Daily Eesti Päevaleht recently published an article (link in Estonian) in which the largest banks in Estonia said they unanimously agreed that the shale oil factory planned by Eesti Energia, and the sector in general, are too risky, adding that they would refrain from investing their own, their clients' and taxpayers' money into such projects. Independent international credit rating agencies Moody's and Standard & Poor's (S&P), which assess companies' ability to repay loans, have also rated Eesti Energia as a firm which should be avoided by risk-averse investors.

Banks and credit rating agencies outline four main risks: Market risks, regulatory and political risks and risks specific to Eesti Energia.

Market risk: Volatile prices and demand

Both parties consider one of the most acute risks to be Eesti Energia's high exposure to risks related to the unstable prices and volatile demand for oil and shale oil.

Eesti Energia states (link in Estonian) that the planned shale oil plant will break even if oil prices exceed US$45 per barrel, and the company pitches (link in Estonian) to investors the project as being a profitable one, on the assumption that oil prices will not drop below US$60 per barrel.

Eesti Energia itself, however, has stressed that investing in producing oil is of significant risk, as it relies on the unpredictable global oil market, and thus there is no guarantee that oil prices will meet this expectation throughout the investment period.

The instability of the oil market is illustrated, for example, not only by the recent negative oil prices, the steady decline in demand for oil, and the increasingly conservative forecasts, but also by the market's dependence on the moods of the Saudis and the tweets from the U.S. president.

Although one of the few arguments for coping with instability has been hedging the risks through pre-selling oil production with fixed prices, the prevailing pandemic-affected market conditions imply that such contracts will not be renewed on such favourable terms.

It is worth recalling that Eesti Energia's management board had to devalue its Auvere power plant by 50 million euros due to impairment costs, which occurred also due to the incompetent forecasts of the company's managers regarding the global oil prices. 

As shale oil produced in Estonia is used almost entirely in marine fuels, the demand in the marine fuel market poses another market risk. According to Fatih Birol, the Chief of the International Energy Agency, the sector been hit the hardest during the current crisis, even though the maritime transport sector took noteworthy steps towards climate neutrality already earlier.

The demand for shale oil is also diminished by growing electrification and use of gas-based fuels in the shipping industry, an issue that has been highlighted by both Minister of the Environment, Rene Kokk (EKRE), and the Head of the Estonian Renewable Energy Association, Mihkel Annus.

Regulatory and political risks at the European level

Moody's has stated that the underlying driver of Eesti Energia's low credit rating is the company's high exposure to environmental risks, primarily carbon regulation, and its inadequate consideration of these risks in its operations.

Moody's notes that in addition to the rising CO2 tariffs, Eesti Energia and the oil industry are threatened by the increasingly stringent environmental policies, which may tighten the conditions of carbon leakage exemptions under the EU emission trading system, which incentivises energy-intensive industries not to transfer their operations to countries with looser emission constraints.

Although Eesti Energia currently presupposes that the oil industry will receive carbon leakage quotas free of charge until 2030, the tightening regulations will notably raise the costs and harm the profitability of the company's shale oil operations.

Banks have also explicitly emphasized the severe regulatory risk regarding the shale oil plant and sector. For instance, Liisi Himma, a representative of Swedbank, has stated that there is a very real risk that a global tax reform will be undertaken to attain EU's climate goals, which would paralyse the profitability of the oil production.

Neglecting and working against these trends would thus breach the fiduciary duty of the asset managers and the state, given that it would endanger the assets of the investors and taxpayers.

Declining political support for shale oil in Estonia

While it is only a matter of time when the EU-level political risk materializes, the political risk at the Estonian level can be even steeper and more unexpected.

Both Moody's and S&P emphasize that due to the weak financials and unstable market, Eesti Energia barely exceeds the speculative investment rating, and then only due to the state support.

The agencies agree that the credit rating of Eesti Energia would fall to the level of a junk company if – in case of financial problems – there was a decline in the government's ability or willingness to provide emergency assistance to Eesti Energia and the oil shale sector.

Despite the government's recent decisions to invest in Eesti Energia and the shale oil sector, the country-level political threat is growing.

The deepening polarization of the Estonian political landscape includes, among others, nullifying previously-taken decisions and dismantling systems in a wide range of areas, rather than gradually enhancing them.

The four-year election cycle does not ensure political stability to ensure the continuation of long-term investments. As a result, there is no certainty that the shale oil operations of Eesti Energia and the shale oil sector in general would be excluded from the process of breaking the existing systems, considering also the growing pressures for a more low-carbon economy from the EU.

The political risk regarding investing in the shale oil sector is also fuelled by the increasingly condemning public opinion, which includes not only the warnings from banks and credit rating agencies but also the on-going lawsuit against the planned shale oil plant, the international civil society appeal to the European Commission, local people's opposition due to health concerns arising from the on-going use of oil shale, the criticism raised by key figures in the oil shale sector and the growing confrontation in the parliament.

Eesti Energia's internal risk

The main risk internally to Eesti Energia is its high leverage. S&P underscores that the company is not able to repay more than a quarter of its debt from its funds from operations, and notes that the agency does not anticipate a reduction of debt levels in the near future.

According to S&P, Eesti Energia's prospects would significantly deteriorate if the debt burden increases further due to the tightening market situation. Moody's also stresses that the time lag between investing and earnings from these investments could put stronger pressure on the company's credit metrics and impede reducing its debt levels. If the credit rating agencies downgrade Eesti Energia's credit rating further due to an increase in debt burden or other risks highlighted above, the value of the company's bonds would likely be impaired.

Moody's emphasizes that fluctuations in oil prices and the materialization of the outlined risks may significantly aggravate Eesti Energia's liquidity problems. This means that Eesti Energia would have to sell its assets, take on additional loans or receive additional support from the state to survive, which has also been the case during the on-going crisis. In any case, the ultimate victims of the materializing risks are the investors and taxpayers.

In addition, Moody's states that implementing the company's comprehensive investment program could take up a disproportionately large part of its managerial resources, which endangers the cost-effectiveness, quality, and profitability of the planned shale oil plant. For instance, there is no guarantee that this time Eesti Energia would be able to avoid the severe shortcomings and mistakes made with the Auvere power plant, which was scheduled to be completed in 2015 but was opened only three years later.

Furthermore, the six-month shutdown of the Auvere power plant (for maintenance-ed.) shows that even when the shale oil plant is completed, Eesti Energia may not be able to ensure its continuous operation.

High risk means high interest rates

Swedbank's representative Liisi Himma has highlighted (link in Estonian) that investing in shale oil is of high-risk because for projects such as the shale oil plant, risks depend on the political decisions and societal expectations and thus they must be assessed a decade ahead.

If the investment is made today but the planned factory cannot start operating at full capacity before 2024 or 2025 the earliest, and if the estimated payback period is ten years, then there is a high probability that one or more of the highlighted risks will materialize during this period, making the plant unprofitable.

When investing, a simple principle is followed: the higher the risk, the higher the interest rate. As Eesti Energia is looking to finance the shale oil plant with foreign debt, the high risks indicate to the fact that the interest rate must be high. The interest rate can be increased further also by the EU's instructions for banks to tighten funding requirements for high-carbon projects and companies.

Due to the outlined risks, SEB and Swedbank indicate that when investing in the shale oil plant and sector, it must be assumed that the loans might not be repaid in full. Madis Toomsalu, the CEO of LHV Group, has added: "As far as the shale oil plant is concerned, I believe that today it will not be financed by any bank or European institution – I cannot imagine where such finance will be found."

In light of the described risks, it is not difficult to understand how investing in the shale oil operations of Eesti Energia can be regarded as playing Russian roulette, where there is a significant probability that Eesti Energia will shoot itself, as well as the taxpayer and investors, in the foot.

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Basing on his studies of business and international development in Estonia, Sweden and the U.S., Uku Lilleväli has gained experience in sustainable finance in an impact investment fund in Mauritius, contributed towards a more responsible banking sector in Estonia, worked on climate risk finance in the Philippines and supported the development of entrepreneurship education at Tartu University.

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