Posted on January 1, 2022 in News

The investments being made in ESG indicate a shift in liabilities, cost and potentially capacity for upstream energy companies

The impact that the move toward instituting Environmental, Social and Corporate Governance (ESG) policies has on energy companies is significant. This attention on socially responsible behavior is important to consider, but no industry bears a bigger brunt of the cost and publicity challenges as upstream oil and gas drillers, extractors, contractors, and the like.

These companies are not protesting the sustainability efforts, often driven by investors, activists and boardroom politics and discussions. Yet the extent that these companies are having to go through to be compliant is extensive to say the least, said RB Jones Marine Director of Energy, Brad Nehring. He feels it is one of the biggest trends impacting energy companies in today’s industry.

“Many energy companies are spending millions of dollars on new staff, programs, auditors, and lawyers,” Nehring said. “Most importantly they are having to spend on infrastructure projects as well.

Plus, there are other costs associated with ESG compliance, that can include research and development, creating new platforms and instituting new processes, Nehring adds.

“The closest comparison I can produce is when Sarbanes-Oxley was instituted in 2002 as a mandate of certain practices in financial record keeping and reporting for corporations,” Nehring said. “It also placed requirements on all U.S. public company boards of directors and management and public accounting firms.”

Let us look on the impact that ESG is having from an insurance standpoint.

Flaring gas is no longer viewed as an acceptable environmental practice

Take the example of flaring gas, or the controlled process of burning natural gas, which is seen by some ESG proponents as harmful to the environment. Energy producers routinely flare, or burn, natural gas during well or processing disruptions and when they lack access to pipelines. One of the solutions is to build more pipelines to prevent gases from escaping into the atmosphere as a way to better adhere to widely accepted environmental practices.

The pipelines of course are a capital expenditure, and a large one at that. But there is a hidden cost on the insurance side too.

“With more pipelines come the potential for more explosions,” Nehring said. “This is an exposure that is new for many upstream oil and gas companies.”

More exposure means higher costs and often together capacity. That is on top of the infrastructure costs, Nehring adds.

Extracting carbon out of the ground is a unique process

Actions to support ESG should be meaningful. But there is a difference between a company like Amazon committing to sustainable process compared with an upstream energy firm whose job revolves around extracting carbon out of the ground. And Nehring asks whether the impact really that different, with Amazon’s ubiquitous delivery vehicles emitting carbon dioxide around the world?

“So far, we have not seen underwriters using ESG as a requirement for policies but if there is enough social pressure, it is a possibility in the future,” he said. Energy companies are already becoming more diversified with efforts at supporting renewable technologies but the nature of the work means some of those efforts is limited. If costs rise too much, survival could be at stake.

Some carriers are setting boundaries

The pressure on energy firms to adhere to ESG guidelines or sustainability practices is increasing from within the insurance industry. Nehring points out that Lloyd’s, the world’s biggest insurance market, has bowed to pressure from environmental campaigners and set a market-wide policy to stop new insurance cover for coal, oil sands and Arctic energy projects by January 2022, and to pull out of the business altogether by 2030.

In its first environmental, social and governance report, Lloyd’s, which has been criticized, said the 90 insurance syndicates that make up the market would phase out all existing insurance policies for fossil fuel projects in 10 years’ time. Less than 5 percent of the market’s £35bn annual premiums comes from insurance policies in this area. Effective December 2020, Lloyd’s directed managing agents to no longer provide new insurance cover for thermal coal-fired power plants, thermal coal mines, oil sands, or new Arctic energy exploration activities.

While these are still extreme examples that target a very specific type of company, it represents an initial salvo in the effort to force the hand of upstream energy extractors.

Fewer policy options is never good news for a business and given the current climate of ESG support (no pub intended), it is likely that the trend is not turning around anytime soon. Whether more carriers follow suit in 2022 is the question.

Other challenges remain

An additional challenge for energy companies is that governmental guidelines come and go depending on who is in power or how the political winds are blowing. “This makes it difficult to plan and budget for the long-term, much less to adhere to current laws,” Nehring said.

It is well known that GHG greenhouse gas is one of the more significant contributors to climate issues.

Methane, a potent greenhouse gas (GHG), has become a major focus of GHG reduction initiatives. Of the many sources of natural and anthropogenic methane, emissions from the oil and gas (O&G) industry have received special attention. In Canada for instance, commitments have been made to cut methane emissions from the O&G sector by 40-45 percent below 2012 levels by 2025, according to the Canadian government.

Natural gas (NG) consists primarily of methane and is invisible and odorless in most upstream settings. Within regulatory and operational contexts, releases of NG to the atmosphere are often classified as either vented or fugitive emissions. Vented emissions are intentional releases of hydrocarbons, typically in a controlled manner, resulting from normal process conditions. In contrast, fugitive emissions, also called ‘leaks’, are unintentional releases of hydrocarbons from sources that should not be emitting.

The bottom-line for energy companies

What we recommend at RB Jones is that oil and gas companies should prepare for more financial pain. Nehring said.

“Some of the actions in support of the ESG movement actually can have an adverse effect on the amount of exposure that these companies will face,” Nehring said. Plus, the threat of not taking steps may lead to brand burdens and PR issues that expose a negative light on the company, leading to additional exposures such as lawsuits, he added.

It will be an interesting line to straddle in the years ahead. So now is the time to prepare. Be sure to review your renewal options with your broker and ask which carriers may be sensitive to ESG trends. The more educated you are about market trends, the smarter decisions you will make, positioning you even further as a leader in the oil and gas field.