Corporates search for license to operate
As shareholders and banks increasingly question their business models and activities, oil and gas companies need to strengthen their social license
Climate change is rising rapidly up the global political agenda. Across all regions, at least three-quarters of the population consider climate change a threat, while in Europe the figure is 93pc. In the US, a growing number of Americans, regardless of political persuasion, believe that climate change is happening now and therefore warrants action.
Governments’ mixed responses on climate change are in turn causing widespread frustration. Greenhouse gas (GHG) emissions are growing even as most countries fail to meet their commitments under the Paris climate accord. Consequently, activist organisations are turning their attention to companies. Increasingly, banks and equity investors are an important lever in influencing companies’ actions on climate change.
Given that the consumption of oil and natural gas is a major source of GHG emissions, companies supplying those fuels are among the first in the firing line. The impact of activist campaigns is compounding vulnerabilities already facing the industry and weakening its social license to operate.
Public trust in the oil and gas industry today is low in all regions except Asia-Pacific. In the US, where global warming concerns are highest among younger generations, polling indicates many young people are turning away from oil and gas as a career choice. Even on the issue of natural gas, a key means of reducing the GHG intensity of energy, the industry is failing to win public support in the US and Europe.
In recent years, oil and gas companies have been confronted with high-profile activist actions and lawsuits brought by US states and local governments. In tandem, other groups have emerged with a focus on the financial sector, challenging oil and gas companies’ business models and activities. For example, investor-focused initiatives, including Carbon Tracker and Climate Action 100+, are producing sophisticated and compelling arguments around value erosion and stranded assets that resonate with the financial community.
On the back of these concerns, climate-related shareholder resolutions have more than tripled in the past five years. Over the same period, the oil and gas divestment movement has grown from fewer than 100 to nearly 1,000 organisations with more than $6tn of assets under management.
Large investment managers have also become a driving force in their own right. With the growth of environment, social and governance (ESG) investing, they are increasingly questioning companies’ responses to climate change and even excluding companies from some funds. Since investment managers own more than 80pc of the Majors’ equity (see Figure 1), oil and gas companies would be wise to take notice.
At the same time, North American and European banks are coming under pressure from activists to improve disclosure of the climate impact of their lending portfolios and curb funding for oil and gas projects (see Figure 2). Central banks are also promoting measures to reduce the GHG intensity of banks’ portfolios, causing some institutions to reduce lending to certain types of oil projects.
The risk for oil and gas companies that do not respond to the financial community’s changing perceptions of the industry is that they face a higher cost of capital, through more expensive corporate and project debt and equity finance and reduced access to both. Ultimately, this could render them economically uncompetitive compared with alternative non-fossil energy producers. Average hurdle rates required by investors for large oil projects are already almost double those for renewables.
So far, the oil and gas industry has been ineffective at engaging with financial stakeholders as a cohesive group and has failed to develop consistent and compelling narratives about its role in energy transitions. To address these challenges and more proactively strengthen their social license to operate with the financial sector, oil and gas companies can focus on three steps.
First, developing a robust fact base about the industry’s role in energy transitions will be critical to enable objective conversations. Oil and gas provide secure and affordable energy and underpin significant economic development worldwide. They will continue to be essential even under a rapid energy transition scenario. The industry also possesses substantial technical capabilities and financial capital that will be indispensable in reducing the GHG intensity of global energy supplies.
Second, companies must develop a two-way dialogue with a wide range of stakeholders. Traditionally, the industry has been effective at building support for projects at a local level by building close ties with individual stakeholder groups. It should apply this localised approach globally and treat the financial community more like a political ecosystem by engaging key investors more directly.
The impact of activist campaigns is compounding vulnerabilities already facing the industry and weakening its social license to operate
Third, companies need to take clearer action to accelerate progress in mitigating emissions, both from their own operations and the consumption of their products. Industrywide commitments by groups such as the Oil & Gas Climate Initiative help, but they must be translated into company-specific actions to be credible. And while many companies have now set targets to improve the emissions intensity of their own operation (scope 1 emissions), disclosure of actions and progress against those targets remains inconsistent or unclear.
With growing public concern about climate change, pressure on the oil and gas industry’s social license to operate can only grow. It is imperative that the industry acts now, starting with a focus on the financial sector.
Alex Dewar, Senior Manager, BCG Center for Energy Impact
Borja Jimenez, Team Manager, BCG Center for Energy Impact