Energy ESG 2.0: The Evolution of a Megatrend

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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The practice of ESG investing dates back to the 1960s when it was termed “socially responsible investing.” Over the years, transformation of topics such as climate change and social inequity have changed the business environment, driving the evolution of ESG risks and opportunities for organizations.

For the energy sector, which is increasingly under the spotlight of climate change activists, the concept of ESG has evolved from “nice-to-have” to “must-have.” Boards of directors, shareholders and regulators demand to make ESG considerations central to business operations. But now, as the oil and gas companies face the dual challenge of addressing energy shortage and a compelling climate agenda, the discussion around ESG has taken a new turn.

While energy companies have taken meaningful steps toward achieving ESG goals, increasing concerns of energy security have given rise to ESG backlash in recent months, with many complaining of burdensome reporting, compliance costs and growing regulatory scrutiny of corporate or investment fund “greenwashing.”

So, what’s next for the three-letter megatrend?

“ESG will continue to evolve as shareholder and other stakeholder priorities change and as pressure from government agencies and activist shareholders continues to mount,” Travis Wofford, partner at Baker Botts, told Hart Energy.

“ESG will continue to evolve as shareholder and other stakeholder priorities change and as pressure from government agencies and activist shareholders continues to mount.”

—Travis Wofford, Baker Botts

ESG has already succeeded in acquiring the mindshare of boards of directors and management teams at many institutional investors and large public companies, Wofford noted, adding that the U.S. Securities and Exchange Commission’s (SEC) new disclosure rules will give rise to more ESG activism.

“New SEC disclosure rules will increase transparency and scrutiny of business operations and governance and will lower the cost of ESG activists to seek board representation instead of just making shareholder proposals,” Wofford said, adding that ESG activism will continue to “flourish and be well-funded.”

‘Stronger than ever’

While many U.S. oil and gas companies have stated that ESG has taken a backseat amid energy security concerns, Appalachian-focused operator Diversified Energy Co. Plc’s ESG commitment is “stronger than ever,” according to the company CEO Rusty Hutson, Jr.

“Our company was resilient through the pandemic and like so many sectors of the economy, the energy industry is facing supply chain and worker shortages, higher costs to operate and an administration that says it wants to encourage increased production while continuing to pursue policies that have the opposite effect,” Hutson said.

“But that doesn’t mean that our commitment to ESG has fallen to the wayside. In fact, it’s stronger than ever at Diversified, and I think that’s probably the case industry-wide,” he added.

Over the past four years, Diversified Energy has bought about 69,000 used wells, beating Exxon Mobil Corp. to become the largest well owner in the country. Despite the calls to produce more, Hutson noted that his company is incorporating ESG into its business model with heavy investments in emissions management.

“We have a zero-tolerance policy for unintended emissions and this year, we’re investing additional capital to prove it,” Hutson said.

Diversified is spending $15 million over its budget on emission reductions initiatives, including aerial detection, increased asset retirement initiatives and equipment conversions and replacements.

“We have a zero-tolerance policy for unintended emissions and this year, we’re investing additional capital to prove it.”

—Rusty Hutson, Jr., Diversified Energy Co. Plc

Hutson noted how his company’s approach of acquiring non-core producing wells, investing in their production and retiring them “responsibly” checks all the ESG boxes.

“Our approach to acquire non-core—often ignored—producing assets, invest in those assets to modernize them, improve production and enhance environmental performance and then responsibly retire those assets at life’s end touches all key aspects of E, S and G,” Hutson explained.

“Environmentally, we’re producing more energy from a smaller footprint and with fewer emissions. Socially, we’re taking assets, improving production, which means more revenue and royalties and investing in communities. Governance, we’re responsibly operating and retiring assets that, in some situations, may have otherwise become abandoned,” he added.

According to Hutson, ESG reporting, investing and sustainability-linked financing is “absolutely here to stay—and for good reason,” adding that ESG action makes “good business and environmental sense,” because it makes the business stronger and grants access to new pools of capital.

“One thing that the industry is making abundantly clear is that ESG is not a separate aspect of our operating processes but is embedded in how we do business, and that’s especially true for Diversified,” Hutson said.

Understanding the ESG story

Specific to the energy sector, understanding the social purpose of energy companies, which enables virtually all aspects of modern life, is critical to understanding their ESG story, Baker Botts’ Wofford explained.

“The energy industry must better articulate its social value so that policymakers and institutional investors can facilitate and enhance that benefit to the public and not create artificial constraints on energy production and innovation,” Wofford noted.

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For example, recent trends show that ESG-led shifts of capital investment away from hydrocarbons led to unintended social consequences. Undercapitalized energy companies result in reduced hydrocarbon supplies, which in the face of growing demand leads to higher prices, fuel shortages, inflation and other unintended consequences.

“This is why traditional energy is a necessary part of large institutional investors’ portfolios in the current economy,” he noted.

In energy, minimizing risk and negative externalities, whether environmental, safety, social or other factors, while increasing profitable operations to meet demand has been core to “best in class” business operations for decades.

“But recent ESG primacy has led to improved safety records, reduced environmental externalities and better governance practices, among other benefits, all while striving to meet the world’s energy needs,” Wofford said.

‘No green without digital’

Although ESG and technology have had a long relationship, experts say the role of the latter in ESG is relatively underexplored and has an enormous potential in achieving ESG goals, especially as ESG reporting continues to evolve.

“Oil and gas companies are finding themselves on the brink of ‘ESG 2.0’ where the line between purpose and profit is dissolving and companies look to identify the best ESG strategies to promote value creation,” said Nicole Robertson, vice president for sustainability and ESG at Nokia.

“At Nokia, we believe that there is no green without digital, and this is particularly true in the oil and gas industry, where a focused commitment to implementing digital technology across the production stream is essential to reaching ESG goals,” she added.

According to Robertson, this is an “exciting time” in both the technology and the energy industry, with an unprecedented opportunity to collaborate to fulfill global energy needs, while embracing digital transformation occurring across the sector.

“The adoption of ESG and the role of technology within the energy industry is only beginning and must accelerate if companies are to satisfy shareholders, maintain a social license to operate, fulfill questions from the SEC and ensure access to capital markets,” she noted, adding that ESG should remain a “key focus” of every energy company C-suite and board, calling for more investment in new technologies.

“Oil and gas companies are finding themselves on the brink of ‘ESG 2.0’ where the line between purpose and profit is dissolving and companies look to identify the best ESG strategies to promote value creation.”

—Nicole Robertson, Nokia

“The industry must embrace technology enabled Fourth Industrial Revolution, not simply as a test case but considering ESG goals and how technology can promulgate them across the enterprise,” Robertson noted.

She added, “This is particularly true in managing the efficiency, safety and sustainability of own operations but also enhancing supply chain transparency and increasing circular practices and processes—particularly closing the loop on manufacturing supply chains and scope three emissions.”

Additionally, she explained how a long-term commitment to ESG requires the workforce to sustain it, where technology plays a critical role.

“Access to digitally savvy employees will remain incredibly competitive. The industry must upskill existing talent with digital skills and build partnerships with companies like Nokia, who can provide both the solutions, and the knowledge to fully enable ESG and digitalization goals,” she said.