Wall Street’s ESG Shift, New Profit-Making Opportunities
This is the second of a three-part series covering the trends, facts, data and cultural movements driving the global transition to a carbon-neutral economy and impacting the global oil and gas business today.
It’s not the strong that survive a crisis, it is those who adapt. Today’s demand-driven challenges and changing investor preferences in the oil and gas markets require Energy companies to adapt.
In Part 1 we covered how the facts about methane as a potent greenhouse gas is driving public opinion, how policymakers are acting to reduce fugitive emissions from oil and gas operations, and how early movers that reduce their emissions can drive value through the development of Responsibly Sourced Gas.
Wall Street has taken notice of emerging data linking emissions of methane and Volatile Organic Compounds to climate change and public health. As a result, institutional investors have recently taken bold steps to influence the companies in which they are equity shareholders. Over the past several years, large investors have made Environmental, Sustainability and Governance factors, or “ESG” issues, important investment criteria within the broader concept of the social license to operate.
As noted in Part 1, forward-thinking executives and boards of directors have already taken steps to adapt to the eventuality of a carbon-neutral future. Several large E&P companies have announced targeted reductions in methane intensity and routine flaring to mitigate the impact of their operations on climate change, both practices that impact ESG performance. Many have gone farther, tying ESG performance to executive compensation. Within the changing regulatory and investment landscape, these leaders see the opportunity that exists for both differentiating their tickers with Wall Street and improving business results.
Investors Have Taken Notice and are Driving Change
BlackRock, one of the largest institutional investors in the world with a reported $6.5 trillion under management, announced just this year that it was imposing strict new ESG reporting requirements on portfolio companies and has elevated ESG performance indicators to the same level of importance as traditional financial metrics.
At the core of the new ESG reporting mandates are adoption of reporting standards developed by the Sustainability Accounting Standards Board (SASB), a non-profit organization that sets financial reporting standards. SASB has developed reporting standards for a variety of industries. Specific to exploration and production companies, the applicable SASB standard is EM-EP that covers topics ranging from greenhouse gas emissions, air quality, water management and more.
The Sustainability Accounting Standard EM-EP-110a.2 for Exploration & Production companies, for example, states that oil and gas producers must disclose emissions (including methane) from “(1) flared hydrocarbons, (2) other combustion, (3) process emissions, (4) other vented emissions, and (5) fugitive emissions from operations” in CO2-equivalent metrics. That is a fairly specific requirement and explains why many public E&Ps are adopting emissions reduction targets.
What SASB does not mandate, however, is how the data is obtained. That opens the door for proactive producers. Companies with equity traded on the public markets with a documented track record of good ESG performance and reducing methane intensity stand to gain a competitive advantage the next time they tap the capital markets. Private companies with demonstrated ESG metrics also stand to improve the composition of their bank groups.
Energy companies that lack effective independent ESG reporting and performance now risk losing support from desirable long-only investors, and instead attracting the attention of financial and environmental activists. This scenario has negative implications for corporate valuation, cost of capital and the ability to access the capital markets.
Although private companies may not have mutual fund managers and hedge funds pressuring them to adopt ESG reporting mandates, they still have strong incentives to implement ESG initiatives and reporting. We anticipate that it is only a matter of time before ESG factors find their way into loan agreements and debt covenants. Additionally, the cultural and regulatory shifts already underway will further influence all energy companies – public and private – into adopting technologies and operational practices that reduce fugitive emissions.
Reducing Emissions is Possible and Affordable
As E&Ps and utilities are held to SASB standards by their investors, they will need to reduce emissions in order to stay competitive. Fortunately, there are simple, cost effective steps they can take to evidence their ESG progress.
The primary source of methane emissions from the oil and gas industry is fugitive emissions from well sites, surface storage tanks and production facilities. As Lori Bruhwiler, co-author of a ground-breaking NOAA study said, “The good news is that fixing leaking oil and gas infrastructure is a very effective short-term way to reduce emissions of this important greenhouse gas.” Most oil and gas operators already have Leak Detection and Repair (LDAR) teams, now is the time to optimize their performance using new technology that is both affordable and reliable.
IEA further reported that “Unlike CO2, methane – the main component of natural gas – has commercial value: the additional methane captured can often be monetized directly, and this is typically easier in the oil and gas sectors than elsewhere in the energy sector. This means that emissions reductions could result in economic savings or be carried out at low cost.” The agency estimated that it is technically possible today “to avoid around three quarters of today’s methane emissions from global oil and gas operations. Even more significantly, around 40% of current methane emissions could be avoided at no net cost.”
The benefit is significant. IEA estimates that implementing methane mitigation measures that have positive economic values would “…reduce the temperature rise in 2100 by 0.07 °C compared with a trajectory that has no explicit reductions.”
As noted in Part 1, proactive energy companies are already taking steps to reduce fugitive emissions and the routine flaring of natural gas by setting methane intensity goals, and then putting teeth into those policies by linking ESG performance to executive compensation.
The institutional investor community is poised to play significant roles as actors accelerating The Great Energy Transition. As Wall Street’s largest money managers adopt ESG performance criteria, we expect more to follow, including lenders. Consequently, ESG factors stand to spread far beyond Wall Street and eventually find their way into lending agreements and debt covenants impacting companies, both public and private.
Adoption of ESG performance reporting, however, offers proactive companies a way to differentiate themselves with the investment community. E&Ps, utilities, pipeline operators and related companies with strong ESG performance that can be evidenced using data that is independently monitored and audited provides the foundation of a strong social license to operate, which in turn has the potential to attract capital on more competitive terms.