Investors increasingly recognize that sustainability issues – environmental, social, and governance (ESG) issues that are often overlooked by traditional analysis – can be material to investment performance. Recent examples demonstrate that ESG issues such as toxic waste, workplace safety, or corporate governance can significantly impact companies’ reputations and financial performances. For instance, Apple’s share prices dropped 5% after unsafe working and living conditions of its Chinese manufacturer’s personnel were publicized in 2010. Similarly, the Deepwater Horizon oil spill wiped out more than half of BP’s stock value.
Studies show that strong ESG management can help companies perform better and can mitigate negative publicity in times of crisis. Therefore, it is imperative that companies understand the importance of ESG issues and adopt sustainability strategies focusing on the three main elements – information, innovation, and integration – to moderate sustainability-related risks and take advantage of associated opportunities.
Transparency can help companies control the information flow, improve their reputations, and prepare for increased disclosure standards in the future. In today’s world, information travels fast. Surfacing mistakes can impact companies’ reputations and financial health. Therefore, it is wiser to report proactively on successful sustainability projects, while also mitigating ESG mishaps with voluntary reporting strategies that uphold the company’s reputation. For instance, by disclosing statistics such as injury, fatality rates, and safety management efforts, extractive companies demonstrate their commitment to safe operations. In 2012, by openly reporting that it fell short of its target proportion of alternative-fueled vehicles in its fleet due to the changes in market conditions, Verizon positioned itself as upfront and proactive.
Companies should measure their carbon footprint and participate in reporting initiatives. By making their sustainability data public, they are more likely to receive improved ESG or credit ratings, and benefit from lower cost of capital. As an additional benefit, this will also help to prepare for more stringent disclosure standards. Growing recognition of the significance of ESG has already led to some changes in disclosure requirements worldwide. In the U.S., several prominent pension funds require consideration of ESG factors in their investment policy guidelines. In 2010, the U.S. Securities and Exchange Commission (SEC) issued guidance on climate risk information disclosure. However, broader disclosure requirements are imminent with organizations such as the Sustainability Accounting Standards Board are already developing industry-specific accounting standards that companies can use to report on ESG issues in their required disclosure filings with the SEC.
Innovation can help companies improve their sustainability, financial performance, and competitive edge. Instead of engaging in costly sustainability initiatives irrelevant to their strategy and operations, they need to focus on ESG factors essential for their business, while also benchmarking against competition. A good start is identifying and eliminating the main sources of inefficiency. Reducing manufacturing waste, decreasing emissions, enhancing energy or water management all can improve operational efficiency and help to realize savings. However, getting ahead of competition requires a broad company-wide innovation. New products, processes, and new business models are needed to take companies to the next level of performance. For example, Apple has reduced the amount of materials and energy utilized to produce and maintain its products by making them smaller, lighter and more energy efficient. Facing criticism, Dow Chemicals Company focused its efforts on eliminating waste at the source and innovation of its products and processes. Between 2005 and 2010, Dow reduced production related waste over 17%, despite company’s expansion.
Integration of ESG factors into the main strategic decision-making processes is key to organically improving companies’ sustainability and financial performance. Such comprehensive approach to sustainability would require an organization-wide understanding of ESG factors and their impacts on the company, and uniting all of the elements – transparency, efficiency of operations, and innovation. According to Westpac Banking, an Australian corporation chosen as the most sustainable company of 2014, sustainability includes not only operational efficiency, but also “mechanisms to encourage meritocracy, diversity, innovation and long-term planning beyond the next financial quarter”. Apple has also been addressing sustainability on multiple fronts by not only diligently providing sustainability reporting, but also committing to minimizing its environmental impact and GHG emissions, supplying 100% of power for its facilities from renewable sources, and ending the use of conflict minerals.
Every company is at risk from climate change. This risk is relevant to all industries and will affect the financial performances of companies across the board. This is not only in a few industries that might immediately come to mind, such as energy or real estate.
Climate change-induced natural disasters may have a detrimental effect on the daily operations and production cycles of companies in a variety of sectors and industries. Logistics companies’ operations are fully dependent on infrastructure. It is clear that their operations suffer if ports and roads are impaired by rising sea levels or are not accessible because of storms. The 2010 volcanic eruption in Iceland and the 2011 tsunami in Japan highlighted the vulnerabilities in the modern global supply chain of many companies from electronics to the automotive industry that outsource their manufacturing around the world. While Japanese plants remained closed, international companies like Ford Motors, for example, suffered from production disruptions due to insufficient supplies of their Japanese-made parts.
Climate change may impact the financial performances of companies by increasing the cost of doing business, whether it is in the form of increased price for electricity or water treatment, or the costs of infrastructure repair. At first glance, IT companies’ vulnerabilities to climate change risk may not be obvious. Yet, these companies rely on large quantities of water to cool their servers and have a high demand for electricity to run their data centers. As the climate continues to change, both of these are commodities that will be potentially more difficult and more expensive to procure.
To reduce the impact of climate change on financial performance, companies’ risk mitigation strategies should address climate change risk. One way is to incorporate climate adaptation strategies into daily operations and focus on both technological and behavioral changes. By taking a risk management approach, companies can mitigate the numerous risks posed by climate change and continue to venture in the future. Companies that fail to adapt will be eclipsed by their competition.
With the U.S. reaping the benefits of domestically produced shale gas, all eyes are on Europe. When will it follow suit? Yet, while shale gas development in Europe is expected to spur economic growth and reduce unemployment, many experts do not see shale gas as a "game changer in Europe the way it has been for the U.S."
A recent study commissioned by the International Association of Oil & Gas Producers quantifies how much Europe’s economy could benefit from shale gas production. According to the study, shale gas production could add a total of more than 3 trillion euros to the economy during 2020-2050 and up to 1 million jobs by 2050. These gains additionally would result in higher tax revenues, more internal investment, more disposable income, better security of supply, and, ultimately, more prosperity.
Understanding potential benefits at stake, some European governments are worried about falling behind the U.S. on unconventional gas and technologies, and are eager to follow the U.S. lead. Many oil and gas companies are enthusiastically looking for new opportunities. Encouraged by significant shale gas reserves, the UK government is planning to open up thousands of square miles of countryside to shale gas exploration, despite protests by local communities. Chevron and other oil and gas giants are already involved in shale gas exploration projects in Poland, Romania, and Lithuania. The company just signed an agreement allowing it to explore for shale gas in Ukraine.
And yet, despite the potential gains from shale gas, European countries are not fully convinced that its pursuit is in their best interest for several reasons. Firstly, Europe’s geology is different from that of the U.S. Deposits in European countries are smaller, more complex, and lie deeper underground. It is also difficult to obtain water for shale gas drilling, as accessible water is less available in Europe. These differences in the environments require more advanced technology than in the U.S., so simple technology transfer would not do. Plus, Europe is already behind the U.S. in terms of its oil and gas infrastructure, equipment, and skilled labor availability.
Population density and land ownership is different in Europe as well. Shale gas drilling requires access to land. Because of Europe’s population density, many deposits lie in industrial and urbanized areas. As a result, shale gas development presents serious environmental and health threats. At the same time, in Europe, individuals do not own underground commodities, as they belong to the state. Being sensitive to uncertain environmental consequences of hydraulic fracturing, Europeans have little incentive to support drilling nearby.
All of the factors mentioned above make shale gas development more difficult and costly in Europe. Furthermore, several recent studies suggest that shale gas prices are not likely to be competitive with cheaper natural gas imports and will not lower gas prices in the near future. In addition, shale gas exploration would require additional incentives from the governments, which will put shale gas development in direct competition with renewable energy sources.
Experts agree that shale gas is not going to play the same role in Europe as it has in the US. After all, most recent European shale gas projects, such as the ones in Poland or Romania, so far remain unsuccessful.