What is ESG?
ESG is a buzzword that is quickly rising in prominence in the current environment of economic, climate change and social justice awareness. Information on companies’ ESG will encompass primarily environmental, social and governance concerns. In relation to the Oil & Gas industry, environmental issues may be at the forefront: energy efficiency, greenhouse gas or carbon emissions, pollution mitigation, waste management, sustainability etc. As regards the social aspect of ESG, companies that employ low-cost labour in another country may come under scrutiny for compliance with workplace health and safety standards, human rights laws, diversity, and wages and benefits issues. Finally, corporate governance is concerned with encouraging companies to structure themselves in a way that fosters higher accountability at the top and oversight of operations on the ground, especially regarding the environmental and social commitments of Oil & Gas firms.
Mandatory Reporting Requirements
There are three major sources of mandatory reporting for listed companies that should be highlighted.
Companies Act 2006
Companies must include in their annual Directors’ Report considerations of ESG issues, and explanations of measures taken by the company to tackle them. Section 172 of the Act writes that directors of companies have a fiduciary duty to promote a company’s success and exercise care, skill and diligence in doing so, therefore must not take action that would damage the financial success of a company. Where failure to comply with ESG standards may post a material risk to a company’s value to shareholders, directors must consider ESG factors in making decisions.
Streamlined Energy and Carbon Reporting Framework
Under this framework, companies’ annual Directors’ Report must also include information on their global total energy use and any actions undertaken to improve energy efficiency. These numbers will foreseeably affect the reputation and ratings of Oil & Gas firms.
Energy Savings Opportunity Scheme
Large UK companies must carry out energy saving assessments every 4 years. This will consider total energy consumption, audits, and identification of where more savings could be made. The UK Environment Agency will review such reports.
There are two types of regulatory compliance that would be expected from Oil & Gas companies. On one hand, there are statutory requirements for licensing as embodied in the Energy Act 2013, which sets UK-wide decarbonisation targets that aim to wind down reliance on fossil fuels, and the Petroleum Offshore Petroleum Production and Pipelines (Assessment of Environmental Effects) (Amendment) Regulations 2007, which lays out necessary Environmental Impact Assessments to be undertaken prior to drilling and construction of production facilities.
On the other hand, there are more specific industry standards concerning, inter alia, tradable permits for emissions, offsetting carbon footprint, and obligations or liabilities for leakages and waste disposal, which Oil & Gas firms must naturally account for to avoid fines and suspensions.
Oil rigs, extraction of liquefied natural gases, and the transportation of these highly volatile fuels by pipeline can be dangerous—as such, there is an abundance of health and safety legislation that companies must abide by. The primary piece of statute is the Health & Safety at Work Act 1974, which imposes criminal liability on companies as well as individuals if breached. More specific legislation for the Oil & Gas industry are instead strict liability or civil liability regimes: Offshore Installations (Offshore Safety Directive) (Safety Case etc) Regulations 2015 and the Control of Major Accident Hazards Regulations as examples. There are also regulatory bodies such as the Health and Safety Executive which provide Codes of Practice and guidance documents. Aside from health and safety, there are also more and more anti-discrimination laws and welfare benefits regimes to keep up with.
Oil and related commodities are often associated with corruptive, non-transparent and oligopolistic practices. Companies must ensure compliance with the Corporate Governance Code and statutory instruments such as the UK Bribery Act, as well as competition laws in general.
Impact of ESG
The most prominent impact of greater focus on ESG and the rise of mandatory reporting about ESG considerations is on the investment climate. New regulations, such as disclosure of high emission fossil fuel investments, have come into play for investors and fund managers, requiring them to reassess portfolios in line with ESG objectives. Hence, Oil & Gas companies are particularly at risk of being dropped, alongside the recent fall in oil prices and COVID-19 crisis that threaten the value of their equity. Mass restructuring and lay-offs in the face of the pandemic have further painted the industry in a negative light with regards to the social aspect of ESG, while the industry is already volatile due to the widely-recognised environmental impacts of pollution, drilling, spillage, and production and usage of fossil fuels more generally.
Compliance with ESG standards and reporting is therefore necessary to provide information that investors will use to make decisions. Recent times have seen the rise of ESG-focussed funds, which invest only in companies with adaptive ESG policies. This is both for public relations as it is for business development reasons: Oil & Gas producers are among the most exposed players during the gradual transition away from carbon-based fuels to renewable energies, which is forecasted to put long-term pressure on oil prices. As such, only those companies in the industry that can show responsible operations will thrive in the future by adapting to stringent government policies and regulations: Shell, for example, reports annually on sustainability and other ESG topics. ESG investments amass over $30 trillion globally and Deutsche Bank estimates this will double in the next 3 years.
Various indices will also assess Oil & Gas companies and affect investor decisions. These include the FTSE4Good Index which has criteria on governance, climate change, labour standards and human rights; the Dow Jones Sustainability Index; the Carbon Disclosure Project; the Standard & Poor ratings among others. An example of the possibly disastrous effects of neglecting ESG is when a €13 billion Danish pension fund removed 100 oil and coal companies from its portfolio over the past 3 years, retaining only holdings in BP and Royal Dutch Shell, which invest in renewable energy technologies. Another Scandinavian pension fund plans to sell shares worth €75 million in oil firms including Shell.
Looking forward, Oil & Gas companies must account for ESG in their objectives, in particular focussing on staying at the forefront of the transition to cleaner renewables. They must also make sure to comply with regulations and mandatory disclosure requirements that are on the rise in UK legislation. Failure to undertake new initiatives or do the bare minimum as mandated in law will cost companies valuable investment as funds and corporate stakeholders commit themselves to ESG principles and pivot away from fossil fuels towards sustainable alternatives.