ESG risk realization in energy offers a glimpse of the future

• The engagement priorities of investors on climate change and the impact on oil & gas companies have been transparently clear, but became realized in quick succession at several different companies
• Three events last week from a Dutch court and in shareholder votes at two listed oil companies highlighted how change can come much faster than expected
• The sudden realization of ESG risks presents a challenge for financial institutions that can’t prepare for every possible outcome , and must prioritize where they make investments to prepare for the next breakthrough issue

The energy transition is shifting into high gear. Recent court rulings and investor resolutions, many of which landed in the headlines last Wednesday, reiterate the urgency of planning for the impacts of the energy transition. The sudden change reiterates how identifiable specific ESG risks can be ahead of time even if it is difficult to prepare for every eventuality up front. Financial institutions with the greatest number of indirect points of contact with ESG risks need to invest the most now to avoid being caught flat-footed in the future.

In the current cases of multiple risks being realized all at the same time, a Dutch court forced Shell to cut its emissions (including Scope 3 emissions generated by the burning of its oil & gas products) by 45% in the next 10 years. A shareholder resolution was passed at Chevron forcing an emissions reduction target including Scope 3 emissions, and an activist shareholder elected two board members to Exxon’s board to direct the company towards a more orderly transition.

One of the notable changes, besides a majority of investors supporting climate reorientation at publicly listed oil companies, is who is on board with the new changes. It’s not just the ethically oriented investors who have been engaging with energy companies for years. BlackRock, whose approach to ESG has attracted criticism for not driving real world impact, was among the investors supporting the new board members at Exxon as well as voting against a company’s climate strategy at BP.

BlackRock CEO Larry Fink, writing in his 2021 letter to CEOs, said, “We are asking companies to disclose a plan for how their business model will be compatible with a net zero economy… We are asking you to disclose how this plan is incorporated into your long-term strategy and reviewed by your board of directors.” To their clients, BlackRock said they were preparing for “increasing the role of votes on shareholder proposals in our stewardship efforts around sustainability”.

The energy transition is shifting into high gear. Recent court rulings and investor resolutions, many of which landed in the headlines last Wednesday, reiterate the urgency of planning for the impacts of the energy transition. The sudden change reiterates how identifiable specific ESG risks can be ahead of time even if it is difficult to prepare for every eventuality up front. Financial institutions with the greatest number of indirect points of contact with ESG risks need to invest the most now to avoid being caught flat-footed in the future.

In the current cases of multiple risks being realized all at the same time, a Dutch court forced Shell to cut its emissions (including Scope 3 emissions generated by the burning of its oil & gas products) by 45% in the next 10 years. A shareholder resolution was passed at Chevron forcing an emissions reduction target including Scope 3 emissions, and an activist shareholder elected two board members to Exxon’s board to direct the company towards a more orderly transition.

One of the notable changes, besides a majority of investors supporting climate reorientation at publicly listed oil companies, is who is on board with the new changes. It’s not just the ethically oriented investors who have been engaging with energy companies for years. BlackRock, whose approach to ESG has attracted criticism for not driving real world impact, was among the investors supporting the new board members at Exxon as well as voting against a company’s climate strategy at BP.

BlackRock CEO Larry Fink, writing in his 2021 letter to CEOs, said, “We are asking companies to disclose a plan for how their business model will be compatible with a net zero economy… We are asking you to disclose how this plan is incorporated into your long-term strategy and reviewed by your board of directors.” To their clients, BlackRock said they were preparing for “increasing the role of votes on shareholder proposals in our stewardship efforts around sustainability”.

The attention focused on oil companies is about their climate-related risks because these are the most financially material. However, what has taken place could be equally relevant to any listed company, with climate change presenting a common risk across many countries, enough so that BlackRock’s Fink said that in the domain of climate risk disclosures, they should also be adopted by private companies.

As we’ve seen in the past week, institutional investors will act when given the opportunity, and proactively as well. The level of expectation they have for companies they are invested in is rising, but it isn’t unreachable or unrealistic for those companies. Although BlackRock voted against management climate policy and director nominations at Chevron, BP and Exxon, they supported plans at Total and Shell (notwithstanding the legal decision about the latter).

The amplification of investor engagement and advocacy on issues like climate change and other ESG issues validates the claim that it is serious and important and that companies need to approach it as such. An oil & gas producer can get the support of investors on ESG, but it takes a clear and well thought-through strategy that acknowledges the ESG issues present and makes a real effort to address them even if it will be disruptive to the company’s current trajectory. If an oil & gas company can gain support from an ESG-minded investor, the same thing is possible in other sectors.

Flipping through various sectors’ key ESG risks, such as those listed in the SASB Materiality Map, makes another thing clear. Financial institutions with reliance on non-financial customers’ ability to manage their own ESG issues will be a significant challenge to track and monitor.

Financial institutions have to respond to their own investors’ concerns about ESG issues. Yet, because so much of their own ESG footprint is indirect and dependent on their customers’ behavior, they can either become an expert on every customer’s ESG risks, or find other ways to drill down to identify where they should invest more to address the concerns that investors have, with the greatest probability of reaching a tipping point where financial risks become amplified and realized overnight.

Want to learn more about how RFI Foundation can help you identify your biggest opportunities in responsible finance? Contact us for more information through our Membership Page or by email at info@rfi-foundation.org.

Republished from the RFI Foundation’s weekly newsletter. Subscribe for free here!