Building on the momentum created by the “Aiming for A” resolutions and the Paris Agreement, the Task Force on Climate-related Financial Disclosures (TCFD) published its recommendations for disclosing climate-related risks in June. How will these new guidelines affect the oil and gas industry and can investors leverage them in their engagement efforts?
The TCFD report represents a framework for companies to disclose climate-related information consistently in their mainstream financial filings. Its effective implementation should enhance the way investors and corporations assess, price and manage climate-related risks. The recommendations are applicable to multiple sectors and enjoy broad stakeholder and international support. The G20 was expected to endorse them had it not been for the US’s recalcitrance. Chaired by Michael Bloomberg, the TCFD’s ask is clear:
- Explain how your board members and executives are looking at climate risk
- Describe your long terms plans to sustain your value proposition in a 2°C scenario
- Elaborate on the internal processes you follow to mitigate climate risk, and
- Measure your actions using the TCFD’s definitions for governance, strategy, risk mitigation, metrics and targets.
In this blog post, we explore the gap between current levels of disclosure and the TCFD’s recommendations for the oil and gas industry. We have grouped oil and gas producers into three categories that reflect similarities in their business models as well as relevant geographic differences:
- Developed Markets Integrated: Large and mid-cap integrated oil and gas producers based in North America and Europe, including oil sands producers
- North American Independents: Pure play upstream exploration and production companies based in North America
- Emerging Market Producers: Both integrated and upstream companies based in emerging markets, including Russia, Asia and South America
For each category, we look at two indicators from our Carbon Solutions product suite that speak to the governance and strategy pillars of the TCFD’s recommendations:
- Climate Risk Governance: Are there board members or executives who have explicitly been tasked with the responsibility of managing business risks related to climate change?
- Climate Risk Assessment: Does the company integrate non-physical climate change risk into its regular risk assessments and strategy?
Source: Sustainalytics Research. Please see the text above for an explanation of the indicators and categorization of oil and gas producers
Developed Markets Integrated
Only a quarter of these companies have incorporated climate risk management into their governance structures. Despite this large governance gap, 75% of these companies integrate non-physical climate change risk into their regular risk assessment and strategy. For example, several factor a carbon price into their investment decisions or disclose some kind of scenario assessment or asset allocation resilience strategy. These measures are meant to safeguard against shifts in demand or the enactment of new carbon regulations. This is not surprising as these companies have traditionally been in the spotlight of the corporate responsibility discussion and have seen a great deal of stakeholder scrutiny on the topic of climate risk in the last couple of years. As a result of this pressure, most of them have also adopted widely accepted sustainability reporting guidelines, such as the SASB, GRI and CDP, which are also aligned to the TCFD’s requirements.
This group of companies is the best positioned to close disclosure gaps. It is likely that they will come to define the standard for effective disclosure, even if explicit lines of responsibility for climate risk are often lacking. However, investors still need to focus on pressuring these companies to increase the quality, credibility and comparability of scenario analyses as well as making capex allocation strategies more transparent. The TCFD’s recommendations provide a useful framework investors can use in their engagement with companies on these topics.
North American Independents
North American Independents generally have a compliance-driven approach to sharing information with investors. It is not usual to see these companies disclose information beyond the templates provided by the SEC. It is therefore no surprise to see that only 3% of these companies disclose their governance practices as it pertains to climate risk and only 8% their strategy to tackle it. The bulk of these companies operate primarily in the US, in a regulatory environment that publicly questions climate change science. Given their compliance-driven approach, it is therefore unlikely that they will implement the TCFD’s recommendations.
US Independents tend to have a more focused business model compared to Developed Markets Integrated. This lack of diversification can make it more challenging to design an effective resilience strategy. A more natural gas-focused reserve base would offer some insulation and potential medium-term upside as the effects of climate change start to impact market dynamics. For oil-focused producers, one may wonder whether these companies will be able to find a value proposition that remains viable in a low carbon economy. If they continue focusing only on the status quo while lowering costs, they ultimately run the risk of being disrupted by changing market forces. For these companies, investors can use the TCFD’s recommendations to start the conversation on business risks related to climate change and to push for the disclosure of (basic) emissions data.
Emerging Markets Producers
Emerging Market Producers are the least likely to have tasked board members or executives with the responsibility of managing business risks related to climate change. For Chinese and South American producers listed in the US, we see a similar compliance-driven approach to disclosure. However, on average they incorporate climate issues into their risk assessments more broadly than North American Independents. This would suggest that they consider climate risks in a longer timeframe compared to the compliance-driven, short-termism characteristic of the highly competitive US market.
The government support for the TCFD’s requirements has been widespread within the emerging markets where these companies operate. Given the high level of state involvement in many of these companies, there is reason for optimism. It is likely that there will be greater pressure on these companies to quickly improve their governance and climate risk analyses and even to consider adopting some of the more advanced elements of the TCFD’s requirements. These companies, however, also tend to limit proxy access, which reduces investors’ influence. Engagement may therefore be largely limited to calls for better risk management and scenario modelling outside of changes to formal governance structures.
Concluding Remarks: TCFD’s Recommendations
The key challenges and drivers that will determine whether oil and gas companies can successfully implement the TCFD’s recommendations are: Stakeholder scrutiny, business model limitations, governance norms and the regulatory environments in which they operate. The business models and geographic location of these companies have played an important role in shaping these companies’ approach to disclosure as well as the strategies and governance structures they employ to tackle these challenges. The strength of the TCFD’s recommendations is that it can serve as a useful framework investors can use to engage with these companies, regardless of where they may be in their sustainability journey.
Do you have additional questions about the TCFD’s recommendations or their impact on oil and gas producers? Please feel free to Get in Touch.