Environmental, social, and governance (ESG) investing is rapidly becoming one of the most visible and durable megatrends in the financial community. ESG, or sustainability, refers to corporate activities that would maintain or enhance the ability of a company to create value over the long-term. It includes both financial and non-financial aspects of a business, such as environment, human capital, social capital, innovation, leadership, and governance—those types of initiatives.
So, why is it important to the power sector? Well, first of all, contrary to what we often read in the news, sustainability doesn’t exclude the continued development of fossil fuels. ESG is an opportunity for the energy industry to tell its story. It’s important to tell that story because there’s been a shift in the investment community and ESG impacts access to capital.
Big Money Hinges on ESG Initiatives
For example, there’s been an increase in ESG-focused mutual funds, which are investing in companies that are committed to sustainability, and those are tied to ESG ratings. There are also performance-based sustainability-linked bonds and loans. That market has been growing, and it’s expected to continue to grow because of investor demand.
Investors—and consumers—are more focused now than ever before on ESG risk. Consumers are beginning to boycott or make buying decisions at an increasing rate based on social issues, as an example. It’s just something that has really increased in our culture in general. So, it has ultimately impacted the flow of capital.
Institutional investors have told their private equity firms that they won’t provide capital unless ESG requirements are met. The most widely discussed example of that is BlackRock, a global investment manager and technology provider, whose CEO, Larry Fink, wrote a letter last year to CEOs of companies in BlackRock’s investment portfolio, stressing the importance of sustainability. He suggested that BlackRock would vote against any management and board directors of companies that didn’t make sufficient progress on ESG initiatives. There are other investors and private equity firms that have made similar public statements.
The important thing for energy companies to do this year, if they haven’t already, is to get started and be proactive in addressing ESG issues. Set a strategy. Several clients have called Opportune, even small producers, saying, “Hey, our investors are asking for an ESG strategy and reporting. Can you help us get started?” Your company should anticipate receiving similar requests. Having a response and showing that you’re thinking about these initiatives proactively can be a differentiator.
Establishing an ESG Strategy
The best way to start is to determine what your company is already doing and document it. Look at your peers and see what they’re doing. You can also be proactive in engaging in conversations with your investors, other stakeholders, and your community to see what their priorities are and consider what that means to your business. Then, you can start to determine where you have gaps and how you should fill them.
As mentioned earlier, this is an opportunity for energy companies to tell their stories and positively impact the market perception of the industry, because the industry already does a lot for the environment and is constantly giving back to local communities. Unfortunately, these actions are not always tracked or reported on sufficiently, so there’s a gap between market perception and what’s actually happening.
One of the biggest challenges is resources, especially for smaller companies. Implementing an ESG strategy and tracking performance obviously takes time, human capital, and ultimately financial resources, not only to implement the initiatives, but also for getting systems in place to track and report on them. So, how do you address that challenge? I suggest starting small and scaling up over time. From what I’m hearing in the market and from private equity firms, there’s not an expectation of perfection in year one, but rather, the expectation is for companies to address the issues and show progress over time.
Reporting poses somewhat of a challenge, too, in part due to the fact that there are multiple standards and frameworks currently available, and it’s difficult to sort through and understand all the options. Furthermore, the various standards make it difficult to compare results among peers, so there’s not really any one way to report on these initiatives currently.
The industry is working to address this challenge. For example, there are several trade organizations providing resources for their members to help them implement and report on ESG initiatives. Meanwhile, the Sustainability Accounting Standards Board has developed industry-specific and investor-focused guidelines, which have also proven useful.
It’s clear that ESG is here to stay and will continue to become an ever-increasing part of the conversation that companies have with their investors. It’ll be interesting to see how reporting standards converge and how that ultimately makes it easier for management, investors, and analysts to compare performance and evaluate progress, which will impact the broader ESG conversation as time goes on.
—Amy Stutzman is a managing director in Opportune LLP’s Complex Financial Reporting group.