Introduction
Generally, the oil industry is put under a microscope from an ESG standpoint due to the widespread negative connotations of the industry presented in the media. An image of a sea otter struggling in an oil spill may be enough to put off an environmentally or socially conscious investor. Others may deem that the importance of oil as a resource makes it a sound investment regardless of the media exposure. Therefore, the presence of ESG in the oil industry continues to be volatile. However, recent global agreements, as well as the Russia-Ukraine conflict may indicate a longer term changing of attitudes towards ESG in the industry for years to come.
Why is ESG important in the oil industry?
ESG considerations have gained increasing importance in the oil industry in recent years. Historically, ESG factors may have been overlooked in the oil sector due to the critical role that energy, including oil, plays in powering households globally, making it challenging for households to prioritise ESG-compliant energy choices over affordability and convenience. As demand for energy continues to grow, at a rate of 4.6% this year, firms may find it easier to bypass ESG procedures to meet demand. However, the potential for ESG in the oil industry is substantial, as evidenced by a 2022 study revealing that five major oil firms, ExxonMobil, Chevron, Shell, BP, and ConocoPhillips, were collectively responsible for 10% of all global carbon emissions since 1965.
Nonetheless, long-term global initiatives such as the Paris Agreement have propelled ESG and renewable energy to the forefront of the energy market, emphasising the need for oil operators to adapt to remain competitive in a changing landscape. The rising prominence of renewable energy, coupled with the emergence of a new generation of investors that prioritise ESG values, has further amplified the significance of ESG considerations. The Paris Agreement aims to reduce global emission levels to 50% of 2005 levels by 2030, while in the US, Order 14008 outlines the need for increased regulation and education surrounding the cutting of emissions. As a result, oil companies that neglect ESG factors may find themselves at a disadvantage in the future legislatively with regulations such as a carbon tax.
Therefore to stay competitive, ESG must improve for firms in the oil industry, with a specific focus on the E component. Currently, the most recognised method is off-setting, where initiatives such as carbon trading allow for decreasing carbon emissions. For example, in 2022 BP offset 2 million tonnes of carbon. However, the oil industry will continue to have a detrimental environmental effect untill it suceeds in net-zero; the current target is to reach net-zero by 2050. Whilst the oil industry is better performing in the S and G components, improvements can still be made. The oligopoly nature of the industry means it is dominated by a small group of very large firms. Therefore, there is potential for inefficiencies in governance leading to social neglect. To improve on this, firms should provide increased social platforms for their employees to be heard aswell as defined metrics in order to better understand ESG underperformance. For example, specific metrics such as the share of capex invested in low carbons.
Overall, it is clear that ESG holds an important place in the oil industry. The need for improvement is significant; without positive change, the climate crisis may become irreversible. Then there is a large potential for innovations leading to improvement; ESG will be at the forefront of the industry for years the next decade and beyond.
How has ESG been affected by the Russia-Ukraine Conflict?
The ongoing conflict between Russia and Ukraine has had significant repercussions for the oil industry, impacting the position of ESG considerations within the sector. Since the start of the conflict, global demand for oil has risen sharply, with war-time demand from Russia and Ukraine representing a significant proportion of this increase. However, this demand is highly inelastic, and thus, not particularly sensitive to ESG practices. Therefore, ESG practices have been sacrificed for many consumers when determining energy consumption.
Furthermore, trade sanctions imposed on Russia have led to increased transportation costs for trade between Europe and Asia. Russia’s decision to limit its oil production, combined with the sanctions, has further pushed the overall price of crude oil upwards. In an attempt to offset these increases, OPEC released some previously withheld oil stocks, but the price of oil reached a peak that was difficult to control. The Brent Crude oil price reached a high of $133 per barrel in March 2022, and while prices have since fluctuated, they have remained elevated.
As a necessary commodity, consumers were forced to bear the burden of these high prices, often at the expense of ESG considerations within the industry. The challenges posed by the Russia-Ukraine conflict have highlighted the need for the industry to find a balance between meeting demand and prioritising ESG practices in the future.
How does the role of ESG change in the oil industry?
ESG will continue to become more significant in the oil industry as oil tries to compete with the increasing presence of renewable sources in the energy market. Firms in this industry have three problems to balance:
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Stakeholders expect changes to be made in line with the Paris 2030 agreement.
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As other energy sources become more reliable, oil prices must continue to be competitive and affordable.
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Retain economic growth in order to continue business operations as oil reserves become more scarce.
From this trilema, it is unclear how oil operators will reach an equilibrium point. Therefore, it is likely that the most successful business in this industry over the next decade will be those who are most innovative in the ESG field to keep stakeholders happy. More specifically, a starting point would be to improve the transparency of ESG in the industry. Stakeholders will no longer settle for unclear or dubious ESG claims and are likely to be increasingly more aware of greenwashing. Further to this, convergence is required within the industry in having a shared ESG framework that companies must adhere to, in order to continue operations. This will help consumers to understand who the better ESG-performing firms are, increasing transparency.
Overall, this evidence suggests that the presence of ESG in the oil industry will increase greatly over the coming years, primarily due to stakeholder attitudes towards climate change and human rights issues. The Russia-Ukraine conflict has represented a stagnation in the presence of ESG as well as other macroeconomic events such as the Covid-19 pandemic. ESG will continue to be particularly significant in the oil industry as society continues to transfer towards net-zero emissions. Whilst in the long-term, it is desirable to move away from oil energy entirely this will not occur straight away and so maximising ESG in the industry will be at the forefront for years to come.
References:
The Importance of ESG in the Oil and Gas industry - Eleven Production, November 2nd 2022. https://www.12eleven.com/news/the-importance-of-ESG-in-the-oil-and-gas-industry
ESG: How it Applies to the Oil and Gas industry, Womble Bond Dickinson, September 22nd 2022. https://www.womblebonddickinson.com/us/insights/articles-and-briefings/ESG-how-it-applies-oil-gas-industry-and-why-it-matters
Russia-Ukraine crisis: Implications for Global Oil Markets, The Oxford Institute for Global Oil Markets. https://www.oxfordenergy.org/publications/russia-ukraine-crisis-implications-for-global-oil-markets/
BBC article: Ukraine War: Oil prices fall back after cap on Russian Oil kicks in, 5th December 2022. https://www.bbc.co.uk/news/business-63855030
World Economic Forum: How can Oil Companies overcome the challenges of ESG reporting? September 1st 2022. https://www.weforum.org/agenda/2022/09/how-national-oil-companies-overcome-challenge-esg-reporting/
The Guardian: Oil firms’ climate claims are greenwashing, study concludes. February 16th 2022. https://www.theguardian.com/environment/2022/feb/16/oil-firms-climate-claims-are-greenwashing-study-concludes
Federal Economic Reserve of Data. https://fred.stlouisfed.org/series/DCOILBRENTEU