NRG’s $900 million Sustainability-Linked Bond: Setting a North American Precedent

6-minute read

On July 24, 2020, NRG Energy, Inc. (NYSE: NRG), an integrated power company built on dynamic retail brands with diverse generation assets, announced the $3.6bn all-cash acquisition of Direct Energy from its UK parent, Centrica. Following this announcement, on November 16th, 2020 NRG announced concurrent offerings to fund the purchase price of the previously announced acquisition. The offerings comprised:

1. Senior secured first lien notes, consisting of senior secured first lien notes due 2025 (the “2025 Secured Notes”) and senior secured first lien notes due 2027 (the “2027 Secured Notes”)
2. Senior unsecured notes, consisting of senior unsecured notes due 2029 and senior unsecured notes due 2031.

The 2027 Secured Notes were issued under NRG’s newly published Sustainability-Linked Bond Framework[1].

The transaction was one of the year’s largest acquisitions in the U.S. energy space to be structured and executed during COVID-19, and its very strong reception in market reflects the tremendous depth and liquidity of both the investment grade, high yield, and equity markets. As part of the financing strategy, NRG issued an inaugural $900 million Sustainability-Linked Bond.

This transaction represented a milestone for the company, and for the broader sustainability themed financing market as a whole, as it represented many firsts including:

• 1st Sustainability-Linked Bond from a North American issuer;
• 1st Sustainability-Linked Bond from a power company outside of Europe; and
• 1st Sustainability-Linked Bond with a “most ambitious target” clause
   

The “most ambitious target clause” means that any future NRG’s Sustainability Linked Bond with the same KPI(s) and Sustainability Performance Target (SPT) Observation Date must utilize an SPT of equal or greater climate ambition. It somehow echoes countries ratcheting mechanism principle inscribed in the Paris Agreement. In addition, at the issuance of such an SLB, any outstanding SLBs would have their equivalent SPT adjusted to reflect the greater ambition. There are three main reasons underpinning this most ambitions target clause:

1. Enabling the increase of ambition over time, and allow NRG to adapt to new circumstances

2. Avoiding the coexistence of SLBs with different SPTs at the same dates for the same KPIs

3. Facilitating the reporting exercise – avoiding the need to validate the KPI against multiple targets
 

Natixis was appointed as Joint Bookrunner and Sole Sustainability Structurer and Coordinator as part of this issuance. The Sustainability-Linked format was applied to the $900 million 2027 Secured Notes, with an absolute greenhouse gas emissions reduction target imbedded in its structure. The target is to be tested for the 2025 fiscal year and will result in a 25-basis point step-up to the coupon should NRG fail to satisfy this target.

The issuance was announced the morning of November 16th and priced November 17th with Natixis hosting a Sustainability focused call the morning of November 17th. Books peaked at c.$3.9 bn, closed at $3.6 bn and saw a compression of 27.5 bps from IPTs of 212.5 bps to clear at 185 bps, implying zero new issue concession.

NRG had previously announced its sustainability ambitions with updated targets of reducing its absolute emissions by 50% by 2025, as compared to its current 2014 baseline, on the path to net zero by 2050.

The issuance of Sustainability-Linked Bonds represents the next steps in aligning NRG’s business and financing with its commitments and values by creating a direct link between its climate and funding strategies.

Transition in the Power Sector

According to the International Energy Agency (IEA) in 2018, the power sector accounted for ~40% of the world’s total greenhouse gas emissions. Through the burning of coal, natural gas and oil for electricity and heat, the sector has become the largest single source of global greenhouse gas emissions.

Many large power providers are acknowledging their environmental impact and striving and striving to transition to a lower-carbon intensity future. Companies such as NRG and its European industry peer and fellow Sustainability-Linked Bond issuer, Enel S.p.A., have made GHG emission reduction commitments and implement decarbonization strategies (see the table 2 in Appendice for an overview of the climate goals of top 20 U.S. electric & gas utilities). These power companies will have to manage their carbon emissions while striving to meet the growing global demand for power.

There is a variety of opportunities to reduce greenhouse gas emissions associated with electricity generation, transmission and distribution. Companies will be tasked to evaluate their internal operational strategies and to deploy certain levers to decarbonize their operations.
 

Table 1. Reduction Opportunities for the Electricity Sector[2]

Source: Green & Sustainable Hub, Natixis (2020)

NRG and Sustainability

As a power company, NRG recognizes the critical role it plays not only for its customers, but also in decarbonizing the economy more broadly.

In 2019, NRG made significant progress towards its goals and commitments while also raising the bar by:

• Expanding its sustainability program and accelerating its greenhouse gas (“GHG”) emissions reduction goals to align with the IPCC 1.5° Celsius (“C)” imperative;
• Improving its financial resilience and providing clarity on its path to deliver value to its shareholders;
• Contracting more than 1.6 GW of renewables for its customers sor far, and planning for more;
• Refreshing its company values, including elevating diversity and inclusion and integrating health and well-being into NRG’s safety commitment.

NRG is committed to leading its sector in terms of sustainability, transparency, and disclosure. NRG follows the leading globally accepted frameworks and standards to provide key information to all stakeholders, including being one of the first in its sector to use the Sustainability Accounting Standards Boards (“SASB”) standards and to support the Task Force on Climate-related Financial Disclosures (“TCFD”) recommendations.
 

NRG’s Climate Transition Strategy and Goals

In November 2014, NRG announced its decarbonization goals to cut GHG emissions by 50% in 2030 and by 90% by 2050 from a 2014 baseline. This announcement marked the first time a major US power generation company put actual dates and quantities around its transition to a low-carbon energy future. These targets were subsequently validated by the Science Based Targets Initiative (“SBTi”) as being aligned with a 2° C scenario. Moreover, NRG was one of the first ten companies in the world to have its targets certified by SBTi.

When the IPCC revised its guidance to limiting warming to a 1.5° C scenario, in keeping with the goals of the Paris Agreement, NRG took the immediate step of re-evaluating its targets.

On September 24, 2019, NRG announced the improvement of its already leading, science-based targets. NRG’s new goals are now to reduce emissions by 50% by 2025 on the way to net-zero by 2050, from a 2014 baseline. (Chart below as of December 31, 2019)

Figure 1. U.S. CO2 e Emission Goals (MMtCO2e)

In addition, in 2018 NRG conducted a climate scenario analysis looking at four specific temperature scenarios: 1.5° C, 2° C, 3° C and 4° C. Tested scenarios incorporate climate projections for emissions reductions and climate physical impacts. The insights developed are still being incorporated into NRG’s strategy and risk management processes with more detail to be reported in late 2020 or early 2021 including alignment with the TCFD.

Source: S&P Global, “Path to net zero: Cracks appearing in natural gas' role as bridge fuel” (July 2020)