Editor’s Note: This is one of a 14-piece series NGI undertook as the energy industry readied for the new year, with Lower 48 natural gas and oil supply continuing to surge in an uncertain environment as liquefied natural gas exports ramp up, Mexico markets remain shrouded and stakeholders demand more value. Get your complimentary copy of NGI’s 2020 Special Report today.
Many oil and gas operators are finding that by opening the door to environmental, social and governance initiatives, otherwise known as ESG, they are reaching new investors who today are becoming more proactive in determining where to put their money.
The ESG movement, long prized by renewables operators, made a lot of headway last year in the U.S. exploration and production (E&P) sector, and its status is only growing, analysts said as companies embrace net-zero emissions initiatives, workforce diversity and corporate transparency.
“Like it or not, E&Ps need to respond to ESG pressures,” said Raymond James & Associates Inc. analysts led by Pavel Molchanov. “It is not going away. Quite the contrary, the trajectory is firmly upward and onward.”
Evercore ISI’s analyst team led by James West said the “cacophony from the energy Twitter-sphere consortium has grown into a full-blown shriek as executive compensation schemes are maligned by an increasingly aware professional community. You don’t have to be socially media savvy to sense this.
“These days, the disruptive impacts of ESG mandates prevailing against declining petroleum reserve replacement ratios means that the true value of hydrocarbons is becoming more subjective. The discord will grow louder before it gets better.”
The WilderHill Clean Energy Index (ECO) posted a 2019 gain of 58%, the strongest energy subsector and the best performance since a 58% gain in 2013, according to Raymond James.
The “global decarbonization megatrend” is “reflecting a potent combination of technological/economic and political/regulatory tailwinds. In addition, there is the concurrent benefit of the ESG investing trend, one of the most visible and durable themes in the investment landscape.”
As energy companies court investors, they are looking to the younger generation, which has a different mindset about where to put their money. Millennials appear to be most interested in applying their ideals on ESG issues to their finances, but Generation X and baby boomers are also expressing interest, according to a recent ESG Investor Sentiment Study by Allianz Life Insurance Company of North America.
Nearly two-thirds (64%) of millennials said ESG issues are important in their investing decisions with Gen Xers at 54% and boomers at 42%. “Millennials get a lot of attention for driving ESG investing,” said chief investment officer Todd Hedtke of Allianz Investment Management LLC. “But when it comes to investing in and doing business with good corporate citizens, there is interest across the board and it’s only going to grow.”
European energy operators and other foreign producers have long touted ESG initiatives, including BP plc, Royal Dutch Shell plc, Eni SpA, Equinor SA and Repsol SA. Operators generally use variations of the Greenhouse Gas Protocol by the World Resources Institute for their environmental direction, which provides criteria to monitor direct-to-indirect emissions, otherwise known as Scope 1 (direct), 2 (indirect emissions they control), and 3 (indirect emissions by customers).
“Various other Big Oils have partial decarbonization targets, also without Scope 3 -- making the point that they cannot be responsible for what their customers do,” Molchanov noted.
Walking The Walk
U.S.-based operators also are instituting ESG initiatives, including ExxonMobil Corp. and Chevron Corp. In a recent interview with CNBC, Chevron CEO Michael Wirth said investors “care about the ‘S’ and the ‘G,’ where we hold our company up against any.”
Wirth said most investors are focused on the “E” as well, especially climate issues, which Chevron is addressing. “Number One is to reduce the carbon intensity of our operations. And so, we’ve got a strong commitment in place, and metrics that affect my pay and the pay of every employee in the company that hold us accountable to reduce the carbon footprint of our operations.”
The second strategy, Wirth said, is to integrate renewables into the business “in a greater way. This includes solar and wind to power some of our operations,” as well as “renewable natural gas, where we’re working with dairy farmers to take the byproducts of dairy farming and capture natural gas for consumption.”
New technology research also is paramount, Wirth told CNBC, “which is really where companies that have the scale and the technical capability should be focused,” such as “how do we find solutions that can work at scale, that can be competitive and economic, with the alternatives today?
“There is work to be done there,” Wirth said. “So, we’re focused on all three of those, as we have discussions with serious investors that want to see our company and those in our industry be part of the solution. I think they understand the things that we’re working on.”
A key theme for 2020 in the E&P sector will be a “fight for sustainability” versus last year’s “fight for investability,” said Goldman Sachs analysts led by Brian Singer.
“Investors will likely focus further on ESG metrics/engagement and differentiation among E&Ps,” Singer said. “While we have seen some investor movement away from E&Ps/other fossil-fuel intensive businesses over the past few years for ESG-driven reasons, we believe that for those willing to consider E&Ps within the context of the broader ESG landscape, there is potential for select E&Ps to stand out.”
The bar to define “through-the-cycle winners and attract/retain through-the-cycle investors in the E&P sector continues to rise,” along with improvements in corporate behavior.
An evaluation of 209 energy companies completed late last year by the Transition Pathway Initiative (TPI) found only 31 had implemented strategies aligned with commitments to the United Nations climate accord, aka Paris Agreement. TPI, backed by investors with more than $15.7 trillion of assets, is a tool for investors that assesses a company’s preparedness to transition to a low-carbon economy, otherwise known as the “energy transition” to renewables from fossil fuels.
ESG initiatives and decarbonization are becoming increasingly relevant in portfolio allocation decisions for investors, according to Goldman. In the past five years, the number of Principles for Responsible Investment signatories “has nearly doubled and with that, we have seen ESG investing grow at a double-digit pace globally...Investors will likely focus further on ESG metrics/engagement and differentiation among E&Ps.”
BlackRock Inc., considered the world’s largest asset manager with nearly $7 trillion in investments, plans to revamp its policies and add more offerings focused on ESG, CEO Larry Fink said in his annual letter on Tuesday to shareholders.
BlackRock, which nearly five years ago noted the rising impact of climate change on investments, plans to begin exiting some investments that “present a high sustainability-related risk,” including fossil fuels projects. The firm also plans to introduce funds that shun fossil fuel-oriented stocks and move to vote against management teams that are not making progress on sustainability.
“We have advocated for clear and consistent naming conventions for ESG products across the industry, so that investors can make informed decisions when they invest in a sustainably labeled fund,” Fink wrote. “We have been working to improve access for several years” by building for example the industry’s largest suite of ESG exchange-traded funds (ETF).
Among other things, BlackRock intends to double its ESG ETF offerings to 150 in the next few years, “including sustainable versions of flagship index products, so that clients have more choice for how to invest their money.”
Raymond James analysts hosted an investor call last October with Sustainalytics, which provides ESG stock ratings for investors. ESG scores now account for 26% of managed assets, and the number is increasing.
“Public companies, in any sector, ignore this at their peril,” said Raymond James’ Molchanov. “It is a striking but not widely known fact that 26% of all U.S. professionally managed assets (equity and debt combined), or nearly $12 trillion, are already covered by some kind of ESG criteria.” The growth in ESG “has been explosive since 2012, with the dollar amount tripling over that timeframe.”
If 26% of the asset pool “were to rise to 35%, 40%, perhaps even 50%, which is what the growth trajectory suggests will happen over the next decade, the headwind will become severe,” he said. “Simply put, it is not realistic to pretend that ESG requirements of institutional investors can be ignored or treated as an afterthought.”
An idealist could say that ESG is a way to align corporate practices and social needs, Molchanov said. The cynical view is that ESG “is just a game, “where the only winners are the ratings providers collecting fees. Whatever your view, the undeniable reality is that 26% of all U.S. professionally managed assets -- and rising -- cannot be ignored. This certainly includes the energy sector. It is realistic, and perhaps easier than some might think, for E&P companies to accommodate ESG pressures.”
MSCI Inc., which also publishes ESG ratings, in late November said it had rated more than 2,900 companies to provide asset managers with more detail. Total assets invested using some reference to ESG data hit $30.1 trillion across the world’s five major markets at the end of 2018, up from $22.8 trillion in 2016, according to MSCI’s Global Sustainable Investment Review.
MSCI awards companies an ESG rating based on 37 criteria such as corporate governance and carbon emissions. Data is expected on more companies this year, taking the total number with public data to 7,500. The index group gives companies a rating from “AAA” to “CCC” based on their exposure to ESG risks and their management of them relative to similar companies.
U.S.-based E&P executives, as well as oilfield services (OFS) operators, last year began stressing how their companies are involved in ESG.
During Occidental Petroleum Corp.’s third quarter conference call last fall, CEO Vicki Hollub said the board created a committee to specifically address ESG to become more engaged with the shareholders. “And if there are issues that we need to address, they're getting that feedback now directly...I think that's been a huge change for us, and I think it's going to be a positive thing for all of our shareholders going forward.”
Pioneer Natural Resources Co. CEO Scott Sheffield during the 3Q2019 call said the company was going to include ESG slides in its earnings reports to detail emissions and other initiatives.
“I think the key points here is that the company is focused on all three of these measures and will continue to highlight all of these measures going forward,” Sheffield said. On social issues, Pioneer is “focused on community, culture and talent development,” and it continues to work on “improving gender diversity...significantly in regard to the percent of women inside the oil and gas industry, inside the management teams, at the board level and all employees throughout the company.”
ConocoPhillips CEO Ryan Lance during the annual analyst meeting in November touted the company’s standing in the S&P 500 ESG Index as well as the Dow Jones Sustainability Index.
“We were the first E&P company to set an emissions-intensity reduction target,” Lance said. “We also lead the pack on social and governance issues with support from an engaged and diverse board of directors. Our board and management team recognize the need to compete against a broad market for investor attention...and we continue to up our game on disclosure.”
Schlumberger Ltd., the No. 1 OFS operator in the world, also has committed to reducing its emissions using science-based targets by 2021 as part of its thought leadership and focus on environmental and social sustainability through its Global Stewardship program.
Liberty Oilfield Services Inc. CEO Christopher Wright during the third quarter call said the company has been focused on ESG from “Day One,” and was a “first mover in driving in an environmental and socially conscious approach to hydraulic fracturing…
“We're in constant dialogue with our customers about how to move the ESG profile of fracture operations forward, and as such, we are looking to upgrade some existing fleets as part of the normal maintenance cycle in 2020” to dual-fuel engines driven by natural gas.
“Being a leader in ESG goes beyond emissions,” Wright said. “These include safe and efficient operations, dust and noise mitigation, traffic management and environmentally safe fluid systems to name just a few.
“The partnerships that we've developed with the communities that we live and work in are unique and provide the necessary insight into how best to provide solutions to specific challenges that our operator partners face.”