Evolving ESG perspective on the energy sector
The energy sector is under tremendous pressure to transform its business model for a net-zero economy. Sustainability-minded stakeholders call for the industry to shift from traditional oil & gas assets into zero-carbon alternatives and achieve net-zero Scope 1, 2, and 3 emissions over a timeline aligned with global climate ambitions.
Not all in the industry agree with this notion. Some reason that cutting supply without a commensurate reduction in demand will drive up prices and endanger energy access and affordability. They worry that financial markets have not necessarily rewarded climate champions in the energy space due to concerns around return on investment. Finally, they argue that divesting and/or downsizing traditional oil & gas businesses would not prevent climate change but instead shift emissions away from the public spotlight and possibly transfer assets to less responsible operators.
We believe the conversation needs to evolve to allow all stakeholders to find a middle ground as the transition pathway is far from linear and is not one-size-fits-all.
There are many caveats to achieving net zero, but the key lies with energy demand. Achieving net zero emissions for the entire economy would require consumer behavior change, government regulations, development of carbon markets, continued technology innovations, and corporates fulfilling their net zero commitments. The evolution and interplay of these variables will ultimately define the real world transition pathway.
Conversation on Scope 3 alignment also needs to be more nuanced. Given the many uncertainties, assessing companies based on their alignment with a modelled transition pathway is far from ideal. Similarly, to make all upstream companies accountable for a ~4% linear annual reduction in Scope 1, 2, and 3 emissions intensity by 2030, which is based on today’s understanding of technologies and the rest of the global economy achieving prescribed net zero demand transformations, is also not realistic. This gap between ambitions and reality is starting to get recognized.
While transition strategies vary depending on size and scope across the energy value chain, we believe traditional oil and gas exploration and production (E&P) companies need to strive to produce the lowest cost, greenest molecules possible while having a rock solid balance sheet. In our view, this means net zero absolute Scope 1 and 2 emissions as soon as possible along with interim targets, which includes eliminating methane emissions and routine flaring, maximizing the use of renewables during the production phase, and limiting reliance on offsets. Additionally, these targets need to be linked to executive compensation to hold management teams accountable.
The industry as a whole also needs to support greater policy actions (such as a carbon price) to create the economic environment necessary to enable greater zero/low-carbon investments. In addition, corporates should engage in the transition conversation given 1) increasing investor pressure on companies to manage their transition risk; 2) more restrictive environment for oil & gas lending as banks set targets to reduce their own financed emissions; and 3) growing societal demand for low-carbon solutions.
