ESG ratings ‘insufficient’ to assess state-owned O&G companies

EM companies with state ownership significantly underperformed on governance versus international peers.

ESG rating frameworks are ill-suited to deal with the complexities surrounding state ownership of oil and gas companies, as well as national oil companies (NOCs), according to a study by Columbia University academics.

The authors noted that ESG rating agencies conduct standardised assessments of both private and state-owned or controlled companies, which may be an insufficient approach as NOCs “pursue multiple objectives rather than only return on capital”.

This means that NOCs – which provide about half of the world’s oil, hold more than half its refining capacity, and own the bulk of oil and gas reserves – are particularly vulnerable to ESG performance reversals because of domestic political changes or broader geopolitical events.

A more stringent framework to rate governance is key to ensuring that “both internal and external systems of checks and balances for NOCs are important to buffer some of these pressures and discourage reversals”, the researchers said.

They added that poor ESG performance is expected to “become increasingly relevant for future creditworthiness”.

Failure of NOCs to address ESG risks could lead investors to hold fewer bonds in such entities, which could impact their ability to refinance or contract new debt. Around 40 percent of NOCs’ outstanding bonds are due by 2030 or later, according to the study, which was conducted by Columbia’s Center on Global Energy Policy.

Researchers said that key deficiencies of ESG ratings products include a lack of regard for the sustainability credentials of a state owner, the extent to which an NOC is legally and functionally separate from the state, and disclosure and clarity of ownership objectives.

Board independence is a critical area of governance for NOCs. Particular attention should be paid to the nomination process, for board members and also senior executives, to ensure that they are not co-opted by government officials.

Another element that could impact the ESG performance of NOCs is whether they operate in countries where there is domestic competition, which often means that independent regulatory agencies step in or are created to set industry rules. This could lead to more transparency and accountability on how NOCs are operated, the report said.

Joint venture partnerships with ESG-minded international oil companies were flagged as another potential avenue for ESG improvements. Publicly listed companies face pressures to improve the sustainability of assets in their home countries but also those in the emerging markets where they operate.

ESG underperformance

Despite the shortcomings of ESG ratings in evaluating state-owned companies, the governance scores of NOCs significantly underperformed those of their international oil company (IOC) peers based on ESG ratings from six providers, the study said.

NOCs and IOCs fared equally poorly on environmental factors and there did not appear to be a conclusive result as to which had better social performance.

ESG ratings were obtained between December 2021 and February 2022, prior to the conflict in Ukraine.

The study covered 14 NOCs from emerging markets that have received at least two ESG ratings, most of which have listed minority shares. The IOCs analysed were BP, Chevron, ConocoPhillips, Eni, ExxonMobil, Repsol, Shell, TotalEnergies and Equinor.

The companies represented about $4 trillion in market capitalisation and about 60 percent of the world’s oil production in 2021, the study said.

The researchers found that all ESG rating agencies in the study already assessed company payments to governments, due to the higher risk of corruption in extractive industries.