Oil and Gas Sustainability Strategies: ESG Fact and Follies

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The pressure to mitigate climate change pervades discussions about energy today, particularly within the oil and gas realm. Hydrocarbon-producing companies are tasked with either lowering or offsetting carbon emissions within their capabilities. Yet while most agree that lowering emissions is a worthwhile strategy, not all agree with third-party objectives steering the outcomes.

Two panels at recent major industry events tackled these questions on ESG as it relates to capital investments and the industry’s path to Scope 1, 2 and 3 emissions targets. At NAPE in Houston, panelists included: Kaitlyn Allen, president and CEO, Global Affairs Associates LLC; Ale Veltmann, founder and CEO, ESG Lynk; Craig Webster, sustainability advisor and director of ESG and sustainability, Tudor, Pickering, Holt & Co.; Brooke Baum, sustainability advisor, Devon Energy Corp.; and Michael Rubio, general manager, ESG engagement and sustainability, Chevron Corp.

At the Colorado Oil & Gas Association Energy Summit in Denver, panelists included Kristi Pollard, principal, P2 LLC; Alanna Fishman, managing director, strategic communications, FTI Consulting; James Reddinger, former CEO, Stabilis Solutions; and Chris Wright, CEO, Liberty Oilfield Services.

Investors: In or out?

The debate today pivots around whether to include or exclude fossil fuels by investors. Global Affairs’ Allen, who works with many companies across sectors on their ESG strategies, wanted to differentiate between “exclusionary screening” and “ESG integration,” which are virtually opposite investment strategies, she emphasized.

Exclusionary screening is when banks or investors decide to eliminate a particular sector or industry from their portfolios, she noted. “But that is not ESG investing,” Allen said. Instead, ESG investing is when an investor actively includes ESG considerations into portfolio decision-making, and “that does not necessarily mean you exclude oil and gas,” she continued. “The majority of responsible investing nowadays is in ESG integration.”

That’s good news for oil and gas companies attempting to align themselves with ESG-focused investors, but the devil is in the details— no uniform standards exist for reporting. Veltmann, founder and CEO of ESG Lynk, likened the environment to the Wild West.

“There are different frameworks and standards” for ESG reporting, she said. “It’s impossible to have comparability if you have different standards.” And any reporting is voluntary. Therefore, when it comes to the materiality of investment decisions, beauty is in the eye of the beholder. “It’s really the definition of what materiality is, and different groups define it differently.”

In an effort to create some uniformity in ESG definitions, the Sustainability and Accounting Standards Board, a nonprofit organization, has defined industry-specific standards for 77 sectors, including upstream, midstream, downstream and renewables. These definitions, said Veltmann, will put a little bit of structure to ESG to facilitate the analysis for the investors. You have to have a way to normalize it for every company.”

FTI’s Fishman said six years ago ESG conversations centered on why the industry was entertaining conversations around activism and environmentalism. Now, she said, the predominant question is, “How do we get our feet in the door? What do we need to do to build an ESG program?

“Sustainability has gone from being nice to have to being a must-have. There really is no opt-out clause anymore, particularly for this industry.”

Fishman works with companies across all industry verticals and oil and gas companies of different sizes, both public and private. “There is no one size fits all strategy,” she said.

“What Chevron might do is very different from what a private equity-backed oil and gas company is going to do.” But does that mean a smaller company needs to wait or be more cautious about what they do? “That’s a resounding ‘no,’” she said. Having a sustainability strategy adds value, “so why wouldn’t a private or small company do it like the larger public companies?”

And right now is an opportune time for the industry to set the standard on best ESG practices and what that looks like quantitatively.

“We’re quickly moving away from that opportunity, so jump on it,” said Fishman. “ESG has been sitting in the private markets, but it’s quickly making its way to the government. When it gets to the SEC [Securities and Exchange Commission] and the rulemakings in the future, you can say you didn’t need to manage me to do this because we’ve already been doing it. We can prove we’ve been doing it.”

Money shapes behavior

Climate activists targeting money have led to the finance community having their own set of ESG issues and criteria, said Tudor Pickering’s Webster. “Part of it is this idea that if you focus on the money, you can change behavior. And that is what has happened.”

He points to the explosion of oversubscribed “green” bonds that are somehow related to ESG as a “shiny, new thing” for the financial community to sell. “A lot of debt is being issued relating to ESG,” he said, “but the question becomes, ‘Is there any advantage to it?’”

Research shows an uptick in sustainability bonds versus the plain vanilla equivalent, he said. Companies are being rewarded with lower basis points when they agree to meet certain indicators that are climate or diversity related that investors agree to reward. The same thing is happening in the equity markets as well.

But, Webster asked, does that make you a better investment if you have these ESG characteristics? The answer is not linear, but the fact is the investment community is interested in ESG and are rewarding it.

P2’s Pollard said investors are applying ESG factors across various industry sectors, not just oil and gas, and that shareholder value is viewed as more than just a dollar figure today but also as being aligned with ESG standards. “As we continue to see ESG metrics applied alongside traditional metrics, the energy industry must continue to innovate and think proactively about these strategies.”

Lenders are seeing their own ESG pressures as well, said Webster. “There are things they will place restrictions on,” he said. All the biggest banks have some level of not lending toward Arctic drilling or oil sands, for example, and J.P. Morgan is requiring companies in its portfolio to lower their carbon footprints by 2030. “These are real world things happening.”

The “G” in ESG

Publishing an annual report on sustainability is no longer enough, said Fishman. That is “absolutely not what we’re seeing anymore. If that’s where your company is, then you’re already 10 steps behind.”

Investors are now looking to the governance side of ESG—boards of directors and executives leading an internal narrative prioritizing sustainability.

“Board members are being called front and center to address what their companies are doing in ESG.” Executive compensation incentives, nominating corporate governance and audit committees adding a chief sustainability officer to the executive leadership team are now pertinent.

“They are the stewards of the future oil and gas space, so what are they doing to create a governance framework to enable strategic decision-making in the day-to-day operations of the company? The first step is board buy-in and an awareness of what the company should be doing.”

Equally as important is executive leadership: What happens at the top needs to be disseminated down, she said.

“We’re finding that employees in the field have no idea what ESG is, or they don’t know how their jobs tie into it. Leadership has to find a way to disseminate their values down to every last employee so everybody knows how they can contribute meaningfully to your ESG program.”

The companies now shining in their ESG strategies are those that can talk to their investor groups and meaningfully say what their companies are doing, she said. But be careful not to overpromise, she warned, when putting target numbers into the marketplace.

“There is pressure for companies to report anything and everything,” she said, “but the worst thing you can do is have an executive throw out a promise like that and not be able to back it up with what your plans are.” If you have to walk it back because you’ve made no progress and people start asking questions, “you have to have a plan of how you’re reducing your own emissions.”

Likewise, companies have to “dig deep” to make sure any goals they are promising are not an intentional misleading of the public.

“ESG is just too fluffy right now. Anybody can claim something about you, and you have to be able to back it up. Just make sure that you have a process in place so if somebody asks you how you got to that number, you can show it. Prepare your executives to say the right things and don’t make empty promises.”

Practical—not idealistic—solutions

Stabilis’ Reddinger generally agrees that cleaner, greener and being environmentally responsible is better than the status quo but believes that goal needs to be pursued with practical and realistic solutions. “The discussion on sustainability issues has really become one-sided,” he said.

First, sustainability goals must be cost effective.

“You need energy solutions that can actually perform the function they’re meant to perform in a cost-effective way.” If the product produced is not affordable to the user or society over time, it is not a solution, he said. “So finding solutions that are green, but also cost effective, sounds logical, but sometimes it’s excluded from the discussion.”

Second, solutions must be reliable and predictable. As examples, he points to Texas’ extended loss of power during the 2021 winter freeze, ongoing power reliability issues in California and New England’s chronic shortage of gas for heating in the wintertime.

“We’ve got a big issue building in this country where we’re very much pushing the ‘E’ and the environmental sustainability part of this, but we’re forgetting the reliability and predictability part, which most people like when their heat or air conditioning comes on. They like when they can cook dinner when they want to. And so, while it sounds very simple, the message of environmental sustainability needs to be paired up with cost effectiveness and with predictability and reliability.”

Reddinger said companies need to be open to ideas but also avoid plowing capital and resources into investments that, at the end of the day, aren’t going to prove fruitful. “That doesn’t help the company by any means. No one’s going to remember in five years when you burned all your cash on a project that didn’t work. They’re going to remember that you have no more cash.

“It’s your job to keep your company focused on what your mission is and how you’re going to invest through that.”

Devon’s Baum said the ESG impetus hit an inflection point in 2020, and it is “most important” for oil and gas companies to improve environmental and climate-related performance to maintain the social license to operate. “This is a journey we’re all on,” she said, “and there’s no finish line.”

In June, Devon published a suite of environmental performance targets, the largest being a commitment to achieve net-zero greenhouse-gas (GHG) emissions for Scopes 1 and 2 by 2050. It also established interim goals of cutting GHG emissions in half and reducing methane by 65% by 2030 and to eliminate routine flaring.

“We don’t believe this is just climate risk mitigation, but we do believe there’s a lot of opportunity to be had for companies that are willing to spend the time, effort and capital to make real change.”

And while she said the commitment for net-zero emissions demonstrates Devon’s confidence to find ways to produce and deliver oil and gas more responsibly, “we believe our net-zero commitment demonstrates our confidence in the fact that oil and gas will remain for decades.”

Helping investors “get up to speed” and understand that excluding oil and gas “is probably not going to do much for anybody,” but integrating ESG considerations more deeply is good for everyone. “It’s good for the environment, it’s good for business and it’s good for the economy.”

The Scope 3 conundrum

While most oil and gas companies can understand how to tackle Scope 1 and 2 emissions strategies, Scope 3 GHG emissions are more ephemeral.

Chevron’s Rubio said the big question hovering over the industry now is how to account for Scope 3 emissions, or the behavior by end users of hydrocarbon products.

“How do you measure those emissions, and ultimately, who is accountable for reducing those emissions” over the entire value chain? “Because we know that the world, we collectively, have to reduce those emissions over time in order to achieve the Paris Agreement. It can get very complicated, particularly when you talk about sustainability and metrics and targets.”

In addition to various programs to abate Scopes 1 and 2 emissions, Chevron introduced its Portfolio Carbon Intensity metric that represents carbon intensity across the value chain. “We need to do better,” he said. “We need to find a way to lower our carbon intensity. The demands from our customers and shareholders are different now, and we’re not waiting for regulatory groups.”

But Chevron is not apologizing for producing hydrocarbons, he said, as affordable, reliable and cleaner energy is at the heart of all prosperity today.

“The world needs it, period. And what we produce—the density of that energy—is very important to the world’s future prosperity.”

And while industry must move to producing that energy in a more sustainable way, it can’t overlook the need to generate returns for shareholders.

“We have to sustain the cash flow. We have to sustain the dividend. We have to sustain the ability to deliver that return so that if you’re a shareholder, you can rest assured that there’s going to be a long-term value proposition.

“It’s at the core of what we do. We need to get better at telling that story. We need to get better at engaging with all stakeholders so that we can be part of the solution rather than being viewed as part of the problem for which people need to completely put us out of existence.”

Webster finds irony when energy company shareholders demand that they lower Scope 3 emissions.

“What you’re really asking them to do is to produce less oil and gas. Think about this: You’ve got investors in these companies that are voting in favor of not taking advantage of your expertise, your valuable asset base and asking them to reduce what you do in your core business. Why would you do that? Actually executing on your core business is an option and an option that has value.”

The answer is a perception of a broader, systematic risk rather than the value proposition of a specific company, he said, but illustrates the inconsistencies and growing pains that the ESG movement is undergoing.

“It is something that should be raising eyebrows,” he said. “What is the role of the investor, and what are we really trying to do? What are the potential outcomes and unintended consequences of some of these things that are happening?”

ESG is being pushed down from investors to the industry, Webster said, and the industry needs to ask them pointedly, “What are your expectations? What’s a good number for emissions? Where do we need to fit in? Who do we need to be comparable to?

“We can talk about inconsistencies all day, but it is happening, and it’s going to intensify. So try to understand how that’s going to evolve with shareholders, lenders and other stakeholders and hold their feet to the fire on what they really want,” he said.

One of those aforementioned unintended consequences, said Rubio, could be the privatization of oil and gas assets. Investors still covet the low-growth, high-returns, dividend-producing model, but reconciling that desire with sustainability directives can send mixed messages. Thus, selling down oil and gas assets offloads the carbon intensity in the portfolio— with environmental costs.

“They’ll sell a heavy carbon asset to the highest bidder to get it off their books, and then they’ll pat themselves on the back and say, ‘We’ve lowered our carbon intensity Scope 1, 2 and 3.’ But what they’ve done is actually sold it to a private firm that’s still going to produce it because the demand is ramping back up,” said Rubio.

“We’re taking emissions from a public, transparent arena and moving it to privatization. So in a perverse way, net-net, it has a negative impact on our effort to achieve the Paris Agreement.”

Chevron’s perspective is to remain transparent with its fossil fuel assets and work to lower the carbon intensity of the commodity that it’s producing, he said. “We think that is what’s going to be resilient not only in the short term but certainly in the long term as demand continues.”

The carbon tax issue

Allen noted that Scope 3 reduction for companies offloading carbon-based assets is not necessarily a Scope 3 reduction for the world. And that’s where mechanisms like a price on carbon become attractive to companies, some of the larger ones which are advocating for that on Capitol Hill.

“In theory, that would bring a level of efficiency and fairness to this,” she said.

Rubio concurred that the most effective way to deal with emissions is a market-based mechanism such as a carbon price. Chevron was one of the lead negotiators in the cap and trade program in California, “one of the largest market mechanisms in the world today,” he said, “that some would argue is working pretty well. Some might argue it’s not.”

But it is shaping the strategies of companies in that market to reduce emissions. The tax, he said, will drive research and change human behavior.

“Whatever demand looks like, the most effective way to get to Scope 3 emissions is a price on carbon because whether it’s mine, whether it’s yours, whether it’s the plane I took or the car [you took], it’s going to be covered. And that’s the real challenge here.”

True to the core

Neither Chevron nor Devon are abandoning their core businesses to achieve ESG excellence, the representatives said.

Rubio points to oil and gas companies allocating capital into solar, wind and nonhydrocarbon alternatives to reduce Scope 3 emissions, but “that’s not Chevron,” he said.

“If you’re looking for a renewable company, you can take your capital and go invest in a renewable company. If you’re looking for a company that’s going to lower the carbon intensity of important commodities that are being used today and per the scenarios that have come out that are going to be used at least for the next several decades, we are your company, because we’re also going to be producing that resource.”

Chevron is, however, investing in carbon capture, hydrogen and renewable fuels, targeting systems in the overall energy system that can’t be electrified today.

“You can’t fly a plane today with solar panels, but we can produce biofuels and sustainable aviation fuels that lower carbon emissions. I think we need all strategies because the challenge we have from the ambition to the reality is significant.”

For Devon, while reducing the carbon intensity of its operations is now a central tenant to its operating model, “we’re not abandoning our core business commitment,” said Baum. “We are focusing on assets that we own and operate where we believe we can most directly and meaningfully impact change over the near and medium term.”

Pushing forward

Reddinger said society is “missing the mark” if the goal is to eliminate all fossil fuels at the expense of economies, human condition and quality of life.

“We need to figure out what we’re trying to get to,” he said. “You can’t just have one target that lets people suffer the consequences; you’re not helping people by doing that. We need to have goals and objectives that are actually measured quantitatively and evaluated objectively, so we know where we’re going and can help companies get there.”

“We don’t have all the answers today,” acknowledged Webster. “It’s only going to be through engagement and sharing of good ideas that we’re going to collectively come together to solve these challenges.”