Impact Investing Conference

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ESG Regulation in the Oil and Gas Industry The National Law ReviewESG Regulation in the Oil and Gas Industry The National Law ReviewESG Regulation in the Oil and Gas Industry The National Law Review

Impact Investing Forum 2024

London. April 24-25, 2023.

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Thursday, September 23, 2021. The establishment of ESG values and metrics is a significant change in the way corporations are managed, measured and operated. This sea change will continue driving companies away from the traditional framework of short-term profit to success that is defined not only by profitability but also by a “sustainable” contribution to the betterment and improvement of society. This new paradigm breaks with a long-standing tradition. ESG may be perceived as difficult to implement and a profit-killer by some, but it actually has the opposite effect for most companies that implement ESG programs. This includes those in the oil and gas sector. According to the International Energy Association (IEA) 2021 Global Energy Review ESG, renewable energy grew 3% in 2020. This includes a 7% increase of electricity generation from renewable sources. This logic would suggest that fossil fuel demand would drop if all things were constant. However, all things are not equal. This is despite the 4.6% increase in global energy consumption this year, which comes at a time when the world is still feeling the effects of COVID-19. The demand for fossil fuels has not decreased and will continue to rise. While coal is the largest driver of this demand, it is also driven largely by Asia. However, natural gas drives almost all geographies. The demise of fossil fuels is highly exaggerated, even as we strive to meet our growing energy demands from renewable sources. The industry is not going away. However, the way it operates and its contribution towards society and the economy will change. Why is this? ESG is an ethical imperative because of its societal implications. Money talks. BlackRock, the world’s biggest investment manager, has $10 trillion in assets under management. According to S&P Global as of February 2021 oil and gas accounted for 2.55% and coal and other consumable fuels for 0.36%. These small amounts are still significant and amount to close to $255 billion and $36 million, respectively, in the energy sector. People listen to Larry Fink, BlackRock’s CEO, even those working in the energy sector. To that end, in a 2020 letter to investors, Larry Fink warned that “Given the groundwork we have already laid engaging on disclosure, and the growing investment risks surrounding sustainability, we will be increasingly disposed to vote against management and board directors when companies are not making sufficient progress on sustainability-related disclosures and the business practices and plans underlying them.” BlackRock was and still is a key player in the creation of the ESG imperative. However, it is only one of many stakeholders pushing companies across all sectors to embrace ESG. It is also helping to create metrics to measure progress towards achieving the goals. Energy companies must not forget that despite all the talk about the energy transition and net zero economy goals, and the importance of ESG overall. Also, 1) there is unlikely to be a decrease in global energy demand – population growth is continuing to increase – and 2) broad index funds cannot abandon the sector or create assets stranded. However, companies will be unable to access public and private capital if they do not have an ESG strategy. This will happen to all companies, regardless of whether they are publicly funded. An ESG strategy that is not in place will eventually limit a company’s ability to access public and increasingly private capital. Companies are under increasing financial pressure to implement ESG programs. This is due to the Administration’s efforts to address global climate imperatives. The Biden Administration has made the fight against climate change as well as environmental justice a central part of its agenda. After his inauguration, President Biden immediately joined the Paris Agreement and set a 2030 goal to reduce GHG emissions by 50% compared to 2005 levels. To get there, federal regulation must be increased and environmental protection must be enforced across many industries. Within days of his inauguration, President Biden signed Executive Order 1408 entitled Tackling Climate Crisis at Home, Abroad. This further demonstrates his intention to establish a governmentwide approach to the “climate crisis” as well as ensuring that environmental and economic justice issues are important considerations in the Administration’s governance. The widespread support for ESG policies, matrices, and the overall energy transition is rooted in some important and likely correct assumptions. In the coming decades, climate change will be a major threat to global economies’ stability. Temperature shifts could make large tracts of farmland unproductive. Rising ocean tides could make major coastal cities uninhabitable. This scenario is a strong argument for ensuring that greenhouse gas (GHG), emissions are reduced as soon as possible to ensure long-term economic prosperity. The social unrest and reality of COVID-19 in the last two years have brought to the forefront of everyone’s minds the importance of social problems across the board. These images lead to the belief that ESG’s “E” stands for climate change, and that ESG’s “S” stands for diversity, equity, and inclusion programs. Both definitions are too narrow. “E” encompasses a wider range of factors and includes the company’s use of natural resources, including water and land, as well as the effects of its operations on biodiversity, the environment, and their supply chains. Pollution and waste includes not only carbon emissions but also packaging and other regulated and emerging contaminants as well as the depletion or limited natural resources like rare earth metals. While investments in renewable resources are a clear opportunity for the environment, they are not the only one. ESG values can be aligned with energy exploration and production (E&P), companies that go beyond the end product. Many large integrated energy companies have already begun to work towards reducing their environmental impact by establishing ESG programs and policies. Occidental Petroleum Corp. was the first large U.S. oil producer to establish a net zero emission target for their own emissions by 2040 and a commitment by 2050 to reduce GHG emissions associated with their products. Shell Oil held a shareholder vote to approve their sustainability strategy. 89% of shareholders approved it. Their goal was to reduce their carbon intensity by 100% by 2050. ExxonMobil announced a four-pronged sustainability framework, which includes $3 billion in carbon capture or storage projects. British Petroleum continues to invest heavily in wind, solar and hydrogen. It is also one of the most significant contributors to renewable organizations worldwide. They sold operations that had reduced their overall emissions by 5.4 million tonnes in 2020, which was a first step towards their goal of reducing emissions to 41 Mte by 2050. Kinder Morgan has also recently established a new unit to investigate green energy opportunities. This includes the storage and handling liquid renewable transportation fuels like ethanol, renewable diesel, and hydrocarbons. It is clear that energy companies are paying more attention to the ESG revolution and are actively embracing it. Big Oil is driving change through shareholder buy-in, media pressure, customer demands, and customer expectations. What about small and mid-sized players? As mentioned above, they will be driven by both capital access and customer expectations as well as ethical concerns. These companies may have different ESG programs. They may have smaller operating margins and less human capital. It is crucial for any company to understand where it stands right now in order to get to where it wants to go. Every company should understand their ESG position and have policies that are tailored to them with goals that align with their business strategies. Although it may seem simple, it is crucial. Only then can progress truly be measured. It is crucial for any company to know where it is at the moment so it can move forward. To be successful over the long-term, it is important to implement metrics within a defined time frame. Amy Stutzman, Opportune’s Managing Director, was correct when she stated, “I think it starts small and then scales up over time.” According to what I hear in the market and from private capital, there is no expectation of perfection in the first year. Instead, the expectation is that companies will engage in the issues and make progress over time. But what about compliance and adherence? The answer for small and medium-sized companies is the same as for large public companies. Industry specific standards and guidelines are required, companies must set goals and targets, and managers need to be incentivized to succeed. Kimmeridge’s September 2020 report on E&P companies reveals that the drive to produce more than returns and wasteful production will continue. This will lead to poor economic outcomes and more flaring. We can all agree that investors like BlackRock expect companies to begin to benchmark, identify policies and develop programs to track progress towards goals. They also need to align executive compensation packages to achieve short- and long-term ESG goals. The establishment of reporting guidelines has been started. These will serve as a guide for the development and benchmarking of programs against other companies. Each framework is based on input from stakeholders. It was developed by the Securities and Exchange Commission (SEC), the Sustainability Accounting Standard Board(SASB), American Petroleum Institute (API), Carbon Disclosure Project, and Task Force on Climate-related Financial Disclosuress (TCFD). Companies must create programs that are specific to their operations, regardless of the standards. Kimmeridge’s report on the “E” suggests three goals for E&P companies. Zero gas flaring. Global methane production is 2% due to gas flaring. 100% recycled water for fracking. Net zero emissions. E&P companies can also look at water recycling in Fracking to address the E component. They can also monitor pipeline leaks and undertake clean air initiatives. This will allow them to reduce environmental releases and non-compliance. ESG’s “S” component includes employee practices, community engagement, worker safety measures, diversity, equity, inclusion programs, customer satisfaction, product safety, quality assurance programs, and overall data security improvements. The “G” in ESG refers to governance factors. This includes policy making and the distribution rights and responsibilities among different stakeholders, such as the board of directors, managers and shareholders. Governance is key to incentivization and compliance to guidelines. It includes the composition of boards, compensation, and oversight of top executives. These are just a few examples of ESG opportunities available to an industry that is perceived as being antithetical to the framework’s guiding principles. Ms. Stutzman is right to point out that ESG offers oil and gas companies the opportunity to tell their stories and positively influence the perception of the industry. The industry already does so much for our environment and gives back to the communities they serve. ESG is now mainstream. Bloomberg tracked nearly 300 mentions of ESG in earnings calls for energy companies during the first quarter of this year. Any company can benefit from recognizing the role E&P companies have in climate change and other ESG initiatives. ESG is here to stay, and the genie is out the bottle. The ESG movement may seem daunting to tackle on the frontend, but it is a functional and cultural shift that companies must embrace and then take action. The ESG movement may seem daunting on the front end. However, companies are expected to embrace the concept and take action. Here are some steps that will help E&P (or any company) get started. To create a plan, a cross-functional team should be formed. This team should include members of the company’s disclosure panel. Consider retaining an outside consultant to help craft your plan and reporting framework–preferably someone with experience assisting companies in the same industry. Get involved in energy industry trade groups to find out what other companies are doing regarding climate plans and preparations to disclose. Examine policies and procedures to ensure they address ESG/climate risk. Then, evaluate how well the company has implemented these policies. The board should ensure that the policies and procedures are in line with the overarching strategy of the board and are moving the company towards net zero. Reporting is required throughout the company to ensure that managers are aware that corporate executives view climate change as a business imperative. Continue education of the board on the frameworks for the plan, and any disclosure obligations. Education is not a one-off event. It should be a continuous process that flows throughout the organization. Regular board reviews and oversight of the planning process, plan itself and progress against it should be established. Your company should document the steps, process, and progress so that they don’t become an undue distractor. Many small-cap businesses won’t be able or willing to dedicate large amounts of staff or resources to climate problems. The company must be able to deliver on its goals and the roadmap must be credible. BlackRock, other shareholders, the SEC and proxy advisory firms as well as trade groups will continue to press companies to address climate risks and adopt ESG policies. Your company can align itself with many stakeholders by taking small steps today and planning for the future. There is no limit to creativity. You can actually look at your business from a different perspective and find hidden value. ESG is a long-term investment that can bring long-term benefits to a company. Sustainability practices can often lead to savings and satisfy the most important constituencies of your company. It can also create a value proposition for investors and a marketing story to attract new capital. Fink wrote that the creation of sustainable index investments had enabled a massive acceleration in capital towards companies better equipped to address climate risk in a 2021 letter addressed to CEOs. He also stated that he is “very optimistic about the future of capitalism” and the economic health in the future–not because of, but because of, the energy transition. He will hopefully be proved right. Copyright (C), 2021 Womble Bond Richardson (US), LLP All Rights Reserved. National Law Review, Volume XI Number 266

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ESG Investing Conference