This amorphous term ESG encompasses a wide spectrum of information and considerations but is so often assumed to mean something it does not. To paint a better picture of what the term ESG actually means, each month we will be outlining examples of what ESG integration looks like in practice across a variety of sectors, through the lenses of risk, opportunity, and impact.
ESG in Action: October 2023
- Sector: Energy
- Industry: Oil & Gas
- ESG Issue: Energy Transition
Risk: The case for divestment
The Oil & Gas sector raked in record profits in 2022. What did they do with those profits? They either expanded stock buybacks, replaced depleted reserves with new reserves, or invested in making it more efficient to extract from existing reserves. When looking at the current patent portfolios of energy companies, the majority continue to be focused on traditional fossil fuels and petrochemicals.1
This is incremental progress, rather than game changing. We need oil and gas companies to focus on both energy efficiency and large-scale investment in renewables to accelerate the energy transition. However, we’re not seeing that large-scale investment in renewables, particularly as the price of oil has spiked and renewable energy investments have waned from rising costs and project delays driven by supply chain disruption, inflation, trade policy uncertainty, and increasing interest rates.
Shell invested about $3.5 billion on the renewables and energy solutions business in 2022, making up about 14% of total capital expenditures. After a year of record profits, that level is expected to remain the same for 2023.2 BP recently announced that it is slowing planned cuts in oil and gas output from 40% to 25% by 2030 compared with 2019 levels.3
These actions are evidence that the energy sector is not moving fast enough. In order to meaningfully reduce carbon emissions in the sector, namely scope 3 emissions, oil and gas companies will need to stop selling oil and gas.
But recent M&A in the sector indicates a continuation of the status quo. In May, Chevron bought shale producer PDC Energy for $6.3B, adding 10% to oil equivalent proved reserves.4 In October, Exxon Mobil acquired Pioneer Natural Resources for almost $60B.5 And just this week, Chevron agreed to acquire Hess in an all-stock transaction valued at $53B. If oil and gas companies continue to commit billions to projects that are out of step with what governments climate pledges are, there may be a time in the future where these companies can’t rely on a sharp increase in energy prices to recoup their costs.
The majority of oil and gas companies have net zero commitments, but we aren’t seeing oil and gas phase-out plans. How will these companies meet those commitments and align with scientific and policy consensus if they continue to pump oil and frack gas?
All of this might make the case for divestment.
A commonly referenced goal of divestment is to create constraints on available capital, increasing cost of that capital, and making these businesses unappealing to investors. And divestment is popular. More than $40 trillion in assets have been committed to fossil fuel divestment6, among them Harvard University, the Norwegian Sovereign Wealth Fund, and the Ford Foundation.
Some investors have decided to divest from fossil fuels because they believe these companies will not be competitive long term as we transition to a low carbon economy.
Here are a few examples:
Parnassus Investments: “[adopting a fossil fuel free policy was] prompted by the firm’s growing concerns about the ongoing deterioration of the competitive advantages and relevancy of the fossil fuel industry. The move also reinforces Parnassus’s commitment to a low-carbon future.”7
Impax Asset Management: “For all of our strategies, we aim to build more resilient portfolios for our investors by managing risks, including climate-related risks. Specifically, we believe climate change poses material risks to fossil fuel companies in the form of expected government intervention to regulate greenhouse gases, changes in consumption patterns, and other liabilities, like stranded asset risk, reputational risk, and litigation risk.”
Many other asset managers offer customizations with the option to screen out fossil fuels, while continuing to invest in the sector for other clients.
There are many motivations for pursuing divestment, and due to progress in technology, investment vehicles, and data, it’s easier than ever before to implement.
Opportunity: How to be a steward of your capital
There’s one major problem with divestment: selling an asset requires someone to buy it. In other words, for you to divest, someone else needs to invest. And that investor probably has very different motivations than you do. They want to generate returns, which for them could mean pushing for continued and increased productivity of fossil fuel assets. The question then becomes, if you divest from fossil fuels, does whatever you reallocate that capital to have climate benefits that outweigh the costs of giving your fossil fuel exposure away to investors with counter-objectives?8
This may be difficult to measure and understand. As a result, some would advocate to hold fossil fuel companies, have a seat at the proverbial table, and exercise your shareholder voice. When shareholders actively engage with companies on climate-related issues, it sends a clear message that sustainability is a top priority. This engagement may encourage companies to adopt more sustainable practices, reduce carbon emissions and publicly commit to net-zero targets.
Today, 77 fossil fuel companies have net-zero pledges in place, up about 50% from the 51 companies that had them a year ago. This is progress, however, the majority either do not cover or do not specify whether they cover Scope 3 emissions or those generated by consumer use of their products rather than the company itself.9
Another argument for engagement is the idea that the demand for oil and gas is not going away any time soon, and these companies will play a meaningful role in the economic transition to meet our carbon targets. According to McKinsey’s Global Energy Perspective 2022, fossil fuels will continue to make up a significant share of the energy mix through 2050, partly because of how they combine affordability and security of supply.10 But even beyond that, there’s a case to be made that these companies, due to their global scale, risk appetite of their investments, large balance sheets and cash positions, and long-standing relationships with energy customers11, are poised and well positioned to scale renewable energy. Pursuing an engagement approach allows investors to be part of that conversation and influence the strategic direction of these oil and gas companies. Many asset managers in the market are doing thorough and ongoing engagement work, and, if this is important to your client, it’s an important topic to ask about.
Like engagement, proxy voting can be a valuable way to address climate change head-on with companies. It’s pertinent to choose managers that vote their proxies in alignment with investor preferences. Many retail investors don’t know that in some cases they are able to vote on resolutions each year for the companies in their portfolio, if they’d like to. Demonstrating the value of shareholder voice to investors can help keep them focused on the long term.
Some examples of climate-related shareholder resolutions from the 2023 proxy season:12
| Company | Flagged Vote | Result |
|---|---|---|
| Engie SA | Resolution on modification of the articles of association on the company’s climate strategy. Filed by MN and ERAFP and 14 others. | 24% FOR |
| Marathon Petroleum | Report on asset retirement obligations. Filed by New Jersey Division of Investment. | 22.8% FOR |
| Report on climate-related just transition plan. Filed by International Brotherhood of Teamsters General Fund | 16.4% FOR | |
| Suncor Energy Inc. | Report on capital expenditure alignment with GHG reduction targets. Filed by Investors for Paris Compliance. | 17.7% FOR |
| Exxon Mobil Corp. | Report on impact of energy transition on asset retirement obligations. Filed by Christian Brothers Investment Services and Legal & General Investment Management. | 16.0% FOR |
| Report on methane measurement. Filed by Sisters of St. Francis Dubuque Charitable Trust with the support of Seventh Generation Interfaith Coalition for Responsible Investment. | 36.4% FOR | |
| Report on climate-related just transition plan. Filed by United Steelworkers. | 16.6% FOR | |
| Berkshire Hathaway | Report on physical and transition risks and opportunities. Filed by California Public Employees’ Retirement System. | 26.8% FOR |
There’s another angle to consider here as well. “Debt finance, largely bank loans and bond issuances, accounts for 90% of new capital for fossil-fuel companies,” said Lily Tomson, senior research associate at Jesus College in Cambridge University. Most of the biggest emitters are mature companies whose need for the equity markets is relatively insignificant compared to their dependence on the debt markets for funding day to day operations. In this case, investment in green bonds or sustainability linked bonds, where the use of proceeds is specifically allocated to finance green projects or to achieve sustainability goals, would offer investors more direct exposure to companies that are transitioning.13
Impact: Look to the private markets
According to BloombergNEF, private debt and investment accounted for 93% of global new investment in renewable energy in 2022, in the form of asset finance and small-scale solar projects . Investment in public markets accounted for just 3.3% of the total.14
Said another way, investors who want to participate more directly in accelerating the energy transition will find more opportunities in the private markets.
Between 2017 and the first half of 2022, according to PitchBook, buyout and growth equity funds had done energy transition–related deals with a total reported value of around $160 billion, the majority of it concentrated in the renewables and clean industries segments.15 The role of private market investment is to provide capital to grow and scale innovative businesses. And these markets are becoming more accessible through new vehicles, such as interval funds, through a growing number of platforms.
The bottom line
There are reasons to divest and reasons to engage. The decision will ultimately be unique to each investor. Understanding their goals and their perspective on the role that oil and gas companies play in the economy will help advisors better navigate which approach to implement for the client.
Learn more
To learn more about supporting your clients with sustainable investing solutions, reach out to our team at sustainable@envestnet.com or visit envestnet.com/sustainable.
The information, analysis and opinions expressed herein are for informational purposes only and do not necessarily reflect the views of Envestnet. These views reflect the judgment of the author as of the date of writing and are subject to change at any time without notice. Nothing contained in this piece is intended to constitute legal, tax, accounting, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type.
Investments that utilize an environmental, social and governance ("ESG") strategy carry specific risks that investors should consider before investing in ESG portfolios. Pursuing an ESG investment strategy may limit the types and number of certain issuers for nonfinancial reasons, as a result, may lead to underperforming other funds that do not have an ESG focus. A fund’s ESG investment strategy may result in the fund investing in securities or industry sectors that underperform the market as a whole or underperform other funds that are not ESG integrated or screened for ESG standards.
FOR INVESTMENT PROFESSIONAL USE ONLY ©2023 Envestnet. All rights reserved.
1https://www.msci.com/documents/1296102/35124068/ESG+and+Climate+Trends+to+Watch+for+2023.pdf
2https://www.bloomberg.com/news/articles/2023-02-02/shell-to-pause-renewables-unit-s-spending-growth-after-record-2022
3https://www.reuters.com/business/sustainable-business/inside-bps-plan-reset-renewables-oil-gas-boom-2023-03-07/#:~:text=It%20also%20lowered%20its%20projected,according%20to%20a%20Reuters%20analysis.
4https://www.chevron.com/newsroom/2023/q2/chevron-announces-agreement-to-acquire-pdc-energy
5https://corporate.exxonmobil.com/news/news-releases/2023/1011_exxonmobil-announces-merger-with-pioneer-natural-resources-in-an-all-stock-transaction
6https://divestmentdatabase.org/
7https://www.parnassus.com/updates/article/parnassus_investments_firmwide_fossil_fuel_free
8https://hbr.org/2022/11/how-fossil-fuel-divestment-falls-short
9https://thehill.com/policy/energy-environment/4047396-fossil-fuel-companies-net-zero-pledges-largely-meaningless-without-better-data-analysis/#:~:text=Seventy%2Dseven%20fossil%20fuel%20companies,ago%2C%20according%20to%20the%20report.
10https://www.mckinsey.com/industries/oil-and-gas/our-insights/global-energy-perspective-2022
11https://www.mckinsey.com/industries/electric-power-and-natural-gas/our-insights/how-oil-and-gas-companies-can-be-successful-in-renewable-power
12https://www.climateaction100.org/approach/proxy-season/
13 Bloomberg Zero Newsletter, https://www.linkedin.com/pulse/climate-activists-missing-huge-source-capital-driving-akshat-rathi
14https://www.alliancebernstein.com/americas/en/institutions/insights/investment-insights/how-private-assets-can-empower-the-energy-transition.html#:~:text=Global%20new%20investment%20in%20renewable,just%203.3%25%20of%20the%20total.
15https://www.bain.com/insights/private-equity-lens-on-energy-transition-global-private-equity-report-2023/
