Macroeconomic trends: changing ESG influences in oil and gas

Oil and gas companies will need effective environmental, social and governance (ESG) policies to steer themselves through the existential disruption that the next three or four decades will bring.

The balancing act necessary to meet net-zero objectives while retaining scale requires companies to sustain sufficient cashflows to handle demand volatility, overhaul their asset portfolios, make incisive investments, and please sustainability stakeholders. GlobalData’s analysis into these trends has revealed a number of areas where the function and importance of ESG compliance are changing.

Although net-zero goals have been set and the importance of ESG rises, production growth remains attractive to oil and gas companies. The six supermajors – Shell, Chevron, Shell, BP, Total, and Eni – are investing heavily in new production and infrastructure; they are expected to contribute over four million barrels per day of oil production by 2025.

Overall, despite the decline in production from existing conventional fields, estimated to reach 5% annually by 2025, upcoming developments look set to deliver significant growth in global oil production over the medium term. Investment in short-cycle projects that can deliver returns quickly will intensify in the next few years as companies look to secure cashflows before carbon taxes make such projects infeasible.

Indeed, the demand for hydrocarbons will not vanish in the foreseeable future. The three largest sources of hydrocarbon demand are the transport, power, and industrial sectors. Though electric vehicles will become dominant in transport, current electric engine technology is insufficient for large ships, planes, or rockets. Several technological breakthroughs are necessary before this changes, so oil figures to remain a key component of the global transport industry in the future.

The power sector’s transition must negotiate the reluctance of emerging economies to forego the easy growth fossil fuels offer, the comparative unreliability and weakness of renewable energy, and the remaining attractiveness of fossil fuel products. The industrial sector must negotiate society’s ongoing dependence on plastic products.

National oil companies (NOCs) in particular are insulated from many of the pressures that international oil companies face. NOCs are run by governments, so they are less vulnerable to public social pressure and unlikely to be hindered by legislation. Strategic priorities, performance, and compliance levels are largely dependent on the whims of the national leadership.

In many NOC parent countries, free speech rights are not total, and government dissidence is criminal. Market pressure is the only force that can encourage NOCs to take sustainable action. Sustainability must be profitable, and hydrocarbon demand must decline, neither of which are a guarantee compared to the historically reliable profits of oil and gas.

The most obvious form of legislation in this area is the Paris Agreement, an international treaty on climate change. Its goal is to limit global warming such that temperatures do not exceed 2^oC more than pre-industrial levels. Meeting the goal requires a significant reduction in global greenhouse gases (GHG) emissions, and, consequently, most signee nations have set targets of being net-zero by 2040 or 2050. Governments will take measures to discourage emissions and ensure targets are met, which will harm the economic viability of conventional oil and gas activity.

Carbon pricing will be a key driver in oil and gas activity. Nations, particularly Paris Agreement signees, will seek to meet emissions goals by imposing higher prices. Oil and gas companies should be cautious about the climate ambitions of nations in which they are active and anticipate that rising carbon prices will render continued hydrocarbon activity there unprofitable. Global carbon pricing initiatives will drive companies to decarbonise both their processes and products.

Governments are imposing methods beyond carbon pricing to discourage emissions. For example, some governments are giving grid priority to renewable energy, while others are reducing fossil fuel subsidies. In the US, at a federal level, tax cuts such as the Production Tax Credit and Investment Tax Credit are the main incentives given to encourage investment in renewable energy projects.

Many states have also implemented a renewable portfolio standard programme requiring utilities to purchase between 10% and 20% of their power from renewables using renewable energy certificates.

There is a similar phenomenon in Europe, where the EU’s targets include having at least 32% of energy generated come from renewable sources by 2030 and being net-zero by 2050. Previously, the EU has used feed-in tariffs to make renewables more competitive, but some countries are replacing these with auctions. Renewable energy auctions bring down the cost as developers underbid one another.

Another way in which market forces can undermine the attractiveness of oil and gas is in the renewables industry. Oil and gas companies want to add renewable energy projects to their portfolio, but this competition is driving prices up. Smaller operators do not have the capital to compete with supermajors for projects and consequently, the energy mix of smaller operators is less sustainable, and they will be punished most by the demand transition and impending regulation.

May 2021 saw a sequence of surprising events wherein oil and gas majors were told, both by their own boards and by courts, that their climate change targets were insufficiently ambitious. ExxonMobil shareholders overthrew much of the company’s board and introduced new directors under instructions to aggressively pursue lower emissions, one of the more striking developments in what seems to be a global shift in opinion away from oil and gas.

Elsewhere, Chevron investors defied executives by setting the company’s first emissions target. Having targeted a 20% GHG reduction by 2030, Shell was ordered by a Dutch court to reach a 45% reduction in the same period. The ruling was hailed as a landmark, precedent-setting victory for ESG, and similar rulings are now expected.

The phenomenon of ‘greenwashing’ has also not aided the reputation of many oil and gas companies. This occurs when oil and gas companies make disingenuous shows of environmental concern in an effort to evade public criticism while continuing their profitable but environmentally harmful activity.

While not all offshore companies make such flimsy efforts, greenwashing accusations more broadly are publicity disasters as they suggest not just environmental negligence but dishonesty. Activists are most suspicious of offsetting initiatives, adverts, and top-line executive statements, since none commit companies to operational change, and each tend to generate good press.

Big Tech is also distancing itself from the oil and gas industry. Groups such as Amazon Employees for Climate Justice can put pressure on cloud providers who service the oil and gas industry, and in May 2020, Google pledged to cease building custom artificial intelligence for the industry.