Interest groups are applying pressure to investors and urging boycotts and divestment of companies in the fossil fuel business. They are warning other businesses, from marketing to insurance, to engage with this industry only at their peril. At the same time, the popularity among investors of companies that have been awarded high marks for their commitment to environmental sustainability, social justice and woke governance (ESG) is leading to initiatives that are disconnected from core corporate mission. Energy companies, caught in a reputational bind, may well be raising hopes of a verdant world beyond what is practical today—and setting themselves up for an eventual crash with calamity that in court investors will call a “liar’s discount.”
Energy companies that chase ESG scores in an effort to ameliorate these pressures often misunderstand reputational risk and the peril they face through their aspirational statements and actions. They are expanding their base of stakeholders and often raising expectations without the operational or governance systems in place to ensure those expectations will be met. That is the definition of reputational risk.
We need not look any further for examples than BP Plc, whose declaration more than a decade ago that it was “Beyond Petroleum” was followed by the Deepwater Horizon disaster—one of the worst man-made disasters and one of the biggest corporate reputational crises in a generation. Now, BP—apparently hoping to become more attractive among environmentalists and investors in ESG funds—is promising to be carbon neutral by 2050. As part of its efforts to date, it has become one of the biggest buyers of forest carbon offset credits and has acquired a company that helps landowners sell their forests as carbon sinks.
One might wonder whether forests were doing their part to reduce atmospheric carbon before BP acquired them, and question how an accounting formula giving BP green credits for the forests’ ongoing efforts improves the planet. But one need not question whether BP’s aspirations and actions are noble and well-intentioned to recognize the magnitude of reputational risks they pose. The board and leadership of the company need to be asking some detailed questions:
- Do we have a governance (the G in ESG) and operational plan in place that ensures these ESG goals are incorporated in everything we do—and that the board can oversee it?
- Do we have an enterprise risk management process in place that can gather intelligence throughout the organization, department by department, country by country, on who the company’s stakeholders are, what they expect and whether there is a plan in place for meeting or changing those expectations—and mitigating the damage if not?
- Are we risking disappointing financial stakeholders who are focused on our core business in an effort to satisfy social and political stakeholders whose expectations we may never be able to satisfy?
Compare BP’s statements and actions to those of Exxon Mobil Corp., whose pledges have been more modest and measured—cutting emissions from its oil and gas production 15%-20%, all under their control, by 2025 and ending routine flaring of methane from its oil-and-gas operations by the end of 2030. The company seems to be taking an approach that focuses on its central mission while promising what it can reasonably hope to accomplish on the environment front. Perhaps they are bearing in mind the old adage that it is better to under promise and over deliver.
Striving for environmental purity may be noble, but it can be materially damaging when companies and their leadership set lofty goals they cannot attain. These reputational issues are playing out in both courts of public opinion and courts of law, where derivative lawsuits naming board members and citing reputational issues are now being upheld. In fact, federal securities lawsuit filings alleging reputation harm are up 60% over last year in the third year of a rising trend.
Why the rise in reputation-related legal cases now?
The Caremark decision that guides this type of litigation has made oversight of mission-critical corporate operations a test of the duty of loyalty, and In Re Signet has made ESG-like pronouncements—once considered to be immaterial puffery—potentially material in the securities arena.
For example, directors’ duty of loyalty was successfully questioned in alleged failures of innovation (In Re Clovis Oncology Inc., board failure to protect the firm’s reputation for pharmacologic innovation); safety (Marchand v. Blue Bell Creameries, board failure to protect the company’s reputation for food safety); and environmental sustainability (Inter-Marketing Group USA Inc. v. Armstrong, board failure to protect the firm’s reputation for oil pipeline-related environmental protection).
When companies and their leaders fail to meet expectations, disappointed and angry stakeholders respond in material ways: impaired cash flows, increased cost of capital, and diminished stock price. Also potentially damaging are regulators and politicians, who are not even waiting for a headliner crisis. Senator Elizabeth Warren made the cost of failure clear earlier this year when evaluating the Business Roundtable pledge to consider the environment a stakeholder of equal standing to actual shareholders, referring to it as “an empty publicity stunt.”
And yet, ESG is here to stay. According to data from FactSet, this year investors doubled the size of the ESG sector, putting a record $27.4 billion into ETFs traded in U.S. markets. And a new report by the European Fund and Asset Management Association (EFAMA) analyzed the ESG investment market across Europe and found that as much as 45% of total assets under management in Europe at the end of 2019 were invested in some sort of ESG selection strategy.
ESG one-upmanship has become a financially and legally precarious sport placing board members and executives in personal reputational peril—unless they are making pledges they are confident they can both afford and execute. There is only one way for companies and their boards to have that confidence. They need their risk management process to resemble a central intelligence unit, with board level oversight to oversee enterprise reputation risk management, exposure intelligence, costs of loss, and costs of mitigation. And they should transfer or finance risk using the currently available broad range of conventional and parametric insurance products—and insurance captives.
Enterprise Risk Management (ERM) in the era of ESG requires more than inward looking operational risk controls and outward looking crisis communication. It requires a stakeholder-centered process. Executed properly, it will deliver the ESG mission, reassure stakeholders and give marketers, investment relations and government relations professionals, and counsel an authentic story to tell about strong corporate governance. ERM focused on reputational intelligence will provide confidence to ESG funds, institutional investors, bond raters and government officials alike.
About the Authors:
Nir Kossovsky is CEO of Steel City Re, a firm whose reputation risk management and insurance solutions enable companies to maximize owners’ value and leadership’s equanimity by mitigating perils of behavioral economic losses.
Denise Williamee is Steel City Re’s vice president of corporate services, where she heads client relations and education for integrated reputation groups.
As the hydrocarbon industries face intensifying pressure from stakeholders to emit less, nine oil and gas leaders share their viewpoints on how the industry should deal with expectations versus reality and why that might cut across the grain.
Hanwha Solutions leads financing round, with participation from other leading strategic energy investors.
Oil and Gas Investor Executive Editor-at-large Leslie Haines explores how the recent small oil spill offshore California raises huge concerns.