Influence of ESG criteria on oil investments

Introduction

Today, addressing global challenges such as climate change and the impacts of hydrocarbon extraction and production practices is fundamental for the oil sector. This has led to the implementation of sustainable strategies by companies and organizations aimed at preserving natural resources. One of the most relevant strategies is framed within the financial sector, involving the implementation of ESG criteria on oil investments, a practice rooted in the commitment to improve environmental, social, and corporate governance aspects.

ESG criteria have become key issues for socially responsible investors. In addition to the financial results they generate, they can also be indicative of long-term success, given the value they provide to each of the operations carried out in the oil sector. Throughout this article, we will examine the effect of this strategy on the oil industry, specifically on investments made to improve the extraction and production processes of the resource.

What are ESG criteria?

ESG criteria (Environmental, Social, and Governance) are a set of standards used to assess the impact of a specific organization on these aspects. Their aim goes beyond merely measuring financial gains, as they have a comprehensive approach that promotes sustainable practices and generates long-term value¹. These criteria seek to provide additional benefits beyond economic ones, aiming to enhance societal development and benefit all stakeholders.

Environmental

This is one of the three fundamental pillars in the evaluation of oil investments, focusing on analyzing and assessing a company’s environmental risks and their impact on the ecosystem. Environmental criteria address critical challenges such as climate change, water safety, environmental health, waste management, and biodiversity. Companies must take a proactive approach to address these interconnected risks, in addition to merely complying with minimum regulations.

Some examples of environmental criteria include measures to reduce carbon emissions, energy efficiency practices, water scarcity management, control of air and water pollution, waste management strategies, and conservation and protection of biodiversity. These criteria are essential for evaluating a company’s commitment to environmental sustainability and its ability to manage associated risks.

Social

These criteria focus on a company’s interaction and engagement with various groups and civilizations, aiming to improve social well-being in all areas of influence. They include efforts to reduce inequalities, advocate for human rights, ensure the health and safety of workers and surrounding communities, as well as promote inclusive and fair relationships.

Companies committed to social aspects can generate a positive impact on communities at both local and global levels. This is reflected in inclusive labor policies, due diligence in the supply chain, and proactive community relations. In conjunction with regulatory compliance, companies can promote improved working conditions by offering flexibility, growth opportunities, and internal promotion.

Governance

This criterion focuses on corporate ethics, prioritizing qualities such as leadership and transparency. To achieve optimal governance, policies are encouraged for diverse boards, strict accounting standards, regulation of compensation, and management of conflicts of interest.

Additionally, governance promotes a system of internal controls to prevent illicit activities such as bribery and corruption, addressing structural and organizational management aspects. These criteria foster corporate responsibility and ethics, promoting responsible and transparent conduct. Their importance lies in ensuring integrity and sustainability in oil investments.

What is the role of ESG criteria on oil investments?

The primary goal of ESG criteria is to carry out sustainable, responsible, or socially responsible investments (SRI) by assessing and considering a wide range of behaviors and policies of companies according to these parameters. Investment based on ESG criteria refers to the evaluation that companies receive based on these criteria and responsibility standards, which influences potential investments.

Environmental, social, and governance aspects measure how a company protects the environment, assesses relationships with employees, suppliers, customers, and communities, and its leadership-based analysis. These criteria help investors assess the impact and sustainability of oil companies in environmental, social, and management terms. These terms can influence their investment decisions and how companies in the sector adapt to market demands and societal expectations regarding sustainability and corporate responsibility.

The impact of environmental policies on the oil sector

Currently, the oil and gas industry is shifting its focus by adopting new models of sustainable and responsible production and business management. This is because decarbonization has become a key factor in ecosystem improvement²; therefore, environmental policies in the oil sector represent a means of ensuring the optimal development of sector activities under rigorous international standards.

Addressing environmental criteria is widely recognized among industry executives, with a focus on evaluating costs and climate risks. Collaboration in emissions reduction is an essential aspect in the field, as it ensures long-term competitiveness and also serves as a means of accessing investment funds.

The importance and value of these regulations are consensually recognized throughout the oil sector. According to investors and financial directors, ESG metrics and strategies will define guidelines for the next decade in the context of sustainable investments. The reason for this is that business models are based on companies’ proper performance with the environment and society so that they can be financed.

Importance of criteria in oil investments

Over time, ESG criteria are becoming increasingly relevant in oil investments. From an investor’s perspective, analyzing these factors provides homogeneous data that serve to compare companies under contexts such as sustainability and management. Its significance lies in understanding and analyzing how companies implement work and production models under environmental, social, and governance standards, allowing for better investments based on the data obtained.

ESG investment is a process by which investing entities assess and determine the utility of companies. Identifying the impact, whether positive or negative, of an organization on the environment, community, or workplace serves as a model for projecting towards better sustainable investments, especially in such an important and delicate sector as the oil industry. Companies that meet ESG goals are considered well-managed, which ultimately serves as an indicator of good values for investors.

Considerations of environmental criteria in the industrial framework

• Diversification and optimization of portfolio resources: Companies have a duty to assess the diversification of their investments to align them with ESG goals. This resource optimization would involve identifying opportunities for renewable energy, emission reduction, and supply chain efficiency.
• Attraction, training, and retention of talent: It is crucial for oil companies to have professionals with skills and knowledge in sustainability and renewable energies. Additionally, training is essential to educate employees on responsible practices. Retaining professionals in the field involves providing a work environment committed to sustainability.
• Full adaptation of operations to ESG requirements: It is essential for ESG criteria to be integrated into all operational areas³, from exploration and production to transportation and distribution. This involves implementing clean technologies, reducing emissions, and improving waste management.
• Influence throughout the business ecosystem: Environmental and social principles impact not only oil and gas companies but also financial institutions, insurers, and investors. Compliance has become a moral and business imperative, leading to repercussions in corporate strategies and investment decisions.

Conclusions

The adoption of ESG criteria in oil investments, besides benefiting sector companies, presents significant advantages for the planet and communities near such facilities. Reducing environmental footprint, promoting fair and ethical labor practices, and embracing responsible business models are among the strategies that can contribute to a better future.

While the implementation of ESG criteria poses certain considerations, these should not hinder progress towards a more sustainable oil industry. Companies that effectively integrate these criteria will have higher standards, positioning them better in the market, ensuring long-term success, securing sector viability, and contributing to a greener and more equitable industry.

References

1. Anderson, K. (2023, August 2). ESG criteria: what you need to know. Retrieved April 12, 2024, from https://greenly.earth/en-gb/blog/company-guide/esg-criteria-what-you-need-to-know
2. green4T. (2022, October 11). How does technology help consolidate the ESG of the oil and gas sector? Retrieved April 12, 2024, from https://www.green4t.com/es/insights/como-ayuda-la-tecnologia-a-consolidar-la-esg-del-sector-del-petroleo-y-el-gas/
3. Michael Kyprianou & Co. (2024, January 16). The Influence of ESG on Oil and Gas Companies. Retrieved April 13, 2024, from https://jpt.spe.org/the-influence-of-esg-on-oil-and-gas-companies