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ESG Drives Oil & Gas M&A Activity

Concerning production, the recent increase in rig count has been driven by private E&Ps, not only to enable them to benefit from higher crude oil prices but to make themselves more attractive takeover targets. In contrast, many publicly held E&Ps are facing ESG-related pressures from investors and have reined in their capital spending, returning more money to shareholders (via stock buybacks and dividends), and recently, directing more of their cash flow into their bank accounts.   This reluctance of many publicly owned E&Ps to invest more in drilling, even in this environment of higher crude prices, has been a significant factor in slowing U.S. production gains.

The purpose of the preamble was to bring to your attention how prevalent ESG issues have become among the factors influencing prices and production levels. The growing significance of ESG has caused upstream, midstream, and downstream players to incorporate these issues into their strategies and operations.

For example, the increase in crude oil prices has supported a rise in energy stock prices. However, many investors, lenders and others remain wary of oil and gas companies, not only based on the energy industry’s historic volatility but also the tremendous social, political and financial pressures that hydrocarbon producers, midstream companies, and refiners face in demonstrating that they are addressing environmental, social, and governance issues. ESG has come to the main stage in the U.S., Canada, and elsewhere, and will influence Oil and Gas (O&G) activity in the short-term and beyond. Energy companies that ignore ESG issues run a significant risk. As we have indicated before, it is important for our clients to focus on their core upstream, mid-stream and downstream activities while firmly grasping the reality of ESG as a key business strategy.

Mergers and Acquisitions in today’s O&G markets, for example, discuss the strategic and financial benefits of the deal and also highlight the level of ESG practices. The new message to investors, lenders, and the broader public includes awareness of the importance of climate change, workplace diversity, and other ESG matters, addressing those issues and ensuring plans to do more are known.

In net, ESG is now a very important concern for all participants in the O&G industry. What does it involve?, How is it gauged? and How did it so rapidly become one of the biggest issues facing the O&G sector? One thing is clear: ESG cannot be set aside, deferred, or ignored.

The Role Of ESG:

So what does ESG mean to O&G upstream, midstream, and upstream operations? Let’s start with the E for “Environment”. For the O&G sector in general, E is all about reducing carbon emissions or otherwise ensuring impacts on the planet in general are mitigated. Examples are using drilling strategies designed to reduce how much ground needs to be disturbed; methane leak-detection programs; piping instead of trucking crude oil and produced water (to reduce diesel use); recycling and re-using produced water; reducing or eliminating gas flaring and using wind or solar power to run drilling operations, pipeline pumps and compressors, etc.

The S is for “Social”. What a growing number of investors, lenders and others are looking for in this realm is evidence that the company is prioritizing worker safety and health; taking steps to develop a diverse workforce and involving itself in the community in real and helpful ways.

The G stands for “Governance”, which involves issues like reporting transparency; compliance programs; executives and managers diversity; and expanded shareholder rights.

Perhaps the first question that comes to mind is: why are investors and lenders not focused on ensuring the quality, viability and return of the company’s assets, as well as traditional financial metrics such as earnings, debt-to-equity ratio, and free cash flow? Another question that arises is how can investors and lenders know whether a company’s ESG efforts are real or just window-dressing given the confusion surrounding ESG issues?

The  answer as to why ESG matters to oil and gas companies is simply access to capital. Focus on ESG is increasingly demanded by investors and lenders. This attitude is not limited to activist investors. In our current reality, social and political pressures will certainly influence where the money will flow. Also, large investors usually focus on the long-term view which nowadays factors in the perception of the company’s readiness to adapt to energy transition pressures and mandates . In today’s financial markets, companies that strive for operational efficiency, promote diversity, and practice best-in-class governance are perceived to perform better financially. Changing demographics also play a role. For example, in general, millennials are limiting their investments to companies with “favorable” ESG rankings and many avoid fossil fuel-related investments as a matter of principle. The next question is on which basis can investors, lenders and others judge whether an energy company is good or bad on ESG issues? There isn’t a widely recognized ranking or index. According to the literature, there are many different lists developed by the financial sector and other specialized companies in the area, each with their own criteria and approaches. The consensus first step in establishing ESG ratings and rankings should be to generate listings of companies by categories and subcategories. For example, we start with energy companies as the category and midstream and refining companies as the subcategories. We would also have for example, electric utilities, gas utilities and renewable energy as further subcategories. The reasons to divide and subdivide companies into buckets are clear: energy companies face a very different set of ESG issues and concerns than, say, a hospital, an electronics manufacturer, or a food packer.

Due to ESG’s increasing level of importance, we have recognized the need to be ready to support our clients in this realm. ESG issues are taking on an increasingly significant role, not just in enhancing companies’ environmental stewardship, but also in improving their position with investors, lenders, and regulators, and even impacting employee talent acquisition.

The author of this article Ivan Parra is a Senior Consultant at Trindent Consulting.