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An era of compliance: part one

Hydrocarbon Engineering,

Environmental issues have been important for the downstream oil and gas sector for tens, if not hundreds of years. There has, however, never been a higher level of scrutiny and accountability of business relating to their environmental and social impact, particularly those involved in the oil, gas and petrochemical processing sector. Globalisation, digital connectivity, the financial crisis, population growth, the explosion of the global middle class, climate change and other economic, social and environmental mega forces are transforming the operating landscape for the sector. A number of high profile events, which have attracted wide spread media attention have opened the industry’s eyes to risks to their business from environmental and social issues and forced them to pay close attention at a board level. In addition to traditional media attention, the significant increase in social media and internet connectivity can easily result in reputational damage, which can have an effect on a business’s ability to operate profitably. Many of KPMG's clients are increasingly looking to understand and value the potential risks and opportunities in these areas.

Oil and gas companies have to make long term investment decisions against a global backdrop of fluctuating commodity prices, shifting energy politics, and both changes in supply and demand and the wider capital markets. Investors are increasingly looking more broadly than just considering financial risks in their investments, with many looking to appraise environmental, social and governance risks (ESG) of their portfolios and potential investments. An increasing number of investment managers and private equity funds are developing responsible investment or ESG policies, which has resulted in some investors reviewing their investments in fossil fuel assets. ESG ratings, which are being produced in house or by external ratings agencies, are used by institutional investors and asset managers to integrate ESG factors into their investment processes. The growth in interest in this area is partly driven by initiatives such as the UN supported Principles for Responsible Investment (PRI), which includes signatories from organisations, including asset owners and investment managers, accounting for more than US$45 trillion in assets under management (AUM).

Each part of the downstream sector has its own particular interacting impact on the host environment, with unique and very crucial social and governance issues, some of which cut across refining, transportation and marketing and distribution and that need to be carefully addressed and communicated to investors. The authors have seen companies responding to these issues by implementing tight and clearly documented governance procedures such as pollution prevention policies and emergency response plans.

The downstream oil and gas industry, with important and high profile ESG issues needs to pay attention to management of these key corporate risks.

Another key factor that is increasingly being considered by investors in addition to environmental issues, are the social matters of labour rights and industrial relations. KPMG has found that clients are increasingly being forced to consider employee rights issues, and that these issues are hitting the headlines with investors requiring companies to disclose their practices in these areas. Issues that can also present important compliance risks to manage during periods of restructuring. These issues have been a major challenge in particular for the European refinery industry including many of the major operators in the UK, which is estimated to have lost 8% of its capacity and 10 000 jobs in the past six years, and may raise further challenges for the wider downstream market in light of recent volatility in oil prices.

The International Energy Agency (IEA) has confirmed that two thirds of existing fossil fuel reserves cannot be burned and emissions released if the international community is to meet its goal of limiting global temperature increases to less than 2°C above pre industrial levels. This finding has the potential to transform the energy market, either by accelerating the development of effective carbon capture and storage solutions, or by bringing into question the value of the fundamental resources or assets the industry relies on. If companies are unable to exploit their fossil fuel reserves, the market for their product effectively ceases to exist and those assets become ‘stranded’. This is a significant challenge for investors, including pension funds, because the valuation of energy companies is tied closely to their proven energy reserves, which could lose much or all of their value if they become ‘stranded’ in the future.

One effect of the debate on asset stranding is that global investors are starting to query energy companies’ business plans, encouraging a better assessment of the financial risks posed by current investments in high carbon assets.

As investors begin to consider the ESG implications of their investments, some are using their influence to put pressure on companies to improve environmental performance. There has been particular attention on investment in oil and gas by pension funds and sovereign wealth firms.

Read part two of this article here.

Written by James Holley and James Bone, KPMG Sustainability team, UK. This is an abridged article taken from the April 2015 issue of Hydrocarbon Engineering.

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