Incorporating ESG into the Oil and Gas Industry

Pillsbury - Gravel2Gavel Construction & Real Estate Law

As we previously reported, the popularity of the sustainability linked loan and the green loan have snowballed in recent years. However, it’s not just the loan market that’s taking the consideration of environmental, social and governance (ESG) practices seriously. Studies show that companies are coming under pressure from all sides to adopt sustainable practices.

In July 2020, Morningstar Manager Research reported that in the second quarter of 2020, inflows into sustainable funds hit $71.1 billion across the globe: a rise of 72 percent. These volumes, coupled with reputational concerns, perceived market pressures and investors taking a greater interest in these matters, mean that companies can no longer afford to pay lip service to their ESG practices. According to an April 2018 ESG Institutional Investor survey by State Street Global Advisors, over 80 percent of institutional investors consider ESG components as part of their investment strategies. So, could ESG be the silver bullet for an oil and gas industry in crisis?

The concept of ESG’s relevance in the oil and gas industry could appear incongruous at a first glance. However, there are increasing signs that the sector is looking to ESG to move with the times, with the aim of bolstering investment. Although the energy transition is firmly underway, oil and gas continue to have a significant role to play in global energy production in the short and mid-term, and many oil and gas companies are looking at ways to become greener and retain relevance. It is therefore critical that future production by oil and gas companies is as sustainable as possible.

Financing into the oil and gas industry has been on the decline for some time. The COVID-19 pandemic has seen this culminate due to the plummeting oil prices resulting from lower demand, exacerbating already squeezed margins and poor returns on investment. The position has been further compounded by the fact that both investors and consumers are turning their focus to newer, cleaner energy sources. However, there are indications that businesses in the sector can afford to be sanguine about investment options in the short term if they address deficiencies in their ESG strategy.

It appears that energy companies are starting to take charge of their ESG profiles to attract investment, and there are early signs that it’s working. Two significant transactions were announced in the exploration and production sector last month in which ESG played an important role.

The CEO of ConocoPhillips made specific reference to the significance of the company’s ESG strategy in relation to its $9.7 billion acquisition of driller Concho Resources. The focus of ConocoPhillips’ efforts in this regard is on its environmental planning. Steps taken include commitments to cut emissions and phase out routine flaring. The emphasis on ESG represents a recognition of the impact of the energy transition, investor demands and preferences, and a desire to mitigate inherent reputational risks.

Similarly, when Pioneer Natural Resources announced its agreement to acquire Parsley Energy, the press release highlighted sustainable development as being one of the key strategic and financial benefits of the transaction. In addition to pledging the publication of a sustainability report, the companies confirmed their commitment to “aggressively pursue improvements and promote a culture that prioritizes sustainable operations.”

The significance of these transactions is in the message that they send to the market. The bottom line for investors will always be the returns; however, companies can no longer afford to neglect their ESG responsibilities. Improvements to a company’s ESG profile has burgeoning benefits. In addition to the positive environmental, social and governance impact and the reputational advantages, effective ESG planning also helps to attract a wide range of investors and promotes long-term financial outcomes.

Whilst the obvious choice for businesses in the sector is to focus on their environmental performance, there has also been much recent attention given to the “S” in ESG. The social aspect is increasingly topical given issues of diversity and inclusion and modern slavery (amongst others) and in particular for energy companies with global operations. It is important that oil and gas companies give sufficient weight to all three letters in the acronym to reap the benefits of a considered ESG policy.

Companies across industries are recognizing that identifying and mitigating ESG-related risks and opportunities may open doors to investment. Businesses must therefore ensure that they are discussing their ESG strategies with investors at an early stage and are reporting regularly on the steps they are taking. Similarly, it is vital that investors are transparent regarding how ESG targets are rewarded, enforced and penalized. All stakeholders must work together to establish ambitious but obtainable goals, effective reporting and reduce the potential for green or sustainability washing.

Companies, and in particular oil and gas businesses, need to act now. Whilst their long-term prospects might seem bleak, ESG presents an opportunity for a graceful and reputation-improving transition. Businesses must integrate their sustainability considerations into their long-term strategy planning and let it be a key focal point for discussions with investors.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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