborative efforts to establish sustainable finance taxonomies, legal advocacy for regulatory standards, and government incentives can contribute to fostering a financial environment that supports both resources and renewables projects. Navigating this fundraising maze requires a concerted effort from industry stakeholders, financial institutions, legal experts, and policymakers to ensure a sustainable and resilient future for Australia’s energy landscape.

Stay tuned

A lack of traditional funding is both a pressing and evolving issue across the industry. Later this year, we’ll release further thinking on alternative funding models such as royalty security and priority arrangements, and how to deal with disparate lender or investor groups (including offshore groups). We’ll also delve into what happens when things go wrong, including insolvency processes and potential exit strategies.

This is an article from our 2024 Edition of Emerging Issues for the Australian Energy and Resources Industry. To read more from this publication, click here.

This publication covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. It is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.