Opportune LLP’s managing director Amy Stutzman outlines how investors in the oil and gas industry are making demands for ESG investing
Environmental, Social, and Governance (ESG) investing is rapidly becoming one of the most visible and durable megatrends in the oil and gas industry, as momentum builds behind efforts to promote renewable energy, sustainability, and the energy transition. The pressure of ESG is being felt throughout the US oil and gas value chain, with the upstream sector facing the most scrutiny for its impacts on the environment, and the midstream for its social impact and governance structure.
Even amid the Covid-19 pandemic, which has rattled global economies around the world in such a short time, investors are viewing the crisis as a major turning point for ESG investing in the long term, alongside traditional financial metrics. In the energy industry, the perception of ESG has shifted from a ‘nice-to-have’ feature to a ‘must-have’ pre-requisite, as it is greatly influencing the way investors invest in the industry, which may ultimately determine winners and losers in the market.
Why is ESG important to the oil and gas industry? Some days it seems like all we read in the news is that industry majors are making investments in renewables and green energy initiatives, but sustainability does not exclude the continued development of fossil fuels. Indeed, ESG is an opportunity for the oil and gas industry to tell its story. It is important to tell that story because there has been a shift in the investment community and ESG now impacts access to capital more than it ever has before.
For example, there has been an increase in ESG funds, which are investing in companies that are committed to sustainability and those that are tied to ESG ratings. There are also performance-based sustainability-linked bonds and loans. That market is growing, and it is expected to continue to grow because of investor demand.
It is not just investors who are more focused on ESG risk. Consumers will often boycott or make buying decisions based on social issues. It is something that has really increased in our culture in general and as such now impacts the flow of capital.
“ESG has shifted from a ‘nice-to-have’ feature to a ‘must-have’ pre-requisite”
Institutional investors would tell private equity firms that they will not provide capital unless ESG requirements are met. The most widely discussed example of this is BlackRock, where the CEO, Larry Fink, wrote a letter to CEOs in 2020 stressing the importance of sustainability initiatives and reportedly stating that BlackRock would vote against any management and boards not making sufficient progress on these initiatives. There are other investors that have made similar public statements and, of course, private equity firms have followed suit.
For the large integrated oil majors the creation of ESG policies and goals is manageable within existing management and reporting structures. But for mid-sized and smaller independent E&P operators that operate on razor thin margins, this will be a challenge. However, there are some things they can do around ESG to differentiate themselves among their peers.
At Opportune LLP, we are often asked: “My investors are looking for an ESG strategy and reporting. Can you help me get started?”
What should you do in that situation? First, anticipate that question and have a response showing that your company is thinking about these initiatives proactively – it can still be a differentiator, especially for small companies.
Then perform a gap analysis. Start by determining what the company is already doing and document it. Look at your peers and see what they are doing. You can also be proactive in engaging in conversations with your investors and other stakeholders and your community to see what the priorities are for them, and how they could be addressed. Then you can start to determine where you have gaps and how you should evolve and improve over time.
“Show that your company is thinking about these initiatives proactively”
Resources are a challenge; not only human capital and financial resources, but also having systems in place to track and report on ESG initiatives. Start small and scale up. Do not expect perfection in year one; aim for an ability to show the company is engaging in the issues and progressing over time.
One private equity group, Kimmeridge, has issued a whitepaper outlining five very specific principles that they believe should be adopted by the oil and gas companies they invest in. Those five principles included things like eliminating flaring, reducing and monitoring methane GHG emissions and ESG reporting. It can be relatively cost-efficient to replace valves with newer technology or replace older equipment. Kimmeridge is also looking at water usage, considering the volumes produced and what percent of that is recycled. Recycling water and re-use in fracking reduces the environmental impact and offers an economic incentive by reducing operating costs.
On the social side, companies are focused on employee safety, as well as giving back to their communities. Oil and gas companies often have a negative public image and the volunteer work by employees and company contributions to the community can be positive.
As far as governance, companies are focused on diversity, equity and inclusion. It is important to note that ESG must be demonstrable and really embedded in the company culture and the tone has to be set at the top; it cannot just be a check-the-box exercise. Senior management really needs to show that ESG is important and a long-term strategy for the organisation.