When it comes to tackling the complexities of ESG, climate change is one of the highest priority issues for boardrooms across the world. From increased regulations to investor pressures to consumer expectations, it is a topic that is here to stay, and companies will be feeling more pressure than ever to articulate a philosophy and approach.
Brand value is now closely linked to a company's reaction to environmental issues, and any missteps are likely to be amplified by a combination of social media reaction, press coverage and political point-scoring. Businesses at risk of climate-related litigation could find themselves marked as pariahs. Investors, banks, and insurers will likely choose to reduce their exposure to them. For those reasons alone, climate change must be on the agenda.
While they are unlikely to be in the role 30 years from now, board members must think about what a CEO can commit to today. They need to be demonstrating not just good intentions, but a measured plan of action. Having smaller, incremental goals that serve as measurable milestones on the path to long-term success is an approach likely to meet the expectations of your various stakeholders and constituencies.
While climate change is a challenge that all board members should be thinking about, first we must understand certain key terms:
Additionally, as boards think about climate needs, they also need to be aware of the demands of all groups ' from investors and communities to employees and customers. Each will hold certain values, and it's essential that those different perspectives and voices are heard. Today 90% of S&P 500 companies publish a sustainability report.
Norges Bank has since been divesting its position in coal and oil sands. Dutch, Swedish, French, and other European investment funds have also followed suit. The big change happened around four years ago when Japan's GPIF, the largest sovereign fund in the world at 1.4tn AUM, adopted an ESG governance framework similar to Norges.
There is interesting cognitive dissonance when you look at Norges. The bulk of Norway's GDP derives from oil and gas and yet they have been the earliest and most stringent adopters of climate initiatives. They have gone so far as requiring that any oil and gas platforms that use diesel to operate are rewired to use electric cables instead - a move that has driven up the cost of oil and gas extraction.
Norway and now Japan's sovereign funds have an outsized influence on US investors, like BlackRock, SSGA, and Vanguard, who have all adopted ESG principles to sell their index funds to these sovereign fund clients. It is fair to say that ESG has become a compelling business catalyst.
Oil and gas managers – both active and passive – are demanding companies embrace ESG. The focus on climate has been particularly strong in real economy companies in the oil and gas, chemical, and mining sectors.
Most public companies have over 70% of their stock held by index funds, of which the average amount dedicated to ESG is believed to be between 0.5% and 3%. There is an opportunity to have these investments increase, potentially, up to 5% in the next 12-24 months. This is significant. If your company can lead its peers by articulating a tactical, measurable plan on climate, as part of a subset of ESG initiatives, you will be rewarded with greater shareholder investments.
'Real economy' companies with a focus on manufacturing face bigger challenges when aligning company strategy to climate and ESG initiatives. In this instance, boards can evaluate their response to investors, embracing ESG in a measurable way, and encouraging continued investment. For example, BHT, the second-largest global mining company in the world, has made a clear commitment to reducing operational greenhouse gas emissions by at least 30% from adjusted FY2020 levels by FY2030.
Additionally, there is a climate push in some consumer-centric companies who want to refurbish their reputation. VW (still recovering from the emissions scandal) has adopted a group-wide comprehensive decarbonization program with the aim of reducing CO2 emissions by 30% by 2025 and of transforming the company into a CO2-neutral company by 2050.
Light industry companies who manufacture parts and components that go into the supply chain can look at possible solutions too (for example, committing that 10% of their energy use (i.e. electricity) will be supplied by renewable sources.) When looking at a typical light industry company, the average amount spent on an annual basis for electricity to support manufacturing is ~1% of the budget. If 10% of that 1% comes from renewable energy, then a company is committing to a tenth of a percent. Utility companies typically offer an option for corporations (or consumers) to purchase renewable entry at a cost premium of typically 10%-15% more depending on your state.
Capital expenditure in infrastructure is another area that manufacturers should consider for review. A boiler that runs the manufacturing plant typically has a life span of 20-30 years. Most boilers run on oil or gas. They are very costly, so it doesn't make sense to rip out and replace working boilers.
However, companies can begin by looking at boilers in need of replacement or retrofit and evaluate new boilers that run on other sources such as renewable fuels like hydrogen, biofuel, or innovative next gen solar.
An example of a utility company taking incremental steps is Xcel Energy. Providers of energy to customers in Colorado, Michigan, Minnesota, New Mexico, North Dakota, South Dakota, Texas and Wisconsin, Xcel has a goal of providing 100% carbon-free electricity by 2050.
Other companies that are focused on emphasizing climate as part of their positioning have included BP - ahead of the market by some 20 years. In 2002 BP rebranded itself from 'British Petroleum' to 'Beyond Petroleum,' committing to hold emissions constant and to be a steward to the planet. However, the company was unable to deliver on such a large promise. In March 2006, a BP oil pipeline caused one of the largest oil spills in Alaska's history. Under financial strain, BP sold off many of its solar and wind assets, quietly deserting the 'Beyond Petroleum' rebrand.
In 2019, Repsol announced it would be carbon neutral by 2050, making it the first major oil and gas company to make a pledge of this magnitude. To achieve this goal, Repsol has announced they will cut their dividend and invest in renewables. The investor response was a 5% decline in the stock price.
Despite this, BP followed suit in 2020 and reinvigorated its commitment to climate by pledging to go carbon neutral by 2050.
Exxon is clear in their view that there will be an ongoing need for oil and gas in the future. They are taking a 'wait and see' approach, looking for more proof that their investors will reward a push toward renewables.
For the oil and gas industry, a key question remains: are you better off focusing solely on oil and gas, or should you pivot towards being an integrated energy provider with a greater focus on renewables?
The auto industry also has a similar consideration of how much of a commitment to make to climate, especially with electric vehicles. Tesla is a great example; their extraordinary market cap has been bolstered by ESG funds who want to invest in the automotive sector. However, the broader industry is still measured in assessing how strong consumer demand will be. While electric vehicles have captured attention, they currently only make up about 4% of the market.
Consumer-driven ESG wellness themes have also gone mainstream. We see this in the popularity of organic fruit and vegetables, and vegan beef alternatives, such as the next gen protein Beyond Meat. AgTech is emerging as a significant part of ESG. Smithfield Foods, the country's largest pork producer, harnessing the methane from manure ponds at swine farms to supply gas to fuel homes is an example of how some companies are investing to make their corporate positioning more climate-friendly.
Here are some questions that you may want to ask management to research:
For companies, the climate change discussion will only gain more momentum and visibility. We should all expect that we will need to have a thoughtful and well-informed corporate philosophy as part of our vision and mission going forward.
How we embrace both the near-term, mid-term and long-term climate initiatives as part of our overall ESG umbrella for all our stakeholders will be critical to our future success. As such, boards and management must seek to clarify an agreed way forward with all stakeholders and representatives. Doing so will ensure alignment and clear expectations for our companies' future.
2021 will be a pivotal year with the climate as an increasingly important topic. Companies will be well served to be proactive.
Brand value is now closely linked to a company's reaction to environmental issues, and any missteps are likely to be amplified by a combination of social media reaction, press coverage and political point-scoring. Businesses at risk of climate-related litigation could find themselves marked as pariahs. Investors, banks, and insurers will likely choose to reduce their exposure to them. For those reasons alone, climate change must be on the agenda.
While they are unlikely to be in the role 30 years from now, board members must think about what a CEO can commit to today. They need to be demonstrating not just good intentions, but a measured plan of action. Having smaller, incremental goals that serve as measurable milestones on the path to long-term success is an approach likely to meet the expectations of your various stakeholders and constituencies.
While climate change is a challenge that all board members should be thinking about, first we must understand certain key terms:
- Net Zero: Net zero means that any carbon dioxide released into the atmosphere from the company's activities is balanced by an equivalent amount being removed elsewhere in the company's activities.
- Carbon Neutral: Carbon neutral is slightly different, allowing companies to measure the amount of carbon they release and offset that with a reduction in emissions or removal of carbon. This can include buying carbon credits to make up the difference, making it appealing to companies that produce a lot of emissions.
- Carbon Negative: The next step ' becoming carbon negative ' requires a company to remove more carbon dioxide from the atmosphere than it emits.
- The Paris Agreement: A legally binding international treaty on climate change. It was adopted by 196 Parties at COP 21 in Paris, on 12 December 2015 and came into force on 4 November 2016. Its goal is to limit global warming to well below 2 degrees Celsius - and preferably to 1.5 degrees Celsius - compared to pre-industrial levels. To achieve this long-term temperature goal, countries must aim to reach a global peak of greenhouse gas emissions as soon as possible to achieve a climate neutral world by mid-century.
Additionally, as boards think about climate needs, they also need to be aware of the demands of all groups ' from investors and communities to employees and customers. Each will hold certain values, and it's essential that those different perspectives and voices are heard. Today 90% of S&P 500 companies publish a sustainability report.
Voices to Consider
When considering a path forward for your company, it is important to also look backward and examine the history of what has driven the climate movement. The first and largest proponent was Norges Bank (the second-largest single sovereign pension fund with 1.2tn AUM).Norges Bank has since been divesting its position in coal and oil sands. Dutch, Swedish, French, and other European investment funds have also followed suit. The big change happened around four years ago when Japan's GPIF, the largest sovereign fund in the world at 1.4tn AUM, adopted an ESG governance framework similar to Norges.
There is interesting cognitive dissonance when you look at Norges. The bulk of Norway's GDP derives from oil and gas and yet they have been the earliest and most stringent adopters of climate initiatives. They have gone so far as requiring that any oil and gas platforms that use diesel to operate are rewired to use electric cables instead - a move that has driven up the cost of oil and gas extraction.
Norway and now Japan's sovereign funds have an outsized influence on US investors, like BlackRock, SSGA, and Vanguard, who have all adopted ESG principles to sell their index funds to these sovereign fund clients. It is fair to say that ESG has become a compelling business catalyst.
Oil and gas managers – both active and passive – are demanding companies embrace ESG. The focus on climate has been particularly strong in real economy companies in the oil and gas, chemical, and mining sectors.
Most public companies have over 70% of their stock held by index funds, of which the average amount dedicated to ESG is believed to be between 0.5% and 3%. There is an opportunity to have these investments increase, potentially, up to 5% in the next 12-24 months. This is significant. If your company can lead its peers by articulating a tactical, measurable plan on climate, as part of a subset of ESG initiatives, you will be rewarded with greater shareholder investments.
Different Industries, Differing Commitments
Let's say that you're a high-growth company with high profit margins. Spending 1% of profit to commit to being 'net zero' (the way Microsoft has done, for example) can be viewed on a relative basis. It's an easy undertaking when compared to companies in industries like oil and gas, chemicals, or mining. These companies are founded on a business model based on the consumption of energy, water or other natural resources and, by the very necessities of the business, they emit carbon. Apple, for example, announced in 2018 that its global facilities (this includes retail stores, offices and data centers) are powered with 100% clean energy.'Real economy' companies with a focus on manufacturing face bigger challenges when aligning company strategy to climate and ESG initiatives. In this instance, boards can evaluate their response to investors, embracing ESG in a measurable way, and encouraging continued investment. For example, BHT, the second-largest global mining company in the world, has made a clear commitment to reducing operational greenhouse gas emissions by at least 30% from adjusted FY2020 levels by FY2030.
Additionally, there is a climate push in some consumer-centric companies who want to refurbish their reputation. VW (still recovering from the emissions scandal) has adopted a group-wide comprehensive decarbonization program with the aim of reducing CO2 emissions by 30% by 2025 and of transforming the company into a CO2-neutral company by 2050.
Light industry companies who manufacture parts and components that go into the supply chain can look at possible solutions too (for example, committing that 10% of their energy use (i.e. electricity) will be supplied by renewable sources.) When looking at a typical light industry company, the average amount spent on an annual basis for electricity to support manufacturing is ~1% of the budget. If 10% of that 1% comes from renewable energy, then a company is committing to a tenth of a percent. Utility companies typically offer an option for corporations (or consumers) to purchase renewable entry at a cost premium of typically 10%-15% more depending on your state.
Capital expenditure in infrastructure is another area that manufacturers should consider for review. A boiler that runs the manufacturing plant typically has a life span of 20-30 years. Most boilers run on oil or gas. They are very costly, so it doesn't make sense to rip out and replace working boilers.
However, companies can begin by looking at boilers in need of replacement or retrofit and evaluate new boilers that run on other sources such as renewable fuels like hydrogen, biofuel, or innovative next gen solar.
An example of a utility company taking incremental steps is Xcel Energy. Providers of energy to customers in Colorado, Michigan, Minnesota, New Mexico, North Dakota, South Dakota, Texas and Wisconsin, Xcel has a goal of providing 100% carbon-free electricity by 2050.
Other companies that are focused on emphasizing climate as part of their positioning have included BP - ahead of the market by some 20 years. In 2002 BP rebranded itself from 'British Petroleum' to 'Beyond Petroleum,' committing to hold emissions constant and to be a steward to the planet. However, the company was unable to deliver on such a large promise. In March 2006, a BP oil pipeline caused one of the largest oil spills in Alaska's history. Under financial strain, BP sold off many of its solar and wind assets, quietly deserting the 'Beyond Petroleum' rebrand.
In 2019, Repsol announced it would be carbon neutral by 2050, making it the first major oil and gas company to make a pledge of this magnitude. To achieve this goal, Repsol has announced they will cut their dividend and invest in renewables. The investor response was a 5% decline in the stock price.
Despite this, BP followed suit in 2020 and reinvigorated its commitment to climate by pledging to go carbon neutral by 2050.
Exxon is clear in their view that there will be an ongoing need for oil and gas in the future. They are taking a 'wait and see' approach, looking for more proof that their investors will reward a push toward renewables.
For the oil and gas industry, a key question remains: are you better off focusing solely on oil and gas, or should you pivot towards being an integrated energy provider with a greater focus on renewables?
The auto industry also has a similar consideration of how much of a commitment to make to climate, especially with electric vehicles. Tesla is a great example; their extraordinary market cap has been bolstered by ESG funds who want to invest in the automotive sector. However, the broader industry is still measured in assessing how strong consumer demand will be. While electric vehicles have captured attention, they currently only make up about 4% of the market.
Consumer-driven ESG wellness themes have also gone mainstream. We see this in the popularity of organic fruit and vegetables, and vegan beef alternatives, such as the next gen protein Beyond Meat. AgTech is emerging as a significant part of ESG. Smithfield Foods, the country's largest pork producer, harnessing the methane from manure ponds at swine farms to supply gas to fuel homes is an example of how some companies are investing to make their corporate positioning more climate-friendly.
ESG Is Here to Stay: Questions to Ask on Climate Change
ESG will continue to be an important topic and board members should expect to see more climate-specific issues raised this proxy season. It is important to gather all relevant data and start the process of framing the discussion, as well as asking your management to gather some facts in preparation for the Q1 board meeting.Here are some questions that you may want to ask management to research:
- What is the position of our peers when it comes to climate change commitments (for example, around being 'net zero')?
- What is our profitability in comparison to our peers?
- Which of our peers is perceived as the leader in adopting climate standards?
- What trade-off do the governance and investment groups of our top 5 ' 8 shareholders want us to make as a company if we have the choice of putting a percentage of our profit into climate initiatives or redeploying that into marketing initiatives?
- What does our multi-stakeholder group think is the most important of those trade-offs? We need to ask customers, employees, investors and the community in an upcoming survey.
- Specifically, what does our management team estimate is the cost for participating in carbon neutral, net zero, carbon negative and other climate change initiatives?
For companies, the climate change discussion will only gain more momentum and visibility. We should all expect that we will need to have a thoughtful and well-informed corporate philosophy as part of our vision and mission going forward.
How we embrace both the near-term, mid-term and long-term climate initiatives as part of our overall ESG umbrella for all our stakeholders will be critical to our future success. As such, boards and management must seek to clarify an agreed way forward with all stakeholders and representatives. Doing so will ensure alignment and clear expectations for our companies' future.
2021 will be a pivotal year with the climate as an increasingly important topic. Companies will be well served to be proactive.
