A few weeks ago, I was in a meeting where ESG was on the agenda. One of the male leaders in the room said, “We should have one of our ladies write something about ESG.” Wait…what??? For a second I thought I had misunderstood, but another female colleague confirmed that I’d heard correctly when she texted me under the table, “Yes, one of our ladies should definitely write about ESG”. The message included an appropriate emoji to express the hysterical nature of the comment.
While conversations about ESG are increasing within the energy industry, there are still misconceptions about the topic. The industry has made progress in beginning to report on ESG initiatives, but there’s a lot of work yet to be done.
What is ESG?
ESG refers to Environmental, Social and Governance aspects of a company’s operations and performance. As the male leader in the meeting emphasized, ESG does have a diversity and inclusion component, but diversity is really just a small part of the broad initiative.
An ESG framework provides a structure to address these issues holistically and consider the ways in which the issues impact each other. For example, strong governance should lead to positive environmental and social impacts. The key is that ESG provides a platform to demonstrate company performance and value creation in ways other than financial performance.
Why Is ESG Important?
ESG initiatives have a positive impact on performance and several studies have proven its direct link to financial performance. A quick Google search results in many academic studies that support this theory. Of particular interest to the energy industry, one Harvard Business School Working Paper provides evidence that “…companies significantly outperform their counterparts over the long-term, both in terms of stock market and accounting performance. The outperformance is stronger in sectors where the customers are individual consumers, companies compete on the basis of brands and reputation and in sectors where companies' products significantly depend upon extracting large amounts of natural resources.”
Additionally, ESG has gone mainstream, with investors now demanding that companies have an ESG focus and employ varying degrees of ESG valuation metrics. Blackrock has made sustainability a priority, cutting investments in some coal producers and increasing the number of sustainability-focused funds that it offers. Recently, Kimmeridge issued a white paper in which they challenged E&P companies to “…Make capital allocation decisions with an understanding of the environmental impact, including: the discontinuation of freshwater use for fracking, zero gas flaring and a commitment to carbon neutrality. Plan to achieve net zero emissions.”
In response to investors and industry trade groups, EOG, Continental Resources, Apache, EQT and WPX Energy, among others, all discussed their renewed focus on ESG performance and initiatives during their Q4 2019 earnings calls last week. Some companies, like Cimarex, have already begun to link executive pay to ESG measures, such as cutting emissions and flaring and responsible water use and disposal. Expect more to follow as boards continue to increase focus on ESG.
How should the industry report on ESG?
Since it’s a relatively new and voluntary practice, there’s diversity in ESG reporting. Chief organizations currently promulgating reporting guidance include the Sustainability Accounting Standards Board (SASB), Global Reporting Initiative (GRI) and the Task Force on Climate-related Financial Disclosures (TCFD). Each of these organizations have a slightly different focus. Notably, the SASB is more focused on the investor stakeholder and has published industry-specific sustainability disclosure topics and accounting metrics for the oil and gas industry.
Additionally, the International Petroleum Industry Environmental Conservation Association (IPIECA), the International Association of Oil and Gas Producers (IOGP) and the American Petroleum Institute (API) jointly developed industry guidance for sustainability reporting. This guidance is linked to GRI guidance.
Currently, information is primarily communicated to investors in an annual report found on the company’s website. Numerous companies publish annual corporate responsibility reports based on the GRI framework (for examples, see Pioneer Natural Resources, Shell, Devon, EQT, Parsley Energy, to name a few). Apache also publishes an annual corporate responsibility report based on the GRI framework, but recently announced they’re aligning this report with SASB and TCFD standards.
Energy industry participants should agree on:
- A framework of meaningful, material ESG information.
- Relevant performance metrics that are cost-effective to track and report.
- A standard presentation and timing of communication of ESG information.
During a time of negative investor sentiment toward the energy industry, taking the lead on ESG issues is a way for companies to differentiate themselves and make headway in restoring investor confidence. It’ll be interesting to see how reporting on ESG continues to evolve throughout 2020 and beyond. No doubt, it’ll no longer be perceived by some as an issue for the “ladies” to write about.