Challenges Around ESG Integration in the Energy Sector – Sumit Kumar

Environmental, social, and governance issues (usually abbreviated “ESG”) are an important trend for every economic sector, and the energy sector is a prime example, given the sector’s intimate connection with environmental needs. Sumit Kumar is a quant / investment analyst and Fintech professional working in Capital Market Financial Technologies for the last 18 years who operates at the forefront of this sector.

Currently Sumit works for THE CERES GROUP (https://theceresgroup.com) as Senior Director (Capital Market) leading Capital Market, Risk , Fintech, Derivatives and Quantitative Finance, ESG Integration Consulting Practice. He is a regular speaker on many financial topics but has a particular interest in ESG Integration in the investment world.

Sumit explains the “environmental” element of ESG initiatives:

“The environmental factor covers a firm’s environmental impact. It can be either positive or negative; however, firms who have proven to be good stewards for the environment may highly be more attractive for ESG investors.

While information directly obtained from the firms may give you an idea of how well the firm is performing under the environmental criteria, some firms may tend to exaggerate or paint a different picture than the truth. So, make sure to check out third party sustainability reports that uses respected sustainability standards such as those by the Global Reporting Initiative (GRI) and the Principles for Responsible Investment (PRI).

Some of the highly relevant environmental issues of today that you, as an ESG investor, might investigate include:

• The firm’s action plans, policies, and disclosures concerning climate change.

• The firm’s objectives with regards to greenhouse emissions and transparency about how they will achieve these goals.

• The firm’s carbon footprint as well as its carbon intensity (e.g., pollution, emissions);

• The firm’s usage of renewable energy especially for manufacturing firms.

• The firm’s recycling and safe disposal practices.

• The firm’s water-related issues and goals (e.g., water usage and conservation, marine life conservation).

• The firm’s usage or the shift towards green products, technologies, and infrastructures; and

• The firm’s current and history with the United States Environmental Protection Agency (EPA) and other environmental regulatory bodies.”

Part of the challenge inherent to companies in the energy sector have to do with activities that are traditionally environmentally “unfriendly” being limited, which directly competes with shareholder interests in many cases. In response to these competing priorities operating on oil and gas companies, the UK’s Oil and Gas Authority (“OGA”) for example developed a Task Force to set out disclosure and investor reporting requirements for operators and licensees. Within the UK and beyond, conditions like these have the potential to shape future legislation in the not-distant future.

The Task Force’s report on March 8, 2021 made a number of recommendations for reporting requirements for companies, including requiring operators and licensees to disclose climate data in their financial documents and/or online content; calling on the industry to be aware of the

typical differences between investor expectations and what is usually reported, calling for greater disclosure & transparency; stipulating that disclosure should be both quantitative and qualitative with marked improvements over time; and encouraging senior leadership teams to model the required behaviors internally.

The task force also called for recommendations for quantitative metrics such as key health and safety statistics and metrics, gas handling – venting and flaring and solutions; air and water pollution risks; and waste management and disposal.

Sumit Kumar explains, “It should be noted that these global sustainability issues are not limited to environmental issues like climate change, deforestation, and air and water pollution, but also include social issues like fair labor practices, safety, and wellness, and diversity. Likewise, in some parts of the world, poverty and starvation also remain to be a big social issue, including income disparity. Meanwhile, global sustainability issues also include corporate governance issues like privacy and data security, corruption, and whistleblowing practices. The 2008 financial crisis, for instance, proved how the lack of governance can cause a collapse in the financial market. These global sustainability issues have inherent risks that are different and more complex, which prompts the modern investor to reevaluate the traditional investment approaches and turn to the ESG framework to incorporate such risks and be able to respond to them appropriately.”

Sumit further explains

Conventional energy sector has taken a hit in investment due to increased awareness of ESG. In our lives, energy is quite vital. Traditionally, investing in energy was seen to be a good financial venture. With greater investor knowledge of ESG (Environmental, Social, and Governance) and climate risk, there is evidence that investment has been diverted away from the traditional energy sector in recent years. This has resulted in a significant drop in investment in this industry. The conventional energy industry required more capital to re-invent itself and go from a higher ESG (Kumar, Baag and Shaji, 2021) risk level to a lower ESG risk level. This lower ESG risk transfer needs enough finance, which has been difficult owing to conventional energy’s ESG problems. There are studies that have already highlighted this problem pertaining to the conventional energy sector (Kumar and Baag, 2022).

Reference

Kumar, S., Baag, P.K. and Shaji, K.V. (2021). Impact of ESG Integration on Equity Performance between Developed and Developing Economy: Evidence from S and P 500 and NIFTY 50.Vol. 20, no. 4, pp. 01-16

Sumit Kumar, Pankaj Kumar Baag (2022), Price of Being a Sin Sector: Funding Issues and Challenges of Conventional energy sector in the ESG aware world, (2) (PDF) Price of Being a Sin Sector: Funding Issues and Challenges of Conventional energy sector in the ESG aware world (researchgate.net)