HOUSTON—ESG has transcended being a checked box for oil and gas companies. Now investors are looking for improved disclosure of ESG-related issues supported by quantitative data to garner capital, according to Daniel Romito, director of ESG strategy and integration at Pickering Energy Partners.
“ESG now impacts all access to capital…your insurance, your banking and your equity, is all heavily influenced,” Romito said at the Independent Petroleum Association of America’s Private Capital Conference on Jan. 20. “Now, it’s not the end all be all, but it is heavily influenced by your ESG profile.”
Investors are not only basing their capital allocation decisions on how well executives implement ESG practices into their business, he told conference attendees. They are pushing for qualitative and quantitative ESG metrics to better examine which companies can compete within the transition.
“They want trending data,” he said. “As cynical as it sounds, most investors that were burned by prior experience with energy need a little bit more validation and a little bit more reasoning, and unfortunately, in most cases, ESG data seems to be the source that they’re turning to for that validation.”
The standard for issuing sustainability reports was set by the technology industry and the energy sector, Romito said, lacked the financial performance to compete, making it increasingly difficult to match the attractive returns. As a result, the energy industry became an easy target, he added with the goalpost moving “what seems to be almost monthly, whether it’s a framework or a dataset.”
“The benchmark [for ESG related data] was set by technology and they’ve had an incredible head start in getting this underway,” he said. “But keep in mind, you’re not competing just for energy. You’re competing against the other sectors that have established the narrative, the paradigm and established the expectations of disclosure, and they have done a really good job of establishing what a sustainability report looks like.”
Data providers, aggregators and raters of ESG data have arbitrarily decided that 50%—give or take—but nonetheless, a massive proportion of an energy company’s ESG profile should be dedicated to the E [environmental], Romito said.
“The practical approach centers on progress, showcasing that you are on a journey—and along that journey, you are progressing and improving,” he said. “So, a three-year rolling trend is a very material and incredibly powerful story to tell.”
Romito’s recommendation is for energy companies to be candid in these disclosures about where there is room for improvement because it is “far more important than arbitrarily saying ‘we’re going to be net-zero on this date.’”
Adding to the complexity, Europe’s regulations are directly influencing how these profiles are structured in America. Specifically, Romito noted the EU Sustainable Finance Disclosure Regulation (SFDR), which is a set of rules that aim to make the sustainability profile of funds more comparable and better understood by end-investors.
These rules require firms to make strategic business and policy decisions regarding their approach to ESG, which must be disclosed on the firm’s website and in pre-contractual and periodic disclosures.
In October 2021, the U.S. Department of Treasury’s Financial Stability Oversight Council (FSOC) published a report identifying climate change as an emerging and increasing threat to financial stability, forging the road to sustainability disclosure rules and obligations.
“European regulation has mandated the tracking and monitoring of climate-related, human capital management-related, and governance-related data,” he said. “They want it implemented into debt underwriting.”
In the report, FSOC’s recommendations for member agencies included assess to climate-related financial risks to financial stability. Examples consist of thorough scenario analysis and enhanced climate-related disclosures to give investors and market participants the information they need to make informed decisions.
Most notably, the committee made a recommendation for “enhanced actionable climate-related data to allow better risk measurement by regulators and in the private sector.”
“Climate change is an emerging and increasing threat to America’s financial system that requires action,” Secretary of the Treasury Janet L. Yellen said in the report. “FSOC’s report and recommendations represent an important first step towards making our financial system more resilient to the threat of climate change. These measures will support the Administration’s urgent, whole-of-government effort on climate change and help the financial system support an orderly, economy-wide transition toward the goal of net-zero emissions.”
On the private side, Romito said various limited partners (LP) have been under incredible external pressure to get rid of fossil fuels and therefore aren’t proceeding with raising capital without seeing environmental-related or, at the minimum, trending data from their partners.
“Now, getting rid of fossil fuels is a foolish notion,” he said. “But there is a very influential contingent that has been very successful in making that case. So those who want to get back into energy have to showcase a material set of data that the external audience wants in order to make the move back into whatever energy investment they want.”
Outside of emissions, the areas investors are examining include a company’s biodiversity strategy, health and safety goals, ESG-based compensation for executives and, most importantly, water stewardship.
“Water stewardship is actually shooting up the list of priorities…it’s going to be the next GHG,” he said. “It is a real business concern considering what’s going on in California and Colorado.”
The remedy to attract capital and operate this ESG landscape? Companies should rely on quantifiable data points being sure to eliminate all “fluff.”
“Those superlatives and antidotes don’t necessarily weigh as much as the quantitative data points that the valuators want to see in the first place,” Romito said. “Anecdotal claims should be matched with quantitative data to mitigate even the slightest appearance of greenwashing and progression is more important than targets.”
“Because it’s an unstandardized world,” he continued, “there is almost like a six-month rotation, and some joker in your class will up the game in disclosure. Then, what ends up happening is ‘company XYZ started reporting on this, why don't you report on that?’ The strategy is to be proactive and to try to stay ahead of the competitive curve, so that you’re not perceived to be the laggard in the group.”
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