Alfredo Álvarez Laparte
Energy Leader, EY Latin America North
EY

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ESG Overview of the Oil Industry: The Evolution of Sustainability

By Alfredo Álvarez Laparte | Fri, 06/24/2022 - 09:00

First, by way of context, it is important to note that the oil industry contributes 42 percent of total global emissions, even though in Scope 1 and 2 the impact is approximately 9 to 11 percent; at the Scope 3 level, the industry has a major impact because of the type of products it generates in a traditional fossil business. This industry in particular is energy- and natural resource-intensive in generating energy sources and contributes substantially to methane emissions, which is a powerful greenhouse gas derived from fugitive emissions and venting to the atmosphere during its transformation processes.

As a result, at a global level, we observe three main drivers of industry transformation in terms of ESG (Environment, Social, Governance) matters:

The first driver is climate change as a determining stakeholder agenda:

  • At all international forums, such as those held in Paris, Glasgow and the European Union, there are increasing legal, regulatory and fiscal obligations on the industry.
  • On the other hand, the main stakeholder driving the transformation is the financial sector, which considers the development of the industry as both a risk and an opportunity.  
  • Likewise, we observe a growing diversification of the portfolios of international companies, setting objectives to create non-energy businesses in the short or medium term.  
  • On the other hand, the growing Generation Z, who are associates of energy companies as well as clients and consumers, seek environmental protection, which becomes a challenge for the attraction and retention of talent, targeting the industry for its environmental impact.
  • Finally, unprecedented in the industry, we have the civil sector as a driver of transformation, in cases where environmental groups have sued and won lawsuits against large multinational companies demanding that they accelerate their decarbonization commitments.

The second driver is the growing demand for renewables, due to the setting of sustainability goals by both governments and companies, with renewable production expected to double by 2030.  

The third driver is related to technology development, even though we have not yet reached a pattern that applies Moore's Law, where development is exponential; however, globally there is significant progress in the development of carbon capture technologies, hydrogen production, batteries and electric mobility solutions as well as in the use of data and digitization, among others.

Derived from such drivers, a strategic transformation of the industry's business models is taking place and sustainability actions are being taken. In our opinion, the industry is witnessing three main strategic transformation approaches:

  1. The first approach is to maintain and improve the traditional or "core" business, which means prioritizing operational improvements, reducing energy consumption, achieving greater energy efficiency and applying technologies to improve the traditional business and its environmental impact.
  2. The second approach involves adding to the previous aspect the development of new products, technologies and businesses related to energy, by leveraging the traditional oil business.
  3. The third approach is transformational, which means adding the development of new multi-energy value chains, new energy and non-energy businesses. This involves the development of new "non-fuel" or non-energy businesses, including new retail and convenience, telecommunications, infrastructure, digital and information businesses, among many others.

From a more practical and operational point of view, the main practices we are commonly observing in the industry are the following:

  • Corporate governance with a focus on sustainability: most of the leading international and national oil companies are implementing corporate governance focused on sustainability, seeking that the balance between business, environment and society is furthered in decision-making at the highest level and, in particular, that top-down transformation programs are being defined. On the other hand, most oil companies have set sustainability and particularly carbon-neutral goals for 2050, working intensively on the pursuit of decarbonization. If these goals are aggressive enough, and the way to achieve them is both effective and efficient, these are issues that are being resolved on an ongoing basis in the industry.
  • Innovation and improvement: throughout the traditional business value chain, engineering solutions, improvement of operating practices, development and application of technology, as well as the development of nature-based solutions (such as reforestation and recovery of green areas, among many others) are being implemented. There are many examples of innovation and improvement; however, the message to send is that the industry is looking for a balance between economic impact and cost savings along with environmental impact.  
  • The industry is looking for streamlined and simplified key business, administrative and support processes, as well as the use of information and digital solutions to optimize processes, all with the aim of optimizing operations and the decision-making process, allowing companies in the industry to react more quickly without compromising control and efficiency.  
  • Many of the oil companies are investing in research and development to create solutions that can later be upgraded and monetized, turning them into an additional source of revenue.
  • Investment in the development of new products: focused on biofuels and bioplastics, among others, where the underlying issue is not only the product itself but the production process, whose key feature is that they should be made with green energy where possible.
  • Culture: several oil companies are developing strategies to include their personnel as a key element to achieve the success of the transformation and address the barriers that prevent it; therefore, change management is a key issue to achieve the transformation.
  • Investment with social impact: the industry has a tremendous impact on the communities where it operates, thus, actions related to the environment, corporate governance and specific programs are being implemented to have a positive impact on the communities, aligning the interests of the public and private sectors and civil society, creating social impact ecosystems.

The energy sector is undergoing a fundamental transformation process, facing disruptive forces that will lead to the development of a new energy system. This means that we will move from...

  • ... revenue and value based on reserve size to value focused on profitability and capital discipline, this being one of the main lessons of the pandemic;
  • ... assuming continuous demand to uncertainty in the market;
  • ... being focused on specific product types and fuels to being focused on economic, environmental and social outcomes;
  • ... being primarily disrupted by geopolitical conditions to having multiple external and disruptive pressures (such as disruption in mobility and green power generation), with associated substitution, regulatory, legal, and environmental risks;
  • ... introducing digital technology without scaling up to large-scale technological innovation and integration.

Two organizational capabilities that will be critical to this transformation are responsiveness and resilience that will allow the industry to better navigate disruptive forces and market needs. To achieve this in a practical way, operational streamlining and simplification efforts are critical.

At EY, we believe that companies should consider the following key aspects in their ESG approach:

  • Strategy and objectives: create an ESG strategy that supports the overall corporate strategy, set ESG objectives and goals, and develop a roadmap for meeting them;
  • Governance: through a formalized operating model, board leadership and commitment, and an end-to-end scorecard for comprehensive ESG performance monitoring; 
  • Purpose and communication: develop a branding and communication strategy to deliver a compelling narrative about the delivery of long-term financial and non-financial value through the ESG strategy;
  • Risk management: integrate ESG matters into the enterprise risk management framework to identify, assess and prioritize risks, and implement effective solutions;
  • Reporting and disclosures: report ESG data in a reliable, objective and consistent manner, with appropriate internal controls and processes, to meet stakeholder needs and compliance requirements;
  • Operations: create a business case and transformation program to achieve ESG objectives within each business function, facilitate communication across the organization and escalate key issues.

This is a transformation process where companies in the industry can achieve concrete economic, environmental and social results.

 

In collaboration with Bernardo Cardona, Deputy Energy Leader, EY Latin America North