Capital AllocationESG

Balancing Act for Energy Firms: ESG vs. Capital Returns, Discipline

By June 10, 2021No Comments

More takeaways from a NeuGroup pilot meeting of oil and gas treasurers weighing the role of finance in energy transition strategies, conducted in partnership with Societe Generale.

By Joseph Neu

Our discussion with oil and gas treasurers validated that there is a strong belief that investors (and especially on the bond side) want capital discipline and not just a commitment to ESG initiatives. ESG mandates are sold as an indicator of strong returns, especially in the long run; so if companies underperform on capital return, it will not endear them to investors, even if their energy transition strategy boosts the firm’s ESG score.

  • “Investors expect a strong return along with low carbon,” as one participant noted.
  • A reading of the Engine No. 1 proxy presentation on reenergizing ExxonMobil reveals an emphasis on capital discipline as much as ESG.
  • Banks also want to put money to work, but lending needs to fit their own ESG stories and pay back on the long-term projects the sector requires.

KPIs are covenants. If finance strategy links up with KPIs, treasurers at oil and gas companies will find themselves on a slippery slope of tying their credit worthiness and cost of capital to non-financial, and still somewhat subjective measures. Their auditors warn these KPIs will act like debt covenants with non-subjective impacts on capital return, cost and access.

  • So treasurers in the sector are understandably not eager to rush into KPI-linked financing until the KPIs are objective (meeting market-accepted standards) and fit the business strategy. Moreover, if they are not, they will be sued for greenwashing.
  • Treasurers in tech or sectors further removed from energy production or delivery as their core business do not face the same risks, nor the same covenant implications.
  • Do investors want real covenants to mitigate risk to capital return or do they want to check the box for ESG mandates?

Risk assessments or weaponizable metrics? All the raters of ESG risk, be it the newer ESG scorers, the proprietary asset manager aggregations or the traditional, regulated credit rating agencies, should strive to bring analytical rigor to their risk assessments and encourage users of these assessments not to weaponize them.

  • As an example, Moody’s, widely regarded as having the most analytical rigor of the raters, has most of the oil & gas sector at an ESG Credit Impact Score of 3, meaning the issuer’s ESG attributes are overall considered as having a limited impact on its current rating, with greater potential for future negative impact over time.
  • If market participants (or regulators) suddenly chose to weaponize the metric by saying all 4 and 5’s are screened out of their investment options,  the risk assessment of those scored a 3 would change overnight.

On edge. The fact that risk assessments can change now at the stroke of a pen, or even a tweet, understandably has many in the oil and gas sector on edge.

  • The energy transition and ESG are not entirely new—the market used to be concerned with peak oil supply and now it is about peak demand; and ESG used to be known as environment, health and safety.
  • But the speed with which market sentiment changes, based on emotion and opinion, is a new phenomenon.
  • Accordingly, firms in this sector should not delay rethinking their energy transition strategies, based on such new risk assessments, so their finance teams will be ready with the finance strategy needed to support them.
Justin Jones

Author Justin Jones

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