‘Who cares wins’: Could ESG investment woes hit the UK supply chain?

Deal-making in the energy industry is no longer a simple affair, regardless of whether it is fresh investment in new capital projects off- or onshore; assets trading; oil & gas/power generation company mergers and takeovers, or supply chain related.

The central driver to the revolution gaining global traction is the need to counteract and reverse the impacts of climate change through the most dramatic energy transition there has ever been; rolling back on fossil fuels dependency and switching to low carbon/zero carbon sustainable energy sources – also maximising energy efficiency.

According to Mitsubishi Heavy Industries Group in a presentation made at last year’s CERA Week in Houston “the rapid pace and increasing urgency of the energy transition are changing how, why, where and when investment decisions are made”.

A variety of new business models – all touted as being more ethical and clean than anything that has gone before – have gradually emerged over the past 25 or so years.

They all share a common core built around the concept of ESG – Environmental, Social and Corporate Governance.

And the foundation of that is CSR (Corporate Social Responsibility); which quite literally goes back centuries though there is widespread ignorance about its deep provenance.

ESG boils down to a set of standards for a company’s behaviour used by socially conscious investors to screen potential investments. In particular, environmental criteria consider how a company may safeguard the environment, including corporate policies addressing climate change, for example.

The term was first coined in 2005 in a landmark study entitled ‘Who Cares Wins’ by Ivor Knoepfel. The idea is that investing is based on the assumption that ESG factors have financial relevance. It is now big business and hugely powerful.

The Organisation for Economic Co-operation and Development (OECD) says that “as market participants show greater awareness and concern of the physical and climate transition risks that may affect financial stability and market efficiency, ESG rating providers and investment funds are increasingly integrating metrics aligned with environmental impact, climate risk mitigation, and strategies toward greater use of renewable energy, innovations and products in their business activities”.

However, this ethical tool has not had a straight run. Last year the European Securities and Markets Authority (ESMA) flagged complexity, lack of transparency, and poor comparability among ESG ratings/data providers.

ESMA basically warned that companies/investors are unlikely to invest in the transition without clarity on eligibility for “low-carbon” investments and material information on climate and transition risks.

The power of ESG

Look no further than Shell for an example of the power of ESG.

On February 9 the NGO ClientEarth, with backing from institutional investors, launched a legal action in the UK against Shell’s eleven current directors individually, alleging board members had failed to prepare the super-major adequately in response to the risks of climate change and were legally accountable.

Shell is also in trouble in the US where another NGO, New Global Witness, has submitted to the US financial regulator a complaint accusing the oil and gas company of greenwashing by “lumping together some of its gas-related investments with its spending on renewables to inflate its overall investment in renewable sources of energy”.

It wants the US Securities and Exchange Commission (SEC) to put the boot into Shell and may succeed.

Meanwhile, DNV has just published its 2022 Energy Transition Outlook, a massive piece of work widely regarded as being hard to beat and which references ESG several times.

It offers global and regional analyses. In the case of Europe, the UK is treated separately as it no longer fits into the EU model.

Zooming in; what is its assessment of the UK’s position?

DNV is clear, even though only 46% of energy capital expenditure in the UK flowed into fossil energy projects in 2019 (the last year for which there appears to be a reliable figure), the pendulum needs to swing faster and further towards low- and zero carbon energies if the London  Government’s goal of Net Zero is to be achieved.

“The scale of the challenge is unprecedented, but there are precedents for solutions,” says DNV. “Offshore wind in the UK is one such example, where the government ‘overpaying’ for electricity gave life to the sector and enabled it to scale.

“The UK is now the world’s largest offshore wind market and has achieved a market which relies less on subsidies and one where the role of private investors is now the mainstay for funding these projects.

“For the finance community, the capacity of companies to achieve a just transition – both environmental and social – is increasingly among the criteria considered by investors.”

DNV claims too that “a Paris-compliant energy transition is affordable”.

But despite an impressive roll-out of investment numbers, the trade body Energy UK virtually concurrently warned that the UK economy could lose out on £62 billion of investment between now and 2030, leading to a shortfall of 54GW of potential wind and solar capacity.

Supply chain crunch

It warns that any investment hiatus “will make it harder to build the sustainable supply chains that are vital for delivering green jobs”.

“Without adequate supply chains, it will be exponentially harder to deploy renewables in the coming decades and leave us vulnerable to the same international energy market volatility that caused the current energy crisis.

“A pause in investment will have long-lasting consequences to the supply chain that will scar the sector even after capital begins to return to the UK. A one-to-two-year investment hiatus could lead to a four to five year supply chain crunch.”

EnergyUK probably doesn’t realise how closely this mirrors the hap-hazard way in which the North Sea oil and gas supply chain grew up. It seems the same mistakes are being made all over again.

According to the association, the government has set a target to create two million green jobs by 2030. Given that the energy sector is much more productive than the economy as a whole (creating £135 of output for every hour worked), these are likely to be high-skilled, high-paid jobs. Slowing down investment now puts this green economy future in jeopardy.”

Aside from the impact of such an investment shortfall on future power generation capacity; it will also hit the buying and selling of windfarm assets; and mergers and takeovers of power generation companies; this would also hamper the development of a healthy supply chain M&A segment; something that is especially important to firms brought up on North Sea oil and gas but which are keen to diversify or even switch wholly into low and zero-carbon activities and necessarily build their ESG profiles.

Notwithstanding the EnergyUK concerns, DNV says it foresee continued strong interest in onshore/offshore wind and solar PV projects, both from capital moving from oil and gas investments, and from institutional investors with a longer-term investment appetite.

“In a declining oil and gas market, priorities are shifting as investors reassess the risks of stranded assets when financing oil and gas projects.

“The financial markets are increasingly factoring in the changing sentiment in society towards a decarbonized future.”

Even in the US, where, according to Deloitte, more than 30% of energy sector deals involved Big Oil buying into low and zero-carbon positions.

Though optimistic, DNV also says that the energy transition will place huge demands on the UK supply chain for raw materials, equipment fabrication, site installation and workforce availability.

Bizarrely, however, it has discovered that thought each low/zero carbon industry sector has commissioned its own supply-chain studies; to date, there has been no holistic assessment of how the UK supply chain will deliver the energy transition in the next three decades.

“Left unplanned or uncoordinated, a failure to prepare the supply chain adequately is a significant risk to the achievement of Net Zero in the UK.”

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