Are SEC ESG Disclosure Proposals a Bane or a Boon for Oil and Gas?

Since last year’s COP26, many companies have rushed to pledge their commitments to carbon reduction and tout their sustainability credentials. But talk is cheap. How can you assess the credibility of those pledges?

That’s one of the challenges that faces both investors and consumers, as they try to evaluate the environmental track record of the companies in which they invest and from which they buy products.

In late March, America’s SEC (which regulates financial reporting by large companies) put forward new proposals that would give environmentally conscious consumers and investors the tools to assess and compare the green credentials of companies. The controversial proposals would require companies to disclose their true environmental impact (include scope 1, scope 2, and scope 3 emissions) and action plans to address sustainability.

Proponents say that the proposals would bring transparency to the market and allow investors and consumers to make better informed decisions about a matter of growing importance. The companies that are making credible strides towards carbon emission reduction would be rewarded with access to cheaper capital markets and greater market share. 

Others believe that the effort and costs of compliance with the new legislation will be too high in relation to the benefits it brings to market participants.  

In this interview, Shivaram Rajgopal, Kester and Byrnes Professor at Columbia Business School, explains why he broadly supports new SEC proposals on emissions reporting, discusses the shift from shareholder to stakeholder capitalism, and speculates that ESG may face an Enron-style reckoning in the coming years.

Diana Davis, Oil and Gas IQ: There’s been a lot of talk in recent years about how we're moving from shareholder to stakeholder capitalism, including in traditionally “dirty and dangerous” industries. How real do you think this shift is?

Shivaram Rajgopal, Columbia Business School:  The origins for this shift can probably be found in the 2008 financial crisis. “Occupy Wall Street” was one of the movements that rose out of the outrage that we bailed out banks instead of homeowners.  Then, the Tea Party movement came along followed by President Trump’s election.

These factors led to a strange dynamic. First, business was the villain. Then, as these other complex socioeconomic trends developed, business became the savior because they were the only institution left in the room that was seen as a grown up.

Wall Street ended up coopting a lot of the ideas from the “Occupy Wall Street” movement. We now see enormous funds like Black Rock, which has over $10 trillion in managed assets, focusing on ESG metrics for investing.

All this said, there is a lot of “greenwashing” in this space. People don't seem to lose any opportunity for virtual signaling. But that doesn't mean that the ESG movement is a waste of time.

There are two reasons I say this.

First, the financial reporting model doesn't handle externalities very well.

For instance, if I smoke, you get hurt. And if I smoke a pack, you probably smoke at least half a pack, and eventually you'll get cancer. Who's going to pay for that? That's the idea of an externality.

The ESG movement pushes us to think harder about both positive and negative externalities.

This is not to say that business is evil. Profits are not a bad word. Without margin, there is no mission.

For instance, we are all consumers of oil and gas products. Until consumers have a credible alternative, what’s going to happen if you stop Western oil supply?  Consumers would simply get oil from Saudi Aramco, Rosneft and Gazprom, Iran and Brazil and Venezuela. Is that really what we want?  

So we need to have conversations about externalities, both good and bad.

Secondly, not everybody in business is a Mother Teresa. ESG is trying to shed some light on some of those practices. How does making a CEO more accountable be bad?

Diana Davis, Oil and Gas IQ: Turning specifically to some of the research that you've done. You’ve looked at the impact of sustainability pledges at the major E&P companies.  Can you tell me about that research?

Shivaram Rajgopal, Columbia Business School: We focused our research on the impact of sustainability pledges on the share prices of Exploration and Production (E&P) companies. Implicitly and explicitly, E&P accounts for roughly 40 percent of global GHG emissions.  

There has been pressure on these companies to pledge some form of carbon reduction, if not net zero. In our research, we were trying to understand what these pledges look like and whether they were credible.  

We focused on the US because the regulatory environment in other countries is different where the regulatory regime may have more of an impact on a company’s sustainability pledges. Some have carbon taxes, for instance. In the United States we have roughly 65 E&P companies – if you exclude the small ones that are not significant from an economic point of view.

In terms of carbon reduction commitments, the data splits up quite evenly. Roughly a third of E&P companies have pledged net zero carbon emissions. Another third of companies have pledged some degree of carbon reduction but not net zero. The final third of companies have not made any promises.

What was the impact of these sustainability pledges on companies?

First, we looked to see how the stock market reacted. I will say that there are some methodological issues with this but we did the best we could to analyze how the stock market reacted to sustainability commitments.

The first thing we found was that the market did not react to a new sustainability commitment. That could mean that the market thinks it’s all just cheap talk or that it will be good for half the companies and bad for half the companies so the net result is no movement in share price.

We then probed deeper to find out whether there is any benefit for a company at all.

It turns out there is some weak evidence that if you clearly articulate a transition plan, that has a date and more granular details, there is a small positive effect on stock price. These granular details could include the specifics around by what amount and how will you reduce gas flaring? Do you have a water management strategy? Is the board committed? Do you have a climate committee on board? Is compensation of the CEO truly tied to climate?

If you don’t have these plans in place, the market does not react to sustainability pledges.

One of the more interesting results we saw followed Engine One’s campaign of Exxon. Engine One is an activist hedge fund that managed to appoint 3 members to the Exxon board last year after buying 0.02% of the company. The fund was focused on pushing the oil giant to reconsider its role in the net zero transition.

Following Engine One's Exxon campaign of Exxon, the stock prices of companies that had not made climate pledges suffered reasonably significant losses (roughly -5%).

I find that a curious response that I’m still trying to understand. I think what could be happening is that there may have been some fear that more Engine Ones would show up and hedge funds would put pressure on companies to pursue net zero strategies.

Another possible hypothesis I have is that if you pledge net zero, you were just seen as a better run company and in better position for regulatory changes that could be coming.

Our final observation was around who was likely to pledge carbon reductions.

It turns out that large companies pledge if they’re owned by BlackRock. Companies are more likely to pledge post Engine One, and you're more likely to pledge if you are gas-heavy as opposed to oil-heavy in your revenues. Gas is seen as a transitional fuel because it emits less carbon per unit heat generated relative to oil.

Diana Davis, Oil and Gas IQ: What were some of the challenges with the research?

Shivaram Rajgopal, Columbia Business School:  It was often very difficult to identify pledges that companies had made. They were scattered across all kinds of sources, such as press releases, websites, sustainability reports, 10K's or even a CEO speech on CNBC.

Figuring out the credibility of each pledge is even harder. Some companies have a transition plan and others don't. How do I know if this transition plan is effective? For instance, sometimes companies will say that they are focusing on carbon capture but when you read carefully, they’re spending only $5 million on it. That’s nowhere near credible.

This goes back to your first question: How much of this is green washing versus how much of this is authentic and real? It’s unclear.

Now, as oil prices have tripled some of these conversations have gotten postponed, ignored, or deferred because now we are desperate trying to pump more. On the other hand, as oil prices rise, renewables become more competitive. It's a very messy, complicated world.

Diana Davis, Oil and Gas IQ: The new disclosure rules that the SEC is proposing would require companies to report not just their scope one and scope two emissions, but also their scope three emissions. I understand that you're broadly in support of these proposals. Why?

Shivaram Rajgopal, Columbia Business School: It's a qualified ‘yes.’

We have literal alphabet soup of NGOs writing standards. You have CDP. You have CRG, DRI. They offer all kinds of twists to the broader idea and the GHG protocol.  

There is need for standardization. I often tell people who object that they should pick through the annual sustainability reports of companies to try to make sense of what is being done.  

If a company makes a corporate commitment, I want to be able to figure out whether it is real. Right now, it’s like a noodle soup! It’s total chaos and that is one reason why some standardization would be helpful.

But I have some sympathy for people who argue that compliance costs will be high. The compliance costs the SEC mentions in its proposal sound low to me. 

To the bigger picture point, I think that reporting is a small piece of the fight against climate change. You can do the reporting. Is it going to solve the problems with our climate? No. But it’s one of a broad range of actions that we can take.

If the SEC fails – and the pushback is already starting to be immense - I think a gazillion NGOs will fill the void.  Somebody else, possibly the ISSB, will become the defacto standard setter in order to satisfy investors but the ISSB has no ability to enforce the standards, unlike the SEC.

The other thing to say in all this is that green products sell.

In the university we are close to the Gen Z and millennials. I’ve never seen any issue that animates them as much as climate changes. There’s an almost messianic zeal in their eyes. Some of that may dissipate as they enter the workforce and start raising their families but I think there’s a demographic change coming. These young people are our future voters and citizen.

I wouldn't be shocked if we have a Green Party in the US like in Germany in, say 20 years or 15 years. As a company, this is an opportunity. Recognize that your consumer is going faster in this than perhaps you are.  

Diana Davis, Oil and Gas IQ: Following Enron, accounting rules were tightened up. What lessons do you think we could learn from that time that are applicable to sustainability reporting today?

Shivaram Rajgopal, Columbia Business School: That's a fascinating question. Worldcom and Enron led to something called Sarbanes-Oxley, which proposed tighter regulations on financial reporting.

Two decades on is a good time to look back and reflect on what SOX did. It achieved a lot. Confidence in equity markets had disappeared following Enron.

Bob Schiller, one of the Nobel laureates, has argued that people lost faith in equity markets. They’re just pieces of paper that we don't even see. That's why people started buying houses instead and that’s where we had the roots of the next problem in 2008.

Trust is essential in the stock market. Earning money is difficult, preserving capital and growing it is even more difficult. We all want to preserve all capital for retirement, legacy or to pass onto our children. I think Sarbanes-Oxley helped to fix many of the issues.

Coming back to ESG reporting. The extent of greenwashing in the system reminds me of the lead up to 2000.

As regulators tighten up, we’re already starting to see big scandals. Look at the DWS scandal at Deutsche Bank. The SEC and federal prosecutors are investigating the Deutsche fund after its former head of sustainability claimed that the company exaggerated its use of sustainable investing criteria.

A lot of funds are making promises that they don't yet have the resources to keep. They'll make claims about not investing in companies that have human rights violations. How can you possibly go check human rights violations if you're a company that operates in 100 plus countries?

Without naming names, I'm amazed by the claims that they make in their prospectuses, for instance.

Will we have an Enron moment? Will we have an ESG version of Sarbanes Oxley? It's very possible that we will eventually have the hammer coming down.

Looping back to why I support the SEC proposals, when these disclosures move away from the sustainability report and 10K, the SEC has more regulatory teeth.

Regardless of which side of the conversation you're on, I think we can all agree that you need less greenwashing and more transparency.

In that sense, the rules are positive step forward.

One final thought to end our discussion on, the next generation are into this big time. The Greta Thunbergs of the world are not the outliers. They are the trend.

If nothing else, there's a big market opportunity. Even if you think that the only purpose of a business is to serve a customer – and there’s nothing wrong with that definition – a CEO would be foolish to ignore this trend.