The war in Ukraine has forced Europe to think hard about energy security and the need to keep all types of energy in the mix – fossil, renewables and nuclear. Amid bumper profits and a fair amount of political posturing, energy companies must respond by demonstrating that they are well-managed, responsible operations with a realistic path to net zero and a low carbon future.
A key measure for stakeholders – notably the investment community - continues to be the strength of ESG policies for the companies concerned. Questions covering everything from carbon reduction strategies to offshore safety are helping to determine how energy companies are managing the risks that may impact on their financial performance and ultimately their share price.
"Companies that manage their financially relevant risks tend to be more efficient … and are doing things that actually improve their business," says Linda-Eling Lee, global head of ESG and climate research at the credit ratings company MSCI. "I think the world is looking for a measure of what they call corporate goodness."
In the UK, the newly appointed prime minister Liz Truss and her cabinet have opened discussions regarding the issuing of new North Sea oil exploration licences and opening the door again to fracking. One of Boris Johnson’s last acts as prime minister was to sign off on the proposed Sizewell C nuclear power station in Suffolk. There is growing support for supporting all sources of energy as a means to achieving greater energy security.
An accelerated transition
"This extreme disruption in global energy markets has shown that affordable, secure, and reliable energy cannot be taken as a given," notes Shell chairman Sir Andrew Mackenzie in the introduction to the company’s Energy Transition Progress Report 2021. He adds: "Essentially, an accelerated transition is the best way to ensure security of energy supplies. It is also the best way to help people in some parts of the world who do not yet have access to energy, which is essential for a better quality of life."
Politicians outside Russia, and indeed large parts of the energy sector, agree with him, that transition is inevitable, and that in the medium and long term, oil and gas companies will have to find a growing chunk of their profits elsewhere. The question is: can an ESG umbrella help explain the mechanics of transition, as well as sound non-financial management, while also protecting the share price?
According to Aniket Shah, managing director and global head of ESG at Jefferies Group, the investment banking firm: "ESG has nothing to do with making the world a better place. What ESG can do within the capital markets is ensure that you, as an allocator of capital, understand the risks associated with environmental, social and governance issues, from the perspective of: how do you make the most amount of money in your investments?"
So, from a corporate energy perspective you need to keep convincing your investors that you have these major ESG risks under control. Are you achieving zero harm offshore? Is flaring under control and could the issue impact on a future licence application? To what extent is the company diversifying away from carbon intensive operations?
And then, a war, which suddenly makes fossil a more acceptable option in pursuit of energy security. It also gives the likes of Shell and BP some breathing space as they enjoy the fruits of sky-high oil and gas prices while making bold pronouncements about their developing renewable businesses.
Riding two horses
Shell’s transition report is a good example of the contrast, in which on the one hand, the chairman is able to make big claims about the company’s ability to ship natural gas to where it’s needed most, while on the other maintaining that the company’s shift to low and zero-carbon energy is at the heart of its strategy. The company appears to be riding two horses while using ESG to explain why there is no risk of falling off either.
Many people, including those in the financial community, are now questioning ESG as a coherent and consistent measure of risk management. But ratings agencies are developing ESG-based methods to score companies – just as they scored the banks prior to the 2008 crash. Moody’s, MSCI, S&P Global and Bloomberg are among the largest doing this; there are also Fitch for climate vulnerability and CDP (the Carbon Disclosure Project), the latter of which gives climate, water and forest scores. Climate risk prediction models are continuing to emerge, and climate resilience, relating to where a business is located, as become just as important as climate mitigation.
Ratings for ESG issues can range from AAA, translating into a numerical score, for achieving top marks across the three pillars, down to CCC and below. Problems can arise when trying to establish the focus of a particular agency and what this might mean to a company’s overall risk profile. Shell, for example, might today be rated more highly for its ESG focus than was the case before the war in Ukraine, but less highly in an area like human rights or tax transparency. This can make it fiendishly difficult for an investor, say, trying to look behind an overall rating score, leading to what consultant Paul Wenman calls "aggregate confusion."
Good data and materiality
The answer, says Wenman, managing director of ESG risk assessment firm InvestAssure, is to focus on the issues that impact that particular company – termed materiality. Focusing on carbon intensity while making light of offshore safety might not cut the mustard for an energy company. But flaring rates, emissions intensity, land and water use would all be considered important for the sector, as might pay disparity and diversity.
Wenman also stresses the importance of good data and how a company both measures and reports on that data. Get those things right alongside the materiality factor and you can have a useful ESG conversation, he suggests.
Another factor driving ESG programmes and ratings has been the explosive growth of the green bond market. According to Moody’s ESG Solutions, sustainable bond issuances are expected to hit US$1.35tn globally in 2022, a projected growth of 36% on the previous year. "Sustainable bonds will continue to rise as a share of global bond issuance, potentially reaching 15% of total issuance this year," says Moody’s Matthew Kuchtyak.
In a recent sustainability paper, NatWest’s head of emerging markets, Alvaro Vivanco, sought to provide a clear link between a high ESG score for energy companies and an uplift in the share price. "Looking specifically at energy companies with a market cap of at least $1bn," noted Vivanco, "of the 19 firms that received ESG upgrades, we find that their share prices rose by an average of 5.2% in the three months following the change in rating. By contrast, the market-cap-adjusted industry average return over the same period was -0.6%."
This is quite a result for ESG winners – and that was before the war in Ukraine and the current energy crisis. Today, Shell’s riding two horses will almost certainly win shareholder approval as will profits rolling in from the high price of oil and gas. The NatWest paper highlights the importance of ESG in the energy sector in particular. Vivanco also emphasised that importance of policy, citing President Biden’s net zero ambition for US electricity producers in 15 years. The result, he says, is that "the market is already very clearly selecting winners and losers based on companies’ current carbon footprints as well as their planned future actions to reduce their emissions."
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This is an edited version of an article that first appeared on 29 September in New Energy World, reproduced with the permission of the Energy Institute.