ESG: How it Applies to the Oil & Gas Industry and Why It Matters

Today's episode is all about ESG.

ESG values and metrics are heralding a revolutionary shift in corporate management and operation, pivoting from a short-term profit focus to a holistic success model that incorporates sustainability and societal contributions. Despite initial challenges and perceptions of ESG as a potential drain on profits, the irony lies in its ability to actually boost profitability, a trend witnessed even within sectors like oil and gas. This transformative change shatters long-held conventions, outlining a future where businesses thrive in tandem with society.

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About the author
Lisa Rushton

Transcript

Welcome to Womble Perspectives, where we explore a wide range of topics, from the latest legal updates to industry trends to the business of law. Our team of lawyers, professionals and occasional outside guests will take you through the most pressing issues facing businesses today and provide practical and actionable advice to help you navigate the ever changing legal landscape.

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Today is Saturday, November 11th. Veterans Day in the U.S. Before we get into today’s episode, we’d like to take a moment to recognize those who have served in our nation’s military. We’re proud to count a number of veterans as colleagues at our firm and we thank all of you for your service.

In today's episode, in anticipation of Tuesday's release of our annual Energy Transition Outlook Survey Report, we’re bringing you an episode focused on environmental, social, and governance, commonly known as ESG, and how it applies to the oil and gas industry.

The institution of ESG values and metrics represents a revolution in how corporations are managed, measured, and operated. This sea change has and will continue to drive companies away from the familiar framework of short-term profits toward success that is not only defined by profitability, but also by a “sustainable” and measurable contribution to the betterment of society at large, a new paradigm that breaks a long-established mold. 

While ESG is perceived by some to be difficult to implement, which it can be, and it may seem like a profit-killer, the irony is that for most companies that implement ESG programs, including those within the oil and gas industry, it has the opposite effect.  

According to the International Energy Association’s 2021 Global Energy Review, renewable energy grew 3% in 2020, inclusive of a 7% increase in electricity generation from renewable sources.  Logic would imply that, all things being constant, fossil fuel demand would decline.  But, of course, all things are not constant. Coal, driven largely by Asia, is a significant part of that demand, but natural gas is a driver across nearly all geographies.  Even as we seek to supply more of our growing energy needs from renewable sources, the demise of fossil fuels – for good or for bad – is greatly exaggerated.  While the industry itself is not going away, the way in which it operates and its contribution to the economy and society most certainly will be transformed.  

Why is that?  Certainly the societal implications of a focus on ESG represents an ethical imperative.  But the truth is that money talks.  BlackRock is the world’s largest investment manager with 10 trillion dollars of assets under management. According to S&P Global, as of February 2021, oil and gas represented 2.55% of its total investments and coal and consumable fuels accounted for 0.36%.  Despite these small percentages, the investments are material and represent close to 255 billion dollars and 36 billion dollars respectively in the energy sector.  As such, when BlackRock’s CEO Larry Fink speaks, people listen, including those in the energy sector.  

While BlackRock has been and is instrumental in creating the ESG imperative, it’s just one of the many stakeholders pushing companies in all sectors to embrace ESG and to develop metrics to measure progress towards identified goals. 

Despite all the talk about the energy transition, net zero economy goals and the importance of ESG overall, energy companies should not lose site of the fact that 1, it’s unlikely there will be a decline in global energy demand, populations are continuing to grow after all, and 2, broad index funds, as opposed to actively managed funds, simply cannot abandon the sector or create stranded assets. That said, lack of an ESG strategy will ultimately affect a company’s access to public, and increasingly private, capital. And that will happen to all companies, whether publicly funded or not.

Aside from the monetary pressure on companies to implement ESG programs, there’s also increasing pressure on companies to properly manage ESG issues stemming from the federal government. The Biden Administration has made both the fight against climate change and environmental justice foundational to its agenda.  Upon his inauguration, President Biden quickly rejoined the Paris Agreement and set a 2030 target to cut greenhouse gas emissions by 50 percent from 2005 levels. Getting there will require stepped-up federal regulation and enforcement of environmental protection across a wide range of industries. 

Widespread support of ESG policies, matrices and the overall energy transition is no doubt rooted in some critical and likely accurate assumptions. Climate change poses a serious threat to the destabilization of global economies in decades to come. Large tracts of farmland could become unproductive due to shifts in temperatures. Major coastal cities could become uninhabitable due to rising ocean tides. The prospect of such catastrophic change makes a compelling case that long-term economic prosperity is dependent on the mitigation of greenhouse gas emissions as quickly as possible.  And the social unrest and realities of COVID-19 have pushed importance of social issues across the board to the forefront of everyone’s mind.

These images drive a belief that the “E” in Environmental, Social, and Governance is defined only by climate change caused by fossil fuel production and consumption and the “S” is defined by diversity, equity and inclusion programs. But both definitions are too narrow. “E” includes a much broader range of considerations and takes into account a company’s usage of natural resources, including land and water use, and the effect of its operations on biodiversity and the environment, both in their direct operations and across their supply chains. Pollution and waste covers not just carbon emissions, but also packaging, other regulated and emerging contaminants, and the depletion of limited natural resources such as rare earth metals.  Investments in renewable resources represent a clear environmental opportunity, but not the exclusive one.  There is much that energy exploration and production companies can do to align themselves with ESG values that extends well beyond their end product.  

Most of the large integrated energy companies are well on their way to establishing ESG policies and programs and have begun efforts to reduce and minimize their impact on the environment.  

In November of 2020, Occidental Petroleum Corp. became the first large U.S. petroleum producer to set a net zero emissions target associated with their own emissions by 2040, and a commitment to reduce greenhouse gases associated with their products by 2050.

The key for any company is to know where it stands now so that it can get where it wants to be.  Every company must understand where they stand within the ESG framework and have policies tailored to that company with goals aligned with business strategies. It may seem basic, but it’s critical. Only then can progress be measured.

Intentional implementation of metrics over a prescribed timeline is vital to longer term success. Amy Stutzman, Managing Director of Opportune, a leading global energy business advisory, was right when she said, “I think you start small and then scale up over time. From what I’m hearing in the market and from private equity, there’s not an expectation of perfection in year one but rather the expectation is that companies are engaging in the issues and showing progress over time.” 

But what about adherence and compliance?  The answer for small and mid-size companies is no different than that for large public companies: industry specific standards and guidelines are needed, companies need to identify goals and targets, and management need to be incentivized for success. A September 2020 report by Kimmeridge rightly or wrongly points out with regard to E&P companies that “without a realignment of management incentives, the drive for volume over returns will continue, as will wasteful production and more flaring, coupling poor economic outcomes with poor environmental outcomes.”  What we all can agree on, and what investors like BlackRock expect, is that companies begin to benchmark, identify policies, develop programs, track progress towards goals, and align executive compensation packages to short and long term progress towards ESG goals.  

Establishment of reporting guidelines has begun, which of course will provide a guidepost for the development of programs and benchmarking against other companies.  The Securities and Exchange Commission, the Sustainability Accounting Standard Board, the American Petroleum Institute, Carbon Disclosure Project, and the Task Force on Climate-related Financial Disclosures, are each designing frameworks based on stakeholder input for disclosures and reporting. But regardless of these standards, companies need to create programs that are tailored to their operations.  

The fact is – ESG has gone mainstream.  Bloomberg tracked almost 300 mentions of ESG on energy company earnings calls in the first quarter of the year.  Self-recognition of the role E&P companies play in climate change and other ESG initiatives as well as a more creative perspective on the framework will hasten the process for any size of company.  The genie is out of the bottle, and ESG is here to stay for the good of society at large. While the ESG movement may well be a functional and cultural change that seems daunting to tackle on the front end, all that is expected of companies right now is that they embrace the concept and take action.  

“The creation of sustainable index investments has enabled a massive acceleration of capital towards companies better prepared to address climate risk,” BlackRock CEO Larry Fink wrote in a 2021 letter to CEOs, adding that he has “great optimism about the future of capitalism and the future health of the economy—not in spite of the energy transition, but because of it.” 

Hopefully, he will be proven right.

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