Sanctions against Russia in response to the nation’s invasion of Ukraine have put oil and gas companies in the spotlight as global citizens. ESG has been a rising priority for the energy sector long before this recent crisis, however.
Activism related to ESG issues reached new heights in 2021, from Exxon Mobil losing three board seats in an epic proxy battle, to Third Point Partners calling for the breakup of Royal Dutch Shell. It’s a trend that seems certain to maintain velocity in 2022, given that just this month the directors of Shell found themselves being sued for failing to properly prepare the multinational oil and gas company for net zero. At U.S. energy companies overall, institutional investors averaged majority support for environmental and social shareholder proposals.
“We’ve talked about three pillars of reform — business model, environmental impact, governance,” Mark Viviano, Head of Public Equities with activist investor Kimmeridge Energy, said in a recent Insightia report. “They’re all interrelated and until they’re addressed, the generalist investor isn’t coming back.”
As You Sow CEO Andrew Behar had an even stronger warning for those resisting reform: “I think the energy industry is at a risk of a lot of these companies being non-viable.”
The message is clear: Oil and gas companies must adapt to a future defined by ESG. Read on for more on this rising imperative — and for steps energy company boards can take today to prepare for a vastly transformed tomorrow.
Intensifying Pressure and Demands
“Carbon-neutrality initiatives go well beyond simple energy efficiency bottom-line concerns and reflect a larger shift driven by societal expectations, changing investment approaches and, of course, grassroots activism.”
Jeffrey Whittle, Partner, Womble Bond Dickenson
Board members of energy companies may have experienced a false sense of security prior to 2022. Activists won just 20 board seats at energy companies during 2021, the lowest on record. But this was due largely to shutouts by Australian and Canadian companies — a dynamic which might not hold true in today’s operating environment. Ample room exists for activists to ramp up their demands.
Activists have been raising their voices on ESG issues: challenging spending on new fossil fuel production; saying no to deals; asking for operational improvements and factoring ESG into M&A and divestment decisions, particularly as divestitures from carbon-heavy businesses hold the potential to increase demand for shares and lead to a company re-rating.
Bluebell Capital Partners, for example, called on Glencore to divest its thermal coal business, and Third Point Partners pushed Royal Dutch Shell to split its refining operations off from its renewable energy businesses, arguing that the stakeholders and shareholders are different for each.
As scientific evidence increasingly underscores the planet’s climate crisis, and with governments and the financial markets responding accordingly, demands on oil and gas companies have escalated in scope and sophistication: more detailed ESG reporting, more transparency on environmental impact, executive compensation tied to ESG metrics, and tangible steps toward a carbon-neutral future.
What an ESG-Focused Energy Sector Might Look Like
Oil and gas companies face a challenging balancing act moving forward. They need to invest heavily in new fields while their traditional revenues and margins are under pressure. Some large businesses have already embarked on the transition: starting up new companies wholly focused on renewable energy and using solar power rather than conventional energy sources to power pipelines and compressor stations.
Moreover, activists are looking for prudent management, particularly in the area of risk. How will climate change impact their operations worldwide? What potential liabilities lurk due to environmental impact? Are their business models equipped for a net-zero future?
Alongside that, activists are also looking for skin in the game, starting at the very top. Kimmeridge has published white papers arguing for executive compensation to be more closely tied to ESG criteria, writing in one piece that “If we truly want to end the pro-cyclical behavior that has historically plagued the industry, commodity prices can no longer serve as both a tailwind and scapegoat for rewarding executives.”
Tactics for Mastering the Transition
Information overload in a complex, evolving landscape is a big obstacle in energy companies’ ESG efforts. “While many companies are keen to demonstrate their ESG credentials, they are hampered in doing so effectively by an absence of globalized standardized ESG metrics,” states Thomas Reilly and Summreen Mahween with Covington & Burling LLP.
Moreover, there are myriad metrics to track: health and safety, gas handling, air and water pollution risks and waste management and disposal, as well as more qualitative measures like methods, actions and oversight toward lower emissions and health, safety and environmental policies adopted by senior management.
Use Technology to Stay Ahead of the Curve
The energy sector is no stranger to innovation. Many oil and gas companies already use cloud solutions, advanced analytics, scenario modeling, artificial intelligence (AI), machine learning (ML) and more in their daily operations. Such technologies can be put to use for:
- Aggregating ESG data from across the organization
- Tracking and analyzing progress against ESG goals
- Monitoring real-time stakeholder sentiment
- Improving accountability throughout the organization on ESG initiatives
Deliver to Decision-Makers the Right Data at the Right Time
Are sustainability initiatives both compliant and cost-effective? Does a potential acquisition have ESG-related liabilities? How do a company’s ESG metrics for executive compensation compare against those of its peers?
Activists expect answers to questions like these along with long-term strategic responses on ESG. Modern governance tools can assist here as well, supporting board efforts to:
- Establish clear ESG goals and objectives
- Monitor progress and benchmarking against competitors
- Quantify ESG impact and calculating net present value for future initiatives
- Drive long-term growth and profitability
“Companies need to establish a clear strategic narrative for stakeholders—one that’s supported by the right metrics and controls—while building trust in the process,” writes Robert Baldwin, Master Limited Partnership Leader with PwC US.
With modern governance tools, corporate leadership can be prepared for ESG issues. They can share information and work with investors, regulators and other stakeholders on solutions for the energy sector’s eventual transition to a zero-carbon economy.
Mastering the Opportunity
The energy sector’s ESG imperative is an urgent alarm and call to action. At the same time, it’s also a powerful opportunity for leadership, competitive edge and first-mover advantage.
“The technological and market path forward is still open, and winners and losers have not been identified,” Lisa Rushton, WBD Partner and Energy & Natural Resources Sector Co-Lead told IR Magazine. “Even players that are entrenched in current markets and technologies have the opportunity to pivot and capture value going forward.”
Oil and gas companies can master this pivot and thrive. It starts with detailed metrics and controls, transparent disclosure, proactive shareholder engagement and strong governance.