As the Masks Come Off, Investors Take a Close Look at ESG
A recent symposium focused on acquisitions and divestitures held by SPE’s Gulf Coast Section offered a face-to-face look at the state of oil and gas investing.
The most striking thing about the recent symposium put on by SPE’s Gulf Coast Section was the more than 100 people in the room.
During the breaks, it was nearly impossible to have a conversation without a mention of how good it is to be back meeting people in person and shaking hands, like it was before the COVID-19 pandemic.
Things, indeed, are looking a lot better.
The feeling that day, and the message from speakers at the Acquisitions and Divestitures (A&D) Symposium, offered an upbeat outlook for those buying and selling assets and, perhaps, a path for more such gatherings.
“Last year, everyone was focused on liquidity and lenders and how many people I am firing this week and cost reductions and mergers and acquisitions,” said Doug Reynolds, managing director for Simmons Energy, a division of Piper Sandler.
So far this year, there have been about $17 billion worth of US deals, and Reynolds said that total asset sales will easily get to $30 billion–$40 billion by the end of the year.
Coincidentally, that afternoon, the US Centers for Disease Control and Prevention (CDC) updated its mask guidance, announcing that those who been vaccinated can go to indoor meetings safely without wearing a mask, which was the case for most of those in the room that day.
“Right now, the data, the science shows us that it’s safe for vaccinated people to take off their masks,” said Rochelle Walensky, director of the CDC.
The risks associated with COVID-19 and the oil industry are real. But life and oil investors are moving ahead more hopefully than they had in recent years.
“We have not seen a company announce something and the market throw up about it,” Reynolds said. He predicted that value of the deals this year will exceed the past 2 years combined.
Still, that total is far short of the boom years, and the bad times are far from forgotten.
“The sector is still a little bit on probation,” Reynolds said. Companies such as Pioneer Natural Resources are making acquisitions that are significantly changing the companies.
But the logic of these deals must remain fixed on debt reduction and increasing the payout to investors who are “skeptical of what organic drilling returns over time,” he said.
“The way they look at assets now is different. It is really looking at cash flow,” said Nick Ferson, a managing director for EIG, an investment company.
The kinds of deals have changed somewhat from year to year, but the motivation is much the same: memories of how oil demand evaporated, ramming US unconventional producers and investors into a period of portfolio triage.
The first stage of change was a spate of megamergers where many of the strongest players combined in all-stock deals that cut overhead by allowing one company to manage the assets of two.
Deals have continued as rising stock prices have increased the buying power of shares, resulting in sharply higher valuations.
Reynolds said he received a call from a long-time client who was “shocked and angry” because he made what he thought was an aggressive bid that turned out to be far below the winning bid.
What’s the Score?
Those putting deals together have concerns that go beyond whether the production outlook and the quality of the reserves justifies the deal’s value.
The price also depends on how the owner has managed environmental, safety, and governance (ESG) aspects of the business. In other words, what is the ESG score?
“It is a bigger part of investment criteria,” said Jack Belcher, a principal with Cornerstone Government Affairs who provides advice on ESG performance in the energy sector. He said his organization is “working with a lot of privately held companies because their backers want good ESG performance when they go public in the future.”
A three-member panel at the symposium, looking at how this pressure is inspiring innovation, admitted that no industry standard currently exists.
The advice from consultants and oil executives was to step up data-gathering related to potential issues, such as flaring, and make sure that addressing them is among the company’s priorities.
“There is a lot of data out there,” which needs to be gathered and stored in a way that facilitates analysis that offers a realistic measure of the problem, said Sean Kimiagar, ESG technical adviser for Enverus. It is one of the energy data firms competing to fill that need.
Simply complying with the operating rules set out by the Texas Railroad Commission is not likely to seal a deal when competing for financing.
“We are now held to a higher standard than what the Railroad Commission says we need to do. That is a low bar now,” said Zach Fenton, chief operating officer for UpCurve Energy, an unconventionals producer operating in the Permian Basin. “We must do better than we are required to do by regulators.”
One sign of the rising importance of ESG has been the wave of oil companies announcing plans to reach zero on carbon emissions.
Among the panelists that day was Stephane Lamoine, a French investor whose many energy ventures include Beam Earth, a private Permian oil company whose top priorities have included achieving the highest ESG score among Permian producers.
Lamoine said that, based on his experience, sharply reducing emissions from finding and producing oil is possible, but, he wondered, “How can you ask oil and gas company to be net zero when 85% of the carbon emissions are from users burning the fuels.”
Beam focused on producing oil with a high paraffin content, which, while it could be used for motor oil, is not designed to be burned in an engine, thus reducing its potential emissions.
But the world only needs so much motor oil. Belcher said oil companies live with a threefold problem. “When it comes to energy,” he said, “they expect cheap, green, and reliable, right? It is not that hard to reach two of those, but it is really hard to reach all three.”
ESG is often equated with environmental performance. Kimiagar warned, however, that, while the environmental aspect is important—Enverus gives it a 40% weighting in its ESG formula—the safety and governance parts represent 60% of the score.
Nearly 30% of companies surveyed for a Harvard Law School report said they would be using ESG measures in their executive-compensation formulas. It suggested this may be in anticipation of likely governance questions about how they calculated the value of these changes to investors.
During the shale boom, top executives were richly rewarded for growth until investors finally forced companies to shift the focus to profits and payouts to investors.
“We have not helped ourselves with the returns over the last decade,” Ferson said. Those struggling to raise money after years of dismal returns should not “blame it on ESG.”