ESG- How did a measurement of sustainability become exclusionary to Canadian Oil and Gas?

It seems in this era of disruption that no sooner than a trend becomes popularized, it is diverted from a perceived original purpose. This is increasingly true of ESG- the Environmental, Social and Governance reporting and assessments compiled by asset management companies aimed at achieving sustainable outcomes for investors. The origins of ESG data collection are in the 1990s with the concept of intangible value assessment which according to MSCI.com (Morgan Stanley Capital International) examines corporate management of environmental and social risk factors to reveal investment risk. As currently touted by market intelligence companies like S & P Global, ESG ratings are offered as solutions offering “financially relevant analytics and timely data to assess risk, uncover opportunities and inform long term sustainable growth.”  ESG risk rating companies like Sustainalytics.com offer ratings, research, and analysis into the investment process, and up the ante by offering “next-generation ESG ratings”, designed to help investors identify and understand financially material ESG risks at the security and portfolio level. Still further, asset management firms like AGF offer ESG 2.0 -promoted as a Post-COVID-19 Roadmap for the Evolution of ESG -noting that the COVID-19 crisis, presents an opportunity for a much deeper assessment of the role of markets, governments, and workers. Another rating agency, State Street promotes their take on ESG 2.0 as an important move towards common disclosure standards but admits “companies and investors are struggling to agree on the ESG metrics that matter most to investors and how companies can best capture and disclose that information.”  Cam Bailey, Senior Exec & former CEO of High Arctic Energy Services recognizes the challenges of ESG reliability and failures to get agreement on metrics.

“It is a very noisy part of the investment ecosystem because you’ve got 200 different companies that are providing ESG ratings and those ratings are derived from scraping public data – company publications, other public records, and third-party data – trying to come up with standards. Those standards are not particularly good. For example, there are about five different standards that they could follow. The most common one for Canada is one called GRI – one of the first global standards for sustainability reporting. The issue is when you go through those standards, they do not seem to really capture the key elements.”

Canadian E&P companies and oilsands are particularly punished by ESG rating agencies and the oilsands are often subject to exclusion using global fossil fuel exclusion indexes that screen oilsands companies out.

“The rhetoric we hear is that Alberta is one of the best regulatory and social policy environments. But it is not resonating with rating agencies. Once an exclusionary attitude prevails,  it’s really difficult to win that back.” according to Bailey. “One of the most striking exclusions was announced by the world’s largest sovereign wealth fund Norges Bank Investment Management which divested from four Canadian oilsands companies over concerns about carbon emissions, following which shares in Suncor Energy Inc., Canadian Natural Resources Ltd., Imperial Oil Ltd., and Cenovus Energy Inc. all tumbled between 5 and 7%. Ironically, the divestment movement is focused on the wrong targets. Independent oil companies currently only produce about 10% of the world’s oil and Alberta’s energy industry is being made up almost entirely of IOCs. The rest of the world’s production is from national oil companies – many with poor ESG standards.”

In addition to the negative effect of exclusion indexes, environmental groups like the Tides of Canada or the Sierra Club have been quietly affecting investor attitude. The group gofossilfree.org cites 1,237 institutions and $14.1 trillion of investment has been diverted away from the fossil fuel industry. State Street Asset Management – in the top 5 of the top ten global asset management firms used to be very active in the energy business in Canada. Today with 33.4 billion dollars under management, their total in Canadian holdings is less than 100 million dollars out of the total portfolio and part of that is because of ESG issues. State Street cited a large gap in the confidence of data quality between issuers and investors as a factor. They have also claimed that there are deficiencies in the reporting and are concerned about how verifiable reporting is. Part of the problem is that proxy advisors can advise companies on how to vote their shares. The environment has become a bigger part of the discussion and environmental issues are considered in the decision process for directors’ remuneration along with social issues. There are far more broad opinions making stock selections.

Bailey is proposing a different approach. He proposes an Alberta Green Bond to tap ESG conditioned financing as a capital market product. In Bailey’s assessment, the Green Bond market has matured to the point where the issues in 2020 will exceed $300 billion. He states an Alberta Green Bond is likely to be one of the best performing Green Bonds to hit the market considering the impact it could have on Alberta energy companies and their ability to reduce GHG emissions and water consumption. Tied to the funding with an Alberta Green Bond would be the fulsome reporting requirements and verification process being demanded by institutional investors. An Alberta Green Bond could distinguish the Alberta energy industry and could be a step towards unlocking capital markets, according to Bailey.

“The idea behind the green bond is not just to provide financing but also to create a direct connection between the companies that potentially issue and participate in a bond and the investors themselves – those that are particularly sensitive to ESG matters and making selections.”

Bailey hopes that an Alberta Green Bond could be a useful tool to counter the negative effect of global fossil-fuel exclusion indexes on Canadian oil and gas investment.

Maureen McCall is an energy professional who writes on issues affecting the energy industry.

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