One of the uncomfortable realities that have emerged from the difficulties of the Covid pandemic and energy market constraints – is that a diversified energy mix inclusive of oil and gas production will be necessary to maintain energy access to billions of people. Decarbonisation goals must be aligned with the practicalities to ensure neither factor of the ‘energy trilemma’ – affordability, accessibility and sustainability – are compromised by the pursuit of one aspect over another.

ESG ratings have become an important metric, used by investors, financiers and credit risk agencies to assess the compatibility of an organisation with global climate goals. The Paris Climate Accords have influenced institutional lenders to be more cautious in their approach to high-emissions industries, with oil and gas producers being among the central targets.

As Wood Mackenzie points out, the conditions and requirements of ESG frameworks can often be far more superficial than the ‘sophisticated commercial, market, financial and legal due diligence otherwise used in major transactions’.

By examining the various criteria used to assess and provide ESG ratings to oil and gas companies, the Energy Council we explain the routes to ESG excellence and how these encourage companies to develop more comprehensive decarbonisation measures.

Defining ESG Ratings

ESG ratings are a complex beast, often assessed across 20 or more criteria, each with a specific weighting to the final risk profile. Obviously, each material issue falls under the broad framework of Environmental (E), Social (S) or Governance (G) impacts – and while the environmental may be the most prominent concern, without ensuring transformation in regards to social and governance matters, a business can suffer severe consequences to their financial wellbeing.

One only needs to see Tesla’s removal from the S&P 500 ESG ETF due to suggestions of racism and misogyny in the workplace.

The UN Principles for Responsible Investment (UNPRI) framework outlines four areas which companies should consider when applying ‘best practices’: first, the visibility of ESG factors; second, materiality of ESG factors; third, environmental issues gaining traction; and lastly, communication and transparency.

Global corporates are more sensitive than ever to the potentially crippling effects of sustained negative coverage. The old mantra, “There’s no such thing as bad publicity”, no longer holds up as it once did.

Material impacts are the direct concern for investors, and so when requesting assessments of ESG ratings by credit risk agencies – the intention is to be introspective of a company’s strengths and weaknesses. These assessments do not remove emissions risks, risks from potential market shocks nor the potential for default – however, companies who have taken a considered approach to their exposure will naturally be in a position of strength.

On one hand, material risk is minimised, and on the other, positive ESG ratings will enjoy the attention of conscious capital providers.

Environmental

Part of the ESG rating paradox is the imbalance towards environmental issues, yet even the most outwardly ‘green’ company can suffer from scoring poorly in social and governance matters.

Leading global energy consultancy Wood Mackenzie have simplified their approach to being proactive toward ESG measures: avoid, improve, implement new technology and finally, offset.

Avoiding creating emissions appears to be an obvious solution, but often it is difficult to see the wood from the trees.

For instance, the prohibition on gas flaring has directly led to a drop in emissions, or divesture from high emissions fields. Better yet, avoid many Scope 1 and 2 emissions by powering operations with a renewables baseload.

The next directive, to improve – look for areas where efficiencies can be located to create value within the value chain. Consider what it takes to access those efficiencies, and engage proactively in the process. Often these are found through the introduction of digitalisation or technological advances – which leads to the third step, implement new technologies.

Whether it be a digital twin, EOR, more detailed seismic mapping, or advanced robotics that can undertake assessments and maintenance in unsafe environments – each will positively impact production efficiencies and lower emissions profiles.

Carbon offsets are the final piece of the puzzle. Too often is carbon offsetting presented as the solution to reducing industrial-scale emissions – however, it is just one tool available whose impacts are limited in the greater scheme of things.

Developing a portfolio of natural carbon-sinks or utilising renewables to power operations or by providing rural stakeholder communities with tools to engage in sustainable agriculture and waste management – can all offset emissions profiles.

The ‘Environmental’ undoubtedly occupies the central concern for most investors and financiers, largely as a result of the Paris Climate Accords and successful pressures from activist investor groups. As such, institutional investors and central banks have limited access to their capital to other lenders if they cannot exhibit both a roadmap to radically reduce emissions and material actions of lowering emissions.

Material Issues considered are:

• Emissions, Effluent & Waste
• Carbon Use / Supply Chain
• Land Use & Biodiversity
• Resource Use
• The Environmental and Social Impact of Products and Services

Social

The ‘Social’ framework is possibly the most sensitive to egregious behaviour by the company towards it’s employees, consumers or a broader disregard for the notions of equality and respect of individuals. Such events can create rapid media storms, often presented as the position of senior management, and when reflected in the public eye – the perception of mistreatment can be far more damaging than what actually may have taken place.

There is an easy solution here – develop a robust framework for the equal treatment of employees, avenues for non-payroll stakeholders to be heard and guidelines that ensure respect is shown to all stakeholders. When respect and dignity is not upheld between employees, develop internal mechanisms for recourse.

A well-considered framework that is presented to all employees and stakeholders is the first step to avoiding ‘social’ impacts. This sets in motion the second directive, to improve. A framework must first exist to be tested against, data collected and critiques implemented.

Some ‘social’ considerations can be overlooked due being standard expectations within society: stakeholders have their human rights upheld and respected; a company ensures a safe working environment; or doesn’t engage in criminality. However, in the pursuit of profits, these standards can slip by virtue of an individual’s poor judgement.

The solution is just as simple – to train staff on the consequences unsafe work conditions, abuse of another’s human rights or engaging criminally to secure contracts. A global multinational’s ESG scores has potential to be negatively impacted by one poorly trained person’s actions.

The ‘Social’ is about giving a voice to all stakeholders, especially those of lower economic or social standing. That each stakeholder’s physical and mental well-being is cared for, that each impacted community is being heard, and that all employees are protected from dangerous or prejudicial practices.

Material social issues considered:

• Human Rights
• Access to Basic Services
• Human Capital
• Occupational Health and Safety
• Community Relations

Governance

‘Governance’ is the most understated of the three criteria, and understandably so, as it should be a fundamental aspect of any business regardless. Ensuring that best business practices have been followed and are sustainable, and that the risks to financial security have been mitigated.

Corporate and Product Governance are more ‘normal’ considerations for organisations outside of the ESG paradigm. According to leading ESG rating agency, Sustainalytics, ‘corporate governance' considers six pillars in this regard: Board/Management Quality & Integrity; Board Structure; Ownership & Shareholder Rights; Remuneration; Audit & Financial Reporting; and Stakeholder Governance.

Much of the focus is centered toward the fundamentals of the financials – does the company enjoy sustainable and risk-averse financial practices? If so, what exposures could be assessed as detrimental to a business? Has ESG integration been calculated into the company’s financial outlook? If so, what changes must be made?

If a company has collected the data and made assessments on the financial, social and environmental health of an oil and gas business – from here, one can begin to see the strengths and weaknesses. As decarbonisation is an expensive but necessary endeavour, the financials reveal the capacity for change.

These assessments will also define the roadmap for decarbonisation action – and that in itself is necessary to attract the capital from institutional investors and lenders. With an understanding of ESG impacts, it becomes instantly easier to make even the smallest positive shifts and present clear actions to investors or financiers that attempts are being made to mitigate risk.

Ethical business practices are assumed to be the norm but realistically many will bend the rules to gain an advantage, some may even use bribery and corruption to achieve their goals. While this may be ‘efficient’ in developing economies to gain access and kick-start a project, it exposes one to repetitive requests, criminal prosecutions, blackmail or even ejection from the country if the political mood changes. While the ‘ethical' aspect may shift depending on jurisdiction, train staff to have broader

Material Issues considered:

• Business Ethics
• Product Governance
• Corporate Governance
• Bribery and Corruption
• Data Privacy and Security
• ESG Integration – Financials
• Resilience

Six easy routes to ESG excellence

Each company will have a varied responses to their ESG roadmaps and there is no ‘one-size-fits-all' approach. Yet here are the five most sure-fire routes to engaging with the most prominent material ESG concerns.

• Environmental – avoid emissions
  • Practically, have your emissions measured, audited and aligned to the jurisdiction’s pledges to supranational agreements.
  • Don’t sell yourself short. Those who go above and beyond to mitigate material ESG concerns can present a comprehensive ESG story to investors.
• Environmental – improve efficiencies
  • Technology advances, both analogue and digital have created avenues to access new efficiencies – O&G has always pushed the boundries of what is technologically possible, embrace this culture.
• Social – be bold about equality
  • Assess your D,E&I deficiencies – address them. Be bold about equality and drive inclusivity, from low-wage workers to the boardroom.
• Social – connect with the communities
  • The social licence to operate is granted on the basis that directly local communities benefit economically, environmentally they are not compromised and socially they are included.
• Governance – reflect ESG risk in the financials
  • Present an ESG case to your lenders and investors that reflects a proactive approach to the zeitgeist that reflects transformational shifts to ones operating procedures.
• Governance – Product governance
  • Develop quality, low-emissions products that your consumers can feel comfortable purchasing.