In my previous blog, I explored how Environmental, Social, Governance (ESG) can and should be used as a valuable risk management tool. In this blog, I explore what it takes for AIM-listed / Midcap energy firms to implement an ESG strategy. In particular, I focus on the ‘new mindset’ required for agile responses in an ever-changing political, environmental and business landscape.
But first, as a reminder, I’d like to ask why designing and implementing ESG processes matters but is perhaps even more important in unpredictable times? Several recent studies demonstrate how robust ESG practices improve company performance in the shadow cast by the COVID-19 pandemic. A recent FTI investor study demonstrates that “58 per cent of investors believe companies with above-average ESG practices have been more effective at managing business risks associated with the COVID-19 pandemic.” They also found that “64 per cent of investors believe companies with above-average ESG practices are better prepared for future pandemics, crises, and other black swan events.”
With this in mind, I’d like to explore some key aspects of what’s needed to address these challenges.
Shifting mindsets
The energy industry has a long track record of implementing risk management strategies. There are clear technical processes and management systems in place. Engineers and HSE professionals have traditionally designed and managed these processes and are experienced in dealing with technical issues and standards.
Levels of uncertainty are increasing in the world of business with many of the major risks coming from ‘soft issues.’ By that I mean, what the UN term as ‘S’ factors, or non-technical risks deriving from social or societal complexities such as; human and labour rights, supply chain transparency, community discontent and protest, cultural heritage, shareholder pressure for action on climate change and the inevitable black swan event.
Current risk management processes appear to be inadequate to deal with the volatile, uncertain, complex and ambiguous (VUCA) world.
In my previous blogs, I mentioned examples where companies failed to manage ESG-type risks effectively and that led to huge financial losses and the loss of reputation. ‘Soft issue’ risk applies equally to smaller companies —especially for mid-tier energy firms. Progress towards implementing ESG practices is slow, and many companies are losing out on opportunities and increasing their exposure to these risks by not implementing ESG practices. Mindsets need to shift, and here’s how:
- Create long-term value: Understand that the opportunity of sustainable shareholder value is linked to environmental and social performance alongside robust governance processes. Not only that, but companies that pioneer and lead by good example would further gain credibility, build reputation and enhance their brand.
- Embed ESG in core expertise: Energy companies need to need to expand on their current skills to create a more sustainable business and incorporate ESG as part of their company-wide DNA to identify and take suitable opportunities and manage threats to their business.
- Re-tool: It is not enough for Boards to instruct and expect that their executive teams can implement ESG practices. Companies need to have a dedicated capability— whether in-house or together with third-party service providers and conduct a gap analysis to establish where they are now, to develop an ESG strategy (where they want to go, undertake materiality assessments), to define priorities and direct resources to get there, and implement and monitor ESG practices to check progress.
- Sit comfortably with the unknown: The current pace of technological, regulatory, social and political change demands new ways of thinking and agility. Traditionally, businesses like to operate in environments with political, regulatory and stakeholder stability. Now companies have to adapt to a situation where 100% accuracy is no longer possible. Decisions will need to be made with 70-80% certainty. ESG practices and processes will provide critical information and knowledge to help support these decisions.
- Reporting on the ‘S’ for social: The United Nations Principles for Responsible Investment (PRI), highlights that, despite the increasing prominence of ‘S’ factors, a lack of data and consistency continues to present challenges. The social element of ESG issues can be the most difficult to assess. Unlike environmental and governance issues, which are more easily defined, and are often accompanied by robust regulation, social issues are less tangible and there is less mature data available to show how they impact a company’s performance. Human rights, labour standards and gender equality—and the risks and opportunities they present to investors—are gaining in prominence for investors. Increasingly there is demand for social data to demonstrate that companies are aware of their responsibilities and are addressing them. It is incumbent on the energy sector to ensure it manages social impacts and reports in a meaningful way.
Practical steps towards implementing ESG practices
If we try to unpack the three elements of E., S. and G. for the energy sector, then it becomes less daunting to implement. For smaller firms, we need to be pragmatic. There is no need or possibility to deliver 100% of all ESG requirements from day one. This is a process, and it will take time. However, as described in the re-tool section above, if companies know where they are, where they want to go and have defined priorities and resources to get there, they can start realising the value that managing ESG risk will bring to both internal and external stakeholders.
The best strategy is to design a plan of action, and accept it may take several years to deliver and will continually evolve as the company and world in which it operates does. The plan must be capable of reaching clear annual milestones towards a stated objective(s). Those aspects that are important to your company must be prioritised, with the ‘buy-in’ of the Board, straightforward to implement and demonstrate continuous progress towards goals.
Some examples of relevant actions include:
- Environmental criteria: How a company performs as a steward of the environment in both its direct and indirect impacts, for example, actions to reduce greenhouse gas emissions, manage waste and water, reduce pollution with commitments to decarbonisation.
- Social criteria: How the company manages relationships with employees, suppliers, customers, authorities and communities is an aspect increasingly important to investors and governments as they look for strong relationships between industry and impacted stakeholders. It’s not acceptable to pay lip service to these impacts in today’s interconnected world, as transparency is key to building trust with all of your stakeholders. For example, respect for human rights, the strength of community relationships, strong corporate citizenship and a commitment to social and community investment. The importance here is not only ‘doing’ but finding ways of quantifiable reporting methods.
- Governance criteria: How well a company’s management structure, culture and internal processes handle diversity, executive pay, and shareholder rights. Examples include transparent audits and financial controls that prevent corruption and malpractice. Ensuring equitable pay structures and diversity in the hiring practices within the company.
Emissions savings derived from operational efficiency
According to a recent Critical Resource interview with Alex Schneider, President and CEO of Lundin Energy,
“A big part of achieving a 2-degree scenario will be efficiency. As a smaller company, we do not have direct access to consumers, and cannot change consumer behaviour directly, so we have to get our own house in order first, and be as efficient as possible. We have pledged to become carbon-neutral by 2030 and are well on our way to achieving that. This is not insignificant, for example, at our oil field Edvard Grieg we are saving about 1.2 million tonnes of CO2 per year through electrification, which is the equivalent of 600,000 cars. To put things in perspective, if all of the world’s oil and gas production operations were to electrify, or otherwise reduce operational emissions to our target levels of near-zero, we would save close to 2 billion tonnes of CO2 per year, the equivalent of 700 million cars.”
Conclusion
The past 18 months has had a profound impact on how companies operate in the present, and how they craft blueprints for the future with several high profile companies losing their social license to operate in the midst of the pandemic. The ever-present danger however is that companies and their board members focus only on the ESG scoreboard, without building resilience—forgetting this is not a game to win.
To further the sporting analogy, implementing ESG practices is practising in private those things you get rewarded for in public such as building stamina, committing to the training, supporting and being part of the team. Then it’s in the playing, it’s being fit, striving to be the best, it’s knowing and playing by the rules for the love of it to succeed.
Mid-tier and AIM-listed energy companies are considerably more agile than the industry majors and could use this competitive edge to their advantage. Agility will be critical for companies to pivot quickly and be ‘first-mover’.
Our dedicated Telos NRG team have several decades of ESG-related experience and we would be delighted to help. Please contact us if your company requires bespoke ESG services. We understand your industry. We are here to support you. We help deliver practical solutions in collaboration with our clients.
