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An era of compliance: part two

Hydrocarbon Engineering,

Read part one of this article here.

The increased connectedness and growth of social media is also having an impact on investments in downstream oil and gas. A recent international divestment movement called for organisations, institutions and individuals to end their financial support for the fossil fuel industry. As of 19 September 2014, 181 institutions and 656 individuals, representing over US$50 billion in assets have pledged to divest from fossil fuels.

In September 2013 a group of institutional investors with US$3 trillion of assets under management asked the 45 biggest quoted oil firms how climate change might affect their business. In January 2015 two shareholder groups filed resolutions urging energy firms to formally assess and manage the risk of climate change, reduce emissions and invest in renewables. As well as the £2.3 billion UK Environment Agency Pension Fund, the shareholders involved include the £150 billion UK Local Authority Pension Fund Forum, the £15 billion Church Investors Group, charitable organisations such as the Joseph Rowntree Charitable Trust and environmental law NGO ClientEarth and insurers. Extraction companies have responded to the pressure from shareholders to manage their climate impacts more transparently by formally assessing and managing the risk of climate change, through operational emissions management; asset portfolio resilience to post 2035 scenarios; low carbon energy research and development and investment strategies; strategic key performance indicators (KPIs) and executive incentives and public policy interventions.

Recent developments by the World Resources Institute (WRI) launched in January 2015, which may present challenges for the downstream sector, aim to amplify corporate demand for renewable energy. The new market based approach has been developed to address the lack of corporate investment and demand for low carbon energy, addressing areas where existing regulations have not been fully successful to date.

The past 10 years has seen challenges in the oil industry as a whole (as demonstrated by the S&P Global Oil index), as well as companies being faced with increases in operational costs and falling reserves. With the fall in oil price since mid 2014 energy companies and their investors have been expecting lower profits. This had led to discussions, from some sources, of large scale take overs in the oil industry, offering a chance for companies to cut costs and save money. Oil analysts have speculated that such slimmed down companies could be targets for takeovers. Such ‘mega mergers’ bring with them complex environmental, health and safety issues associated with multiple downstream assets, trading relationships, contractual agreements, and legacy sites (contaminated land liabilities) which will require management by both buyers and sellers during, and after, any potential deal.

An increasing number of clients from the downstream oil, gas and petrochemical sector also wish to increase their understanding of environmental, health and safety (EHS) compliance not only of their own operations but across their supply chain. In this era of increased transparency, the environmental issues associated with supplier operations are often not viewed by the public as separate from that of the company, whether the company is able to have any control over the supplier or not. Companies are increasingly understanding the risks to business continuity from reliance on suppliers with poor EHS performance, which includes issues broader than just carbon emissions with companies considering a long list of issues in the supply chain including safety, water consumption, waste management, and labour rights.

The accurate valuation of environmental liabilities is important during a transaction, but also during ‘business as usual’. An increase in companies required to hold provisions on their balance sheets for environmental and decommissioning liabilities has been observed. It is increasingly important to accurately value and manage environmental remediation projects and associated costs and accounting provisions, which can have an impact on company’s cash flow and ultimately value, and which have come under increasing scrutiny from regulators. There is an increasing requirement for strict governance procedures over such issues, requiring expertise in the financial accounting as well as environmental and technical issues. Businesses operating in the downstream oil and gas industry with the potential for multiple sites in jurisdictions with different regulatory, political and non-governmental organisation (NGO) drivers require strong processes for the control of environmental provisions.

Over the past 100 years that more and more externalities have become more internalised by regulation and practices such as health and safety compliance and carbon emissions. KPMG has developed a three step methodology, which helps companies to understand their externalities, forecast and manage the rapid rate of internalisation of externalities and make better decisions. There are three key drivers of internalisation: regulations and standards; stakeholder action and market dynamics.

Whatever the future holds for oil price volatility, one thing is clear, that ESG compliance and incorporation into business and investment processes will remain and become more complex as the regulatory landscape evolves and society becomes even more influential. This presents opportunities for the downstream sector to demonstrate strong governance procedures for EHS issues, and the ability to respond to market demand for low carbon energy.

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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