Improving ESG to stay relevant in the changing investor environment
Could ESG be the panacea for an oil and gas industry that is being buffeted by the globe’s burgeoning environmental awareness?
The 2020 EY Climate Change and Sustainability Services Institutional Investor Survey reveals that companies can no longer afford to pay lip service to their ESG practices, with 98 per cent of investors surveyed stating that non-financial performance or ESG performance played a pivotal role in their investment decisions.
Of those, 72 per cent conducted a structured, methodical evaluation of non-financial disclosure, up from 32 per cent in 2018.
The weight of reputational concerns, perceived market pressures and the growing number of investors focused on environmental and climate change threats post COVID-19 is forcing the hand of companies that have been slow to adopt ESG practices.
To meet the expectations of investors, companies need to build a strong connection between financial and non-financial performance.
“We have got to get away from thinking of ESG as being a non-financial factor; they are financial factors and absolutely have the potential to affect the long-term performance of the companies and assets we invest in,” Aware Super Head of Responsible Investments Liza McDonald said as part of a recent EY institutional investor survey webcast. “They are a financial risk to their business.”
The survey encouraged companies to build a robust approach to analysing the risks and opportunities from climate change and instil discipline into non-financial reporting processes and controls to build confidence and trust. Ultimately, companies that ignore the expectations of investors could see their risk profiles increase, potentially impacting their ability to access capital.
ANZ Banking Group Head of Sustainable Finance Katharine Tapley said the fact that capital was mobilising around sustainable finance such as green bonds, social bonds, green loans and sustainability linked loans was a testament to the marked shift in how investors were weighing climate risk.
“Sustainability strategy needs to lead the finance strategy, not the other way round,” she said.
Falling oil prices resulting from lower demand, tightening margins and poor returns on investment has seen market capitalisation of the top-listed oil and gas companies decline by nearly 50 per cent in the past two years, according to the IEA World Energy Investment Report 2020.
In contrast, the report showed renewables shares over the past decade offered higher total returns relative to fossil fuels, with lower annualised volatility.
From January to April this year, renewable power companies held up better than fossil fuel companies during a period of severe stress and volatility.
The situation has been exacerbated by investors and consumers turning their focus to newer, cleaner energy sources.
However, there are indications that businesses in the oil and gas sector can change the investment picture in the short term if they address deficiencies in their ESG strategy.
ESG represents an opportunity for oil and gas companies to retain relevance and improve environmental credentials by integrating sustainability considerations into long-term strategy planning and transparent discussions with investors.
Ms Tapley said ANZ was talking to its customers about climate risk, how are they measuring it, and whether they had a mitigation strategy in place.
“We are finding that customers are wanting to exchange ideas, and how to identify these physical and transitional risks,” she said.
The EY survey showed that investors are embracing Task Force on Climate-related Financial Disclosures recommendations as part of their investment evaluation. The TCFD recommendations provide companies with a comprehensive framework to report the impact of climate risks and opportunities systematically, making it easier for investors to analyse a company’s potential financial impact due to climate change.
Ultimately the oil and gas sector has a key role to play in the clean energy transition. Possible opportunities include public-private partnerships to increase the scale and pace of investment in lower-carbon infrastructure, such as carbon capture and storage, hydrogen, EV charging networks, battery charging technologies, biofuels and storage technology.