Continuing ESG Success: Emerging Issues for the American Energy Industry

In the face of ever-changing market dynamics caused by the crisis in Ukraine, cyber threats and investor activism, America’s natural gas and oil industry remains immensely focused on its core mission: sustainably producing affordable and reliable energy supplies to meet the world’s growing demand.

The essential role of American natural gas and oil cannot be overstated, particularly as it relates to ensuring key climate as well as economic and security objectives are fully realized. The proven resources are here – the industry’s talented and highly trained workforce is evolving and getting better by the day – and the confidence across our capital markets in the sector is on an upward trend.

Yet there are both challenges and opportunities regarding access to capital, particularly given heightened environmental, social and governance (ESG) expectations as well as regulatory realities.

Today’s geopolitical dynamics aside, American upstream natural gas and oil producers – as well as the sector’s robust supply chain, the oilfield services (OFS) space, and the midstream and export sectors – are meaningfully raising the ESG bar to meet and exceed the performance expectations of their stakeholders, especially investors.

This overwhelmingly sector-wide commitment to continuously heightening ESG performance positions the industry well for continued and sustained success. There will always be leaders and laggards in any industry. On balance, however, we have seen a sea of change in the industry’s focused approach to identifying and managing material risk, transparently engaging with its most critical internal and external stakeholders, and effectively communicating strategies to create sustainable value.

As we know, simply adhering to regulatory requirements and being a self-defined good corporate citizen is not enough to succeed in the new era of ESG-centered investing, which extends across both institutional public- and private-asset classes.

Given our deep experience working alongside energy producers and other sector participants – providing strategic guidance to ensure organizations are well-positioned to earn the trust of their investors and other stakeholders – we’ve highlighted several key emerging-issue areas for the natural gas and oil industry’s continued ESG success.

Key Considerations, Trends, Opportunities and Risks

Sustainability must be led from the top.

According to recently released research from FTI1, both investors and working professionals agree that sustainability must be high on CEOs’ agendas, and they want to hear directly from business leaders on progress made in the realms of ESG.

When asked what issues they want CEOs to address, specifically those which they are now more concerned with compared to prior to the pandemic, professionals and investors both selected sustainability as their second and third most important issues, respectively. And when it comes to goals to reduce a company’s environmental impact, the buck stops with the CEO. More than 8 in 10 professionals (81%) and investors (85%) believe CEOs have a responsibility to work toward lowering their company’s environmental impact. As much is true when it comes to board-level management of ESG strategies. A competent and diverse board is essential to ensuring a company has the right mechanisms and rigor in place to hold its leadership accountable when it comes to credibly delivering against ESG priorities in the eyes of a company’s stakeholders.

Align and clearly articulate priorities, goals and aspirations.

Failing to plan is planning to fail, as they say. This is especially true in the context of ESG reporting and positioning. In many cases, upstream E&Ps have indicated to the market their otherwise robust approach to ESG reporting and commitments to continuous progress.

However, the governance of that activity has lagged along with the right level of investment in the resources necessary to enable those commitments to be realized. This disconnect can be a deterrent to building or maintaining stakeholder trust when measurable progress is slowed or is not transparently communicated. And there may be very good and valid commercial reasons for such realities. Not clearly articulating the fluid dynamics of one’s ESG journey increases risk.

Put another way, effective ESG governance and execution requires disciplined and effectively integrated multi-stakeholder communications strategies to ensure confidence and trust is earned and maintained.

Educate and engage your stakeholders.

It is important to take a multi-stakeholder approach to engagement around your ESG priorities to ensure you are reaching the right audiences with the right messages to maintain license to operate.

This requires a thoughtful approach to understanding your key audiences and developing audience-specific engagement strategies and content to ensure your efforts are resonating. The business case for strategic stakeholder engagement is immense, to name a few:

• Focusing time and energy on improving your ESG strategy is a top priority for engaging with investors who will help unlock access to capital. From a regulatory standpoint, top scores can also serve as an important proof point for key decision-makers in the public sector at the local, state and federal levels as these emergent issues take greater priority in regulatory and legislative agendas.
• As the war for talent continues to heat up and as stakeholders look for companies to demonstrate they are purpose-driven, your ESG priorities can and should be leveraged as a competitive advantage that will help your company distinguish itself from others in the space as an employer of choice.
• Similarly within the value chain, partners and suppliers are looking for companies with shared values that can help them achieve their own sustainability goals. Having a clearly defined strategy with tangible goals and measurable outputs that can be mapped is essential to elevating your profile as a partner of choice.

Don’t trust your guts.

It is not a sign of weakness to ask for help. ESG framework alignment and rating-agency engagement, for example, is complex, time-intensive and highly nuanced. It’s also unrealistic for internal resources at an E&P to master this landscape, which is both art and science. What’s more, collaborating with industry and other sector peers and partners demonstrates a genuinely collaborative approach to meeting the industry’s most pressing challenges. Look no further than the rapidly expanding market for differentiated gas, or responsibly produced gas (RSG). According to Enverus Intelligence Research’s John Gutentag, “Roughly 90%, or 18.6 Bcf/d, of estimated 2022 RSG volumes were announced in 2021, highlighting the significant increase in producer interest in the RSG space over the past year. As we move into 2022, we expect to see expanding midstream certification along with more development surrounding the marketing of RSG.” Material and decision-informing ESG performance data, through utilizing a measurement-based to continuous-emissions monitoring, is one of the many examples whereby the E&P sector has embraced technological solutions to further demonstrate and enhance a commitment to operational excellence. The RSG market also reflects the imperative to show and not tell.

ESG impacts the ability to transact.

From the Securities and Exchange Commission’s (SEC) recently proposed rule that would mandate specific disclosures on greenhouse gas emissions and associated climate change risks by all publicly traded companies to the Federal Trade Commission’s (FTC) heightened focus on natural gas and oil transactions, federal regulatory scrutiny has created market uncertainty. How will the SEC’s rule be implemented and when? What are the relevant litigation-related challenges? How could this proposed rule impact the IPO market? At the same time, ESG is increasingly front and center in the deal-making diligence and valuation process. Does a prospective acquisition target’s ESG performance align with the potential acquirer’s commitments and values and, by extension, that of its stakeholders? A compelling transaction extends beyond SG&A synergies, adjacent acreage positions and complimentary hedge books. Investors, including private equity LPs, need ESG assurances to fully get behind a deal – no matter how accretive it may be in terms of proven reserves.

Share buybacks, total shareholder returns and paying larger dividends (or even just paying a dividend) are core metrics of success for boards and management teams. Yet without a strong and proven license to operate, the ability to deliver on those financial initiatives becomes more – not less – challenging. Furthermore, sector laggards are prey to otherwise preventable shareholder activism.

Increasing production and replacing reserves was once the widely accepted playbook for E&P success. Today, however, capital discipline is expected and rewarded.

At the same time, the ESG goalposts are continuously moving. What “good” looks like in the eyes of the most critical ESG influencers changes quickly. This new era of ESG investor prioritization and engagement – against the backdrop of the energy transition – is high stakes and high rewards, especially for natural gas and oil producers.

Without strong, credible and authentic ESG strategies, rigorous data-management systems, and a measurable commitment to continuous improvement and executional excellence, access to capital and credit – both in the public and private markets – is threatened.

In our view, the energy industry is well-positioned to do what it always does: improving every day, fully committing to solving some of the world’s most complex challenges and finding new ways to safely deliver lower-carbon energy solutions.