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Clean up your act: Learning from energy companies and ESG

When is an environmentally-friendly deal not an environmentally-friendly deal? Oil and gas company M&A will increasingly be influenced by rising demand for better environmental, social and governance (ESG) performance. But simply passing the buck isn't going to cut it.

As more funds and investors begin to shed fossil fuels from their books, what can corporates learn from this industry’s efforts to clean up its act?

1/ Clean living means more than just divesting

Last month at the NAPE Expo in Houston, one of America's largest energy conferences, panelists called out a quick fix that companies are using to try and reduce their carbon emissions—selling off assets. But this doesn't solve the problem.

As Michael Rubio, general manager for ESG engagement & sustainability for Chevron highlighted, the seller's sustainability credentials improve, but the private company won't face nearly the same disclosure requirements, making it harder to see if conditions are getting better or worse at the asset in question.

"If that private company cranks it back up, it's actually net negative to carbon intensity and the Paris goals," he said.

Craig Webster, managing director for ESG & sustainability with Tudor Pickering Holt, added that it is not hard to foresee investors taking steps to try to block such assets sales.

"If you fast-forward a few years…as pressure builds, I can see shareholders making proposals that say you can't sell assets just to lower your carbon intensity," he said. "And if you do sell that, you have to account for it publicly."

2/ The rising tide of ESG will lift all boats

Oil and gas producers will have to get their house in order one way or another. Upstream energy deals inked this year have had ESG explicitly cited by participating companies as factors in the transactions.

Civitas Resources, formed by the merger of Bonanza Creek Energy and Extraction Oil & Gas, has repeatedly stated that it will be a net zero producer of Scope 1 and 2 emissions. By their very nature, fossil fuel businesses can't commit to Scope 3, which pertains to emissions produced from their own products. That's simply not possible.

But companies are doing what is within the realm of possibility. The deal announcement for the merger of Cabot Oil & Gas with Cimarex Energy, for example, said the companies would continue to link executive compensation to ESG performance and there would be "strong board oversight of ESG risks and programs.”

A precedent is being set and these are the kinds of baseline commitments that would-be acquirers will need to meet to get deals done in future. As one sector attorney speaking at Enercom's Oil & Gas Conference in Denver last month pointed out, this public emphasis from the companies on ESG creates a significant hurdle for any prospective interlopers, providing a rationale for rejecting bids that simply trump the valuation of either company in the all-stock transaction.

This could, in theory, play out across the industry. As companies make greater ESG commitments, those outfits that are trailing behind will not get a look in. To compete more successfully in M&A, they will have to raise their own game on sustainability.