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Six key ESG issues in energy credits

Six key ESG issues in energy credits

06-04-2017 | Insight

The energy sector is faced with big ESG challenges. Information on how companies tackle these issues provides credit investors with valuable information on companies’ ability to manage these risks and, therefore, their aiblity to repay debt. We look at six ESG issues in our analysis of energy credits.

  • Frances Pang
    Frances
    Pang
    Credit Analyst
  • Francis Condon
    Francis
    Condon
    Sustainable Investing Analyst, RobecoSAM

Speed read

  • The energy sector is faced with significant ESG challenges
  • We have identified six material ESG factors for energy credits
  • We incorporate them into our valuation of company credit profiles

Looking through the lens of a credit investor, we have identified six key sustainability issues in the energy sector that can have a material financial impact on a company’s long-term business position. Incorporating this type of information in addition to purely financial data allows us to make better investment decisions.

The six ESG issues are energy use and greenhouse gas emissions; water management; health & safety; community relations; bribery and corruption; and corporate governance. We will review each of them and explain why they are relevant to us as credit investors and how we expect company management to mitigate or diversify these risks.

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1. Energy use and greenhouse gas emissions

Energy use and greenhouse gas emissions are relevant to credit investors because a company’s position relative to the industry-average carbon intensity is an indicator of its overall operational and energy efficiency, and its operating margin. In addition, energy producers are subject to regulations, which may include natural gas emissions. In the US, for example, local or state level Specific Gas Emitters Regulations require companies to pay attention to energy use and greenhouse gas (GHG) emissions.

We are interested in the extent to which companies are able to avoid, reduce or mitigate the overall risks arising from energy intensity and GHG emissions. For us key factors are the company’s overall environmental management and its specific focus on GHG emissions. We obtain information from company reports and responses to the Carbon Disclosure Project questionnaires.

2. Water management

A company’s water intensity is an indicator of its overall operational and energy efficiency and, consequently, its operating cost base. In addition, companies are subject to regulations and agreements on access to water. Changing regulations and alternative demands for access to water resources may increase costs. In waste water disposal, North American unconventional onshore producers in particular are facing increased risks of new regulations being introduced and an increase in costs associated with disposal wells due to concerns about environmental impact and induced seismicity.

As credit investors, we look for company-specific information on water consumption and operations in water stressed areas, as well as water disposal methods. We are interested in the extent to which companies are able to avoid, reduce or mitigate the overall risks arising from water. For us the key factors are the overall focus of a company’s operations, its general environmental management and its specific focus on water management. An adequate water management program that focuses on efficiency gains to reduce water use or on water-efficient operations, such as recycling, lowers costs, scarcity risk and waste water issues. We also look for a good track record in compliance with permits and regulations.

3. Health and safety

We use occupational health & safety and environmental data as a proxy for operational excellence. We therefore look at the track record and disclosure of occupational health & safety indicators, including fatalities, injury rates and, increasingly, process safety events. We require disclosure on environmental impacts such as loss of containment incidents, and examine the proportion of assets located in challenging operating environments as well as the extent to which the company is able to manage the risks.

We are concerned about how companies manage the health & safety of their employees and contractors. We want management to address situations in which their company performs worse than peers, to look closely at individual cases of fatalities and injuries, and to address sequences of events that may suggest a failing safety culture.

4. Community relations

Companies need to be able to manage their community interactions and prevent reputational risks. Examples include incorporation of community relations into operating management systems, and country level stakeholder engagement programs. We require companies to provide good disclosure on the community relations issues they are exposed to, as well as on how these are managed across the company and in individual examples.

5. Bribery and corruption

In order to get more insight into corruption risks in the energy sector, we look at the exposure of energy companies to countries associated with higher levels of corruption. We use, among other sources, RobecoSAM’s Country Sustainability Ranking for this. For an even closer look we also combine reported production data and the Transparency International Corruption Perception Index (TICPI) to develop a ‘production weighted TICPI score’ for individual oil & gas companies. We use this to understand how well companies diversify their general corruption risks and to identify specific risk exposures.

6. Corporate governance

In understanding corporate governance in the energy sector we look at company ownership and the presence of government or other shareholders with the potential to influence management. Board quality is important: are directors independent, well diversified and do they have the appropriate skills? The remuneration of executives needs to be closely aligned with the interests of investors, including credit investors.

As credit investors, we expect companies to meet good practice standards of corporate governance based on the International Corporate Governance Network (ICGN) principles.

Conclusion

The energy sector is moving fast towards the adoption of new technologies for developing and finding new hydrocarbon resources and improving operating efficiency. At the same time the sector is also facing large challenges from various regulatory changes, including those relating to climate change. We use our ESG perspective to monitor the impact of such new developments on the companies we cover with the aim to making better informed investment decisions.

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