From Oil and Gas Investor Editor-in-Chief: The ESG Ultimatum

Presented by:

[Editor's note: A version of this story appears in the January 2021 issue of Oil and Gas Investor magazine. Subscribe to the magazine here.]

In December, the New York State Common Retirement Fund, the third largest state pension fund in the U.S. with $226 billion invested, announced a goal to transition its portfolio to net-zero greenhouse gas emissions by 2040. A plan to assess energy sector companies in its portfolio against a set of undefined minimum standards for “climate-related investment risk” is already underway, with the Canadian oil sanders first in line.

New York State Comptroller Thomas P. Di-Napoli, who controls the fund, said the decision puts the Empire State pensioners “at the leading edge of investors addressing climate risk, because investing for the low-carbon future is essential to protect the fund’s long-term value.

“We continue to assess energy sector companies in our portfolio for their future ability to provide investment returns in light of the global consensus on climate change,” he said. “Those that fail to meet our minimum standards may be removed from our portfolio. Divestment is a last resort.”

The announcement didn’t say the fund would outright divest from or no longer invest in hydrocarbon equities, as many from the fossil fuel divestment movement would like, but it very well could, depending on those minimum standards. It is, however, the latest in a growing list of big institutional funds globally and domestically to either denounce hydrocarbon investments altogether or scrutinize them against more rigorous environmental, social and governance (ESG) standards.

The New York decision to question fossil fuel investments is no longer an outlier.

A year ago the conversation around the need for oil and gas companies to incorporate ESG principles into their business strategies was postulated as a good idea but not necessarily an immediate directive. A year later, it is a fast-growing and forceful mandate.

Why does it matter? Because more and more of the capital providers that oil and gas companies rely on are either pulling away from fossil fuel investments entirely or making their participation conditional. The Forum for Sustainable and Responsible Investment in November released a report showing that at the beginning of 2020 some $17 trillion in U.S. domiciled assets under management apply ESG criteria to their investing decisions. That’s a 42% increase from 2018, and it represents 33% of all U.S. funds under management.

Why does it matter? Because enough of society wants reduced atmospheric carbons and are electing officials to effect these changes with regulations. The industry cannot take its social license to operate for granted, assuming the societal need for its product predisposes its ability to produce it. That license to operate is dangerously close to being revoked, as society is willing to risk the costs and consequences of powering the economy without oil, gas or coal.

“Bottom line, ESG considerations are real and—regardless of what you think of the motivation behind investor demands or requirements for ESG metrics in their investments—those demands and requirements are here to stay,” said Hillary Holmes, partner and co-chair of the global capital markets practice for law firm Gibson Dunn & Crutcher LLP speaking on a virtual panel at the Rice Energy Finance Summit in November.

“The need for energy companies to access capital in such a tight investing environment means that completely ignoring the ESG focus by capital sources could be unwise for the individual corporations long term and, frankly, could hamper the industry’s recovery as a whole.”

Investment bank Cowen last month released its “Themes 2021” report with “ESG & Energy Transition” as one. Socially conscious investing, it said, was well underway pre-COVID-19, but it has gained momentum as institutional investors are shifting their portfolios away from carbon-intensive assets and toward renewables.

At Cowen’s Virtual Energy Conference in December, however, Marianne Kah, adjunct senior research scholar at the Center on Global Energy Policy at Columbia University, said she recently participated in a discussion with investors on perceived value from companies’ decarbonization strategies. Quoted in a Cowen research note, she noted that investors do not view oil and gas as “uninvestable,” though “we’re starting to see a differentiation between the good and bad players.”

Oil and Gas Investor recognizes ESG as a sea change that is shaking how the industry operates its businesses. Our cover story this month addresses “ESG and the Independent E&P,” showing why and how producers are responding to the call to reduce emissions. Through the upcoming months we will also explore the social and governance aspects of ESG, and the capital perspectives as well.

The industry urgently adapted and responded to the double black swan events of 2020—the COVID-19-induced global demand destruction and the OPEC+-driven supply glut, but it must also mobilize as fervently to the third black swan of 2020, the ESG directive. Oil and gas producers are already in a transition in which they are retooling business models to generate investor returns over sheer growth. So too must they incorporate ESG into that model.

It could be just as critical to an oil and gas company’s survival.