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.
In the aftermath of the notorious oil spill in the Gulf of Mexico, which had vast environmental, economic, and social consequences and in light of U.S. renewed dedication to combating climate change under the current administration, oil and gas companies need to pay more attention to several sustainability issues that, as it turned out, can have a direct and significant effect on the companies' bottom lines and shareholder value.
Safety of Operations
Since exploration and production activities are often conducted in extremely challenging environments, they increase the risks of technical failures and natural disasters. As a result, it is extremely important to develop a strong safety culture and establish a thorough and systematic approach to safety, risk management and operational integrity across the company and in relationships with contractors. The Gulf of Mexico oil spill that took place in April 2010 illustrates the risks companies face in their production activities. Such risks are exacerbated when companies are operating in difficult locations to develop unconventional resources, such as deepwater oil. After the oil spill, BP share prices plummeted on increased uncertainty regarding its potential liabilities with estimates of billion of dollars, which raised fears of bankruptcy. Although the stock price has been recovering, on April 29, 2013, it remained at $42.61 per share, still below its $60 price before the spill. Without robust operational safety efforts, the companies are highly prone to accidents, which can significantly lower their returns, blemish reputations, cause costly litigation and fines, as well as cause interruptions in operations and more stringent regulatory management. Each of these consequences can present significant negative impacts on value, with the extent dependent on the severity of safety issues. Companies committed to maintaining excellent operations safety and continuously improving their safety records will protect shareholder value in the long term.
Response to Accidents
The oil and gas industry is prone to environmental risks and hazards. Oil spills, for example, happen several times every year and lead to significant negative consequences. Since BP’s Deepwater Horizon oil spill, several oil spills took place on U.S. territory. Several thousand barrels of oil spilled from Trans-Alaska pipeline in May 2010. In June 2010, a Chevron pipeline ruptured and spilled an estimated 33,000 gallons of oil into a creek near Salt Lake City. In July 2010, an Enbridge pipeline in Michigan spilled over 843,000 gallons of oil into a creek, which flows into the Kalamazoo River. In July 2011, a pipeline beneath Montana's Yellowstone River ruptured and spilled 63,000 barrels of oil into the river. In addition, several oil spills took place in other countries, including Canada, Brazil, UK, New Zealand, and China. While the ultimate goal is to have no accidents, it is very important for Oil and Gas companies to be prepared and equipped for a swift and effective response to potential accidents. In the public opinion, the way BP responded to the Gulf of Mexico oil spill was ineffective and has hurt its reputation and its shareholder value. The company inadequately interacted with the media regarding the accident, provided inaccurate and incomplete information, and spread the blame. It treated the spill as a short-term issue, underestimating its consequences. BP’s indecisiveness and waste of time in the recovery process caused damage to its reputation. As a result, the company spent $50 million alone on an apology commercial, as well as additional millions of dollars to repair its image. Other recent examples of ineffective handling of accidents by Oil and Gas companies demonstrate how lack of solid preparation plans may have significant negative impacts on shareholder value and tarnish the brand in the long term.
Relationship with Contractors
Modern oil and gas operations generally involve a team effort between companies and many specialized contractors and subcontractors. Therefore, to be able to operate successfully and avoid accidents that diminish the value of companies involved, it is important to define and actively manage the relationship between the various parties, as well as to develop and follow clear rules and procedures to guide roles and responsibilities, communication, training, and accountability.
While the operator and contractor/subcontractor relationship can be beneficial in many ways, such teamwork also creates the potential for miscommunication. Investigation of the Deepwater Horizon oil spill highlights communication failures and shows that BP and its contractors, including Halliburton and Transocean, “lost sight of operational risk, compartmentalizing information that would have been useful to other companies carrying out their respective tasks.” While BP relied heavily on its contractors to advise it regarding important decisions, it failed to adequately supervise its contractors and ensure that they, as well as BP’s own employees, were providing all of the relevant information to the respective decision makers. At the same time, Halliburton, failed to alert BP of many potential problems with the work that it was doing. Both companies and their contractors can be negatively impacted by costly lawsuits, if inability to establish a well-structured, functional relationship leads to accidents. For instance, since 2011 BP has been seeking about $40 billion in damages from its contractors, Halliburton, Transocean, and Cameron International. Most recently, in April 2013, the state of Florida filed a lawsuit against both BP and Halliburton over the 2010 oil spill demanding over $5 billion for the companies' misconduct. Therefore, it is very important for both oil and gas companies and their contractors to ensure that their relationships are well structured and governed, and are mutually beneficial. Without such relationships, these companies put themselves at risk of costly litigation and diminished shareholder value.