Institutional Investors Demand Greater ESG Adherence From Oil Majors, Can Independents Pick Up The Pieces?

Institutional funds have increased their pressure on the world’s largest oil and gas companies to further and hasten their commitments to meet a carbon output of net-zero by 2050. The calls by ‘activist’ investor groups seek to restrict investment by institutional investors, if carbon reductions and ESG principles are not extended beyond their current framework.

The UN Principles for Responsible Investment (UNPRI), Institutional Investors Group on Climate Change (IIGCC) and the Climate 100+ group are a few of the investment networks pushing greater adherence to ESG policy and wider practical action to follow the pledges. A report by Morningstar, an investment research firm, delved into the regional cash flows and assets under management by signatory funds.

These statement come despite the world’s largest oil and gas producers committing to increased reductions of their carbon emissions in order to meet a carbon output of net-zero by 2050. Among them, BP and Total have deepened their commitments this year, and in light of further oil price uncertainty, the oil majors are competing for a greater share of the renewables market than ever before.

State of the Oil Majors

Many of the ‘oil majors’ approach to the climate crisis is continentally distinct, with the European-headquartered BP, Shell, TOTAL and ENI SpA each having announced targets for net-zero emissions by 2050 – committing to reduce ‘scope 3’ C02 emissions by at least 50%.

Meanwhile, the US-based conglomerates of Chevron, Exxon and ConocoPhillips each declared vague targets that seek limited cuts to emissions only as far as 2025. These decisions were in-line with the Trump administrations view on the Paris Climate Agreement, although these may come under consideration once the incoming administration of Biden re-enters the accord.

This places the oil majors in an interesting dynamic, how institutional and ESG funds based-on either side of the Atlantic approach these differing business models. While the supermajors have the capacity to fund new explorations, the capacity to operate is within a greater ecosystem of joint ventures and corporate partnerships, each of these subject to the same rules and demands of funds that seek to encourage the necessary ecological shift.

State of ESG Funds

Globally, ESG ‘impact’ funds topped $1 trillion (AUM) in Q2 2020 for the first time, signaling a marked interest of sustainable practices on the global economy. The US and Asian ‘sustainable, impact’ funds have committed a combined $251 billion. A figure that sits significantly far behind the European ESG funds who had committed over $600 billion by Q4 2019. Yet, in both cases, these numbers had swelled exponentially year-on-year.

The impact of such swiftly developing investment interest is the consequence of companies being reactive to the demands of capital. The year Covid hit required oil companies to not only conduct introspection into their profitability, necessitating extensive cost cuts, but also revealed to them their distinct exposure to having all their eggs in the oil basket.

Consequences of Capital Demands

Even as BP (among others) has led the way in shifting their business model away from an oil and gas giant to become an incorporated energy company, these measures appear to have been insufficient to hold the wolves at bay. The expectation now is net-zero is not only achievable in a shorter time frame, but the need to do so has only increased.

The International Renewable Energy Agency (IRENA) has forecast that, to meet the Paris Climate Agreement of net-zero carbon by 2050, more than $19 trillion will need to be invested over the next 30 years. This number stands far off the current commitments of $2 trillion. Moreover, while the capital costs of development have lowered, easing the constraints of entry into the market – investors have not shown the same desire for renewables as they previously have for fossil fuels.

This leaves the market in a position of flux, whereby the Brent and WTI crude oil prices have stabilised at around $40/bbl, a price below the in-house forecasts produced by the oil majors, which place $50/bbl as the long-term break-even marker for major oil producing states.

As a result, the global energy market is torn between the need to change and the capacity to change. If investment cannot meet the measures outlined to ensure protection of the atmosphere and environment, then the consequences are dramatic. If the renewable energy markets cannot supply the demands of society without fossil fuels, then economic activity will incur serious challenges and the consequences are similarly dramatic in different ways.

Alternate Concerns

One of the major concerns resulting from the growing distaste of Western institutional investors toward the oil and gas markets is the precarious position of leaving future oil production in the hands of non-democratic states. The necessity of oil and gas (and their by-products) ensures global society will remain committed to the market for the foreseeable future insofar as oil and gas are a matter of economic and national security.

Most activist investor groups focus on public companies headquartered in Europe and North America, despite many of the world’s worst polluters headquartered outside of these jurisdictions. For instance, Saudi Aramco entered the public markets via their long-awaited IPO and yet they continue to occupy an oversized role in determining the Brent crude oil price, unburdened by the climate conundrum.

Although China is one of the biggest adopters of renewable energy, they remain the world’s biggest consumer of oil and gas – and their recent climate commitments outline net-zero objectives by 2060, a decade after the Paris objectives and the scientific concerns on the warming of the atmosphere. No country has the power or will to dictate to China a different path, and the consequences of a divergent vision make global solutions impossible.

Nordstream 2 gas pipeline to Europe has created a series of dilemmas in how to act toward an increasingly unpredictable Russian internal affairs and foreign policy. The EU having to consider the reality of placing the project on-hold or halting it altogether to the cost of billions of Euros, and the likelihood of more expensive energy.

Reactions by NOCs & IOCs

What effect do these actions by ‘activist investors’ have on the wider energy industry? In late 2019, Saudi Aramco instituted a $500m ‘green energy fund’ shortly before their IPO in order to mitigate the ESG concerns. China has long stood as the world’s largest single producer of solar PV energy, while Russia remains committed to developing their more carbon-friendly natural gas supplies.

Institutional investors benefit from massive, diversified portfolios that are not beholden to the returns or successes of any one sector – an instrument they utilise to their distinct advantage by encouraging global change through market influence. The result is that both Western-headquartered companies and those in Asia, the Middle East and Africa have all begun to respond to the conditions required to attract European capital.

North American and Asian funds remain divided in placing climate caveats on their portfolios; many have calculated long-term returns based-upon these investments while others simply hold that capital is amoral. However, 20% or over $250 billion of the US index funds now require ESG adherence – doubling in just the past three years. In Asia, the situation has not advanced as rapidly with just $1 billion or 2% of Asian index funds (excl. Japan) committed to sustainable funds.

The result however, is that the increased ESG pressure on oil and gas majors has led to extensive restructuring, cost cutting and implementation of ESG governance principles to varying degrees, in order to satisfy and attract the level of investment that their corporations require.

There is a perception that capital has fled the fossil fuel industry, and some has but this is largely misplaced. Funds have been careful to state they will not engage in “new” fossil fuel investments rather than commit to outright divesture. Many of these funds have significant stakes in the oil majors and continue to receive healthy dividends regularly.

Oil majors headquartered in the West will maintain their path to diversification of their generation capacity, but they will also drive the commercial viability of CCUS – and if successful, will have monetised their emissions and brought the emissions in-line with the guidelines of Paris Climate Agreement.

Capital has not fled the industry, as much as capital is demanding change within the industry in order to continue what has been a fruitful relationship for investors and investees alike.

The Energy Council takes the view that, while the public markets can sway the decisions of ‘Big Oil’, it is the independent producers who can continue to maintain an industry presence without the shareholder pressure. Private equity funds and high-net-worth offices own many of these independents, which can simply ignore ESG demands in favour of maximising profits in jurisdictions unencumbered by ESG legislation.

We may yet witness the ‘Big Oil’ dispose of their non-core assets to the smaller independents who will ignore ESG concerns in favour of shareholder dividends – dependent on their domicile.

With M&A picking up as oil prices stabilise, there has been similar noise of the Asia Pacific oil and gas sector beginning to see consolidation of resources in several forms; the disposal of maturing assets by IOCs to the independents, larger independents purchasing smaller independents with quality assets, and the mergers of companies of similar size and portfolio.

One certainty is known – institutional funds in the West will no longer provide investment to new ventures as they begin to divest from the shares currently held. How this progression towards ESG will manifest within the APAC, Middle Eastern and African oil and gas markets remains relatively unknown, but appears primed for independent producers to acquire assets where others dare not tread.