An in-depth report on the state of ESG initiatives in oil and gas. This Energy ESG special report produces a clear picture of ESG today.


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ESG metrics have become a major priority for the oil and gas industry. It is shaping how investments are being made, and this trend is expected to continue.

At the same time, though, especially in the wake of the war with Ukraine, concerns over energy security are also in the spotlight, and the industry will need to strike a balance between meeting rising demand—against the backdrop of a transformation in global oil and gas trade flows—and maintaining its focus on decarbonization efforts and the energy transition.

There is also significantly more clarity needed on ESG and how ESG metrics are measured and reported. Efforts to standardize ESG reporting are underway and are expected to make it easier for investors to assess industry performance. While this is being worked out, there are already steps oil and gas companies can take to attract more investment in the era of ESG.

Under pressure

ESG has affected the oil and gas industry’s access to capital like never before. Other significant developments of recent years, including the COVID-19 pandemic and, most recently, the war in Ukraine have not changed this, though they have complicated the dynamics at play.

“ESG investment strategies have developed beyond the traditional negative screening, where certain activities or sectors are broadly excluded due to their environmental, social or governance characteristics,” Nneka Chike-Obi, Sustainable Fitch’s head of APAC ESG research, told Hart Energy. “Currently we see a larger number of asset managers choosing engagement as an ESG strategy—that is using annual meetings with portfolio companies to press them on their ESG performance and identify the most important areas for improvement,” she continued.

Hart Energy August 2022 - ESG Capital - The Future of Oil and Gas Investing - Sustainable Fitch Nneka Chike-Obi headshot“A number of surveys of institutional investors show that other than climate, social and governance factors rank as the top ESG concerns.”—Nneka Chike-Obi, Sustainable Fitch

According to Chike-Obi, although oil and gas companies are no doubt affected by this, the pressures are more likely to be focused on strategy and operations first, before those companies face a significant drop in investment capital.

However, accurately assessing a company’s ESG performance remains a challenge, given that the push to standardize the metrics is still ongoing.

“There are some major challenges regarding identifying which exact stocks within upstream are better on ESG,” Alisa Lukash, Rystad Energy’s head of ESG analysis, told Hart Energy. “Data standardization and reporting transparency are the major challenges for GHG [greenhouse gases], water management and spills reporting,” she continued. “But in general, it is expected that institutional investors will continue to focus on balancing the portfolios toward sustainable businesses. And the regulations will bridge the data challenge.”

There are various types of investors that have emerged, including ESG funds, providers of sustainability-linked bonds and loans, and institutional investors that require their portfolio companies to perform at a certain standard. Lukash noted, however, that there are also other investors that are not bound to follow specific ESG metrics and are “strongly supporting upcycle” in the U.S. shale industry. Thus, operators are not necessarily required to perform well on ESG in order to attract investment yet, but this increasingly appears to be changing.

Leading the way

There are also regional variations in the evolution of ESG investment and reporting, with Europe leading the way, while the U.S. is seen by some as lagging.

“Europe has driven the initial demand, without regard for the cost of, or sustainability in, the pace of such investments,” Josh Sherman, Opportune partner in charge of complex financial reporting, told Hart Energy. “I believe there is a floor to ESG demand in that a portion of the investing public will always push for an end to fossil fuels, regardless of the consequences.” He noted that other investors, however, viewed too rapid of a transition from fossil fuels as a detriment to society, especially in developing countries.

“The world needs energy addition [all forms], not subtraction,” Sherman said. “E&P operators understand and have accepted the responsibility of reducing their carbon footprint.”

Hart Energy August 2022 - ESG Capital - The Future of Oil and Gas Investing - Rystad Energy Alisa Lukash headshot“Data standardization and reporting transparency are the major challenges for GHG, water management and spills reporting.”—Alisa Lukash, Rystad Energy

European ESG investment trends can have an impact beyond that region, though, including in the U.S.

“The EU’s SFDR [Sustainable Finance Disclosure Regulation] and the EBA’s [European Banking Authority] green asset ratio pilot program mean that financial institutions in Europe have more pressure to increase the volume of green investments and the quality of reporting and disclosures on investment products,” said Chike-Obi. “Given the global nature of the largest institutional investors, this is likely to have an impact beyond the EU’s borders.”

The additional pressure in Europe to step up green investments has translated into some of the largest European-based oil and gas companies adopting more ambitious decarbonization goals over the past few years.

“This pressure from investors is certainly a factor in why European majors have been the first movers in terms of setting net-zero targets for their Scope 1 and 2 emissions,” William Attwell, Sustainable Fitch’s associate director, told Hart Energy. “Several have also gone beyond their U.S. counterparts in also setting targets for Scope 3 emissions, which includes ‘use of sold products,’ and accounts for the largest share of oil and gas companies’ carbon footprints, although methodological challenges persist,” he said.

Pressure on U.S.-based companies to also adopt Scope 3 targets is expected to grow, however, despite the challenges relating to establishing clear methodologies for measuring these emissions. Indeed, the U.S. Securities and Exchange Commission (SEC) is proposing that publicly listed companies disclose their Scope 3 emissions in cases where they are considered “material” or if the company in question has already set a decarbonization target that includes Scope 3. A final rule is expected to be introduced in December, but the proposal has received pushback from those concerned about how workable it would be.

“Many U.S. operators do think that it is impossible to report Scope 3 as suggested by the SEC as it is extremely difficult to have the same methodology of [calculation] across the industry, so the methodology framework should be set in place first,” said Lukash. She also sees differences in how European and U.S. supermajors are approaching their energy transition targets.

“One strong trend is that in Europe supermajors are targeting diversification (into renewables, hydrogen etc.) and decarbonization as energy transition strategy while in the U.S., it’s predominantly decarbonization,” she said.

Social and governance

While the environmental aspect of ESG targets has overwhelmingly come to dominate discussions around ESG, the social and governance elements should not be discounted. For E&P companies that view sustainability as a whole as a core value, the social and governance elements become particularly important, and it is possible that they will be viewed more favorably by investors as a result.

“Environmental concerns will continue to take center stage because it’s getting the most media attention,” said Sherman. “Ultimately, ESG is about sustainability in total, not just the environment. Sustainability is the combined efficient and economic development of natural resources [environment], advancement of employees and investors [social] and protection of a company’s business model and underlying economics [governance].”

Hart Energy August 2022 - ESG Capital - The Future of Oil and Gas Investing - Opportune Josh Sherman headshot“I believe there is a floor to ESG demand in that a portion of the investing public will always push for an end to fossil fuels, regardless of the consequences.”—Josh Sherman, Opportune LLP

Sherman noted that Laredo Petroleum Inc. and Encino Energy, among numerous other E&P firms, reference sustainability as a core value on their websites.

“They’re thinking more broadly than just the environmental aspects and, as a result, are returning capital to their investors,” he said.

Rystad and Sustainable Fitch both also see investors taking an interest in ESG metrics beyond the environmental.

“Governance is actually the most important aspect of ESG as it actually sets sustainability and social impact targets, which are linked to compensations for board and management, so that drives the overall sustainability strategy,” said Lukash. She added that she believed social investments and safety/diversity were also “extremely important” and frequently asked about by investors.

Chike-Obi, for her part, sees the top ESG concerns as spread across the three elements.

“A number of surveys of institutional investors show that other than climate, social and governance factors rank as the top ESG concerns,” she said. “These include gender and diversity, worker health and safety and board independence. In a recent set of analytical reports, Fitch has found that a number of social issues are credit-relevant for companies in the extractive sector, for example.”

Global shake-up

The evolution of ESG investing continues to play out despite the impact of Russia’s war in Ukraine, which shook up energy markets and trade routes, pushed commodity prices to multiyear highs and brought the question of energy security sharply into focus. But while the war has improved the prospects for oil and gas in the short-term as Europe scrambles to replace Russian energy imports, it does not appear to have affected long-term decarbonization targets. Indeed, it even makes development of domestic renewables and cleaner sources of energy more attractive to countries seeking to bolster their energy security.

“The war in Ukraine has reminded the world about the importance of energy security,” said Sherman. “The expansion of renewable energy sources is great, but the world remains dependent on reliable, affordable and accessible fossil fuels. Again, sustainability is more than the environment and we need all forms of energy. Investors will come back to responsibly sourced oil and gas producers with the discipline to grow their asset base while distributing free cash flow.”

In the short term, oil and gas companies, especially those that have not yet diversified away from their upstream operations, are benefiting from higher commodity prices and an increased appetite for fossil fuels.

“Many fear underinvestment in oil and gas. This gives strength to some of the operators who initially didn’t choose to diversify out of upstream,” said Lukash, citing Exxon Mobil Corp. as an example. Against the backdrop of the war in Ukraine, she currently sees a less negative response from investors and media to increased upstream investments.

Recent quarterly results also illustrate how oil and gas companies are benefiting from current price trends and geopolitical developments.

“The supply-side tightening that has accompanied the war in Ukraine has been a key driver supporting the elevated profitability of oil and gas companies, with several majors reporting record profits in recent months,” said Attwell. “Although demand-side pressures may soften on the back of weak economic growth and recession fears on some markets, supply challenges should keep prices at historically high levels.”

However, Attwell also sees potential for an acceleration of the energy transition on both sides of the Atlantic over the long-term thanks to the war.

“The war has also focused attention on energy security, which could accelerate the transition to renewables, as demonstrated in the European Commission’s REPowerEU plan, which proposes increasing the renewables target from 40% to 45% of the EU’s energy consumption by 2030,” he said.

This is playing out at the country level too, with Attwell noting that Germany had also approved a proposal to raise its country-level renewables target.

“This, alongside progress on the draft climate bill in the U.S., could further incentivize and bolster interest in clean energy projects by ESG-focused investors in the coming years,” he said.

Next steps

It will take some time yet for ESG reporting to become more standardized, especially given some of the challenges involved in measuring Scope 3 emissions, for example. In the meantime, there are steps oil and gas companies can take to make themselves more attractive to ESG-focused investors.

“Increasing attention is also likely to be paid to companies’ Scope 3 emissions, notably how they are defined and calculated, and to the credibility of companies’ transition plans.”—William Attwell, Sustainable Fitch

“Some companies have spun off fossil fuel divisions as separate entities to attract investment into the less carbon-intensive areas of the business and allow the fossil fuel standalone to then raise capital at whatever cost the market sets for them,” said Chike-Obi. “They can also improve the non-emissions parts of their business. In most ESG ratings, such as Sustainable Fitch’s, environmental impact and policies are only a portion of the overall assessment,” she added.

Chike-Obi noted that oil and gas as a sector has high exposure to certain social risks, such as indigenous and community rights in proximity to pipelines.

“These are areas that companies can show progress in even if their core activities are highly emitting,” she said.

Attwell, meanwhile, anticipates that certain types of targets, including for emissions and interim targets on the path to net zero, could increasingly find themselves in the spotlight.

“ESG-focused asset managers and owners face rising scrutiny as the market becomes more sophisticated, and more jurisdictions roll out and enhance their disclosure requirements for sustainable investments,” he said. “They are therefore likely to value further detail and clarity on oil and gas companies’ progress on meeting their Scope 1 and 2 emissions reductions targets, particularly given how several majors have set interim targets,” he added. In most cases, these interim targets are for 2025 or 2030.

“Increasing attention is also likely to be paid to companies’ Scope 3 emissions, notably how they are defined and calculated, and to the credibility of companies’ transition plans,” Attwell said.

Rystad’s Lukash identified a variety of different actions oil and gas companies could take to continue attracting investment, starting with having a detailed sustainability strategy and energy transition plan that secures long-term cash flows. On top of this, Lukash views higher transparency on ESG reporting and initiatives to help standardize reporting as factors that can be viewed favorably by investors. In terms of decarbonization measures, she suggested steps such as investing in carbon capture and storage and clean forms of hydrogen as well as electrifying operations in order to lower emissions.

Finally, she suggested that oil and gas companies cooperate with third-party data providers to help identify areas of weakness and ways to improve their ESG rankings.

For Sherman, a focus on returns takes priority.

“It starts with oil and gas companies returning capital to their investors,” he said. “Returns are happening through improved governance by management teams, their boards and capital providers. The luster of other industries will fade as the broader market pulls back into a likely recession. It may be a longer cycle, but investors will return to E&Ps and midstream if the industry remains disciplined,” he added.

Sherman believes that this is the very early stage of a longer cycle of ESG investing.

“Like many cycles, there are ups and downs. I believe we’re at the peak of a current cycle, where only a handful of ESG investments [as a percentage of total such investments] are economic without government subsidies. Many ESG investments may languish until broader demand expands or consolidation occurs,” he said. And he does expect this to play out over time.

“ESG investments will continue to grow across every sector of the energy industry and are helping usher in a very exciting evolution of responsibly sourced fossil fuel development and emissions management,” Sherman said.