Strong financial performance — once virtually the only criteria of interest to investors — is no longer enough. Today’s investors are aware that strong environment, social and governance (ESG) performance is increasingly linked with stronger operational performance and higher returns. Data and performance on ESG metrics are increasingly important as individuals and organizations seek to understand companies’ long term sustainability.
For example, the Global Sustainable Investment Alliance (GSIA) estimates that ESG-focused investments represent in excess of US$30 trillion globally, and Deutsche Bank suggests this will double in the next three years (Fitzpatrick, 2019). At the beginning of 2018, some US $30.7 trillion in sustainable investing assets were under management across the five major markets worldwide (GSIA, 2019), following a 34 per cent increase in the previous two years.
“Investors are increasingly requiring companies to provide more disclosure on ESG factors that may have an impact on a firm’s long-term valuation – with a focus on credible, standardized information that helps investors assess material risk,” comments Ben Brunnen, VP, oil sands, fiscal and economics, Canadian Association of Petroleum Producers (CAPP).
And Jackie Forrest, senior director, ARC Energy Research Institute, adds, “Many investors believe we’re heading to a lower emissions future, so carbon tax and policies to reduce emissions are becoming more stringent over time. If you’re investing in oil and natural gas, you’re interested in lower-carbon production facilities because they’re likely to be more resilient, with less carbon tax, less environmental liability. These are business risks, and to attract investment capital a company must show action to address them.”
Read More: CanGeo’s Climate Change and Energy video
A developing field
According to a recent article in Forbes magazine, the term ‘ESG’ was coined in 2005. The concept builds on the older Socially Responsible Investment (SRI) movement. Unlike SRI, which primarily uses negative screening such as not investing in alcohol, tobacco or firearms, ESG investing is based on the assumption that ESG metrics are nonfinancial risks that are material to stakeholders and capture a more complete and transparent picture of the risks to a firm than financial metrics alone. To many investors, ESG information is vital to understanding corporate strategy and management.
Credible ESG data gives investors the opportunity to vote with their money. Disclosure on ESG performance can help investors identify companies that are well positioned for the future, and to evaluate how companies address risks arising from such business challenges as climate change, operational safety, and corruption. For government policy makers, ESG is a market-led means to ensure common societal values are not sacrificed for short-term profit and shareholder value creation.
But even as ESG reporting becomes more common, standardization is a concern — investors and other stakeholders need confidence that ESG scores are consistent and comparable performance measures.
Another major issue is a lack of data and the necessary tools to objectively understand the fragmented and incomplete information available. Despite ESG reporting improvements since the launch of comprehensive reporting frameworks, a gap remains between company disclosures and investor requests for information. The first largely adopted framework was the Global Reporting Initiative (GRI) standards. More recently, the International Integrated Reporting Initiative (IIRC) and the U.S.-based Sustainability Accounting Standard Board (SASB) have helped to advance sector-specific reporting.
ESG in Canada’s upstream industry
“Environmental and social risks are well managed and seen as part of running a business, and governance is becoming part of that mix,” says Brunnen. “ESG is synonymous with good governance, which in turn drives positive environmental, social and business performance.”
“ESG scoring services have sought to meet investors’ disclosure and ranking needs, but scoring currently lacks relevant context or criteria are focused on non-material risks,” says Brunnen. “Producing companies now bear the burden of responding to multiple surveys and/or developing their own disclosure materials, which may not be consistent across the industry and may not meet the needs of investors. The investment community has also expressed frustration with the current state of ESG disclosure.”
Canada is an ESG leader
Even without an accepted common framework for ESG assessment, individual Canadian oil and natural gas companies are top performers according to a number of independent assessments including BMO Capital Markets and IHS Markit.
While company-specific ESG measures continue to evolve, Canadian oil and natural gas firms generally exhibit strong performance in this space. Canada as a nation also ranks highly compared to other oil exporting nations when it comes to internationally recognized environment, social and governance indices and metrics such as corruption, human rights and the rule of law.
CAPP and member companies are working to develop an approach for ESG reporting. Through CAPP’s ESG and Capital Markets Steering Committee, the industry is building a consensus on its ESG strategy and approach. Climate, community and indigenous engagement, process and personal safety, and environmental management are top ESG priority areas for the group.
For additional information, BMO Capital Markets has created a series of podcasts titled “Sustainability Leaders,” offering insights on ESG from an investment perspective.