Master in Public Administration, Economics
and Governance
Ricardo Armando Ramirez Ubidia, s2002280
Master thesis: The impact of governance in the energy transition on the
environmental, social and corporate governance (ESG) performance of the
highest emitting fossil fuel companies
7/07/2019
Abstract
This paper conducts a detailed analysis of the Environmental, Social and Corporate Governance (ESG) performance outcomes of the highest emitting firms around the globe and their evolution throughout an energy transition in the past 30 years. This study takes into account the different policy mixes approaches that governments use to address negative externalities such as air pollution and climate change. Applying the theoretical framework developed and considering cross-sectional and time-series variances, this paper shows empirical evidence that reveals two main findings: First, all the policy mixes approaches mentioned in the literature led to a significant positive effect on ESG performance outcomes of the major emitting firms. This finding can be observed by contrasting policy goals and ESG outcomes such as reduction CO2 emissions (environmental), involvement of local communities in major projects (social) and firms’ portfolio diversification with greener energy sources (corporate governance), among other indicators. The second finding of this paper relates to the relevance of specific firms’ environmental performance to the global CO2 emission outcomes. Empirical evidence shows that state-owned corporations in the energy sector in China, Russia and Saudi Arabia are responsible for a major part of the global CO2 emissions from 1988 to 2015.
Acknowledgements
Reaching this point in my academic formation is possible thanks to the constant and unconditional support from my parents Patricia Ubidia and Jorge Ramirez. I thank them for the values they have taught me and for being my inspiration to become a better person and to always aim at ambitious objectives. I would also like to thank my thesis supervisor Dr. Sarah Giest who has guided me and always remained approachable and helpful throughout my whole research process. Finally, a special mention to my friend Angela de Luise in Peru, who has cheered me to persist and continue working hard to overcome any challenge along the way. Thank you all.
Table of content
1. Introduction……… 5
• Research question..……….6
• Relevance to Public Administration..………..……. 6
2. Theoretical framework………..……….……….……….. 7
• Governance in the energy transition...……….. 7
• Policy instruments mix……….……..…….. 9
• The regulation dilemma…………..………...………..….13
• Transition theory………..…...……..…15
3. Hypothesis.……….…….……….……….. 15
4. Research design……...……….………... 16
• Research Method………....…16
• Causal inference………..…16
• Data and collection analysis………...………....…17
• Independent variable: Governance in the energy transition…...…18
• Dependent Variable: ESG performance………..18
• Confounders: negative externalities……….19
6. The Case………20
• Energy transition and the major oil and gas companies..…………..20
• Highly regulative approach–innovation and conversion to gas...24
• Self-regulative governance observed………...27
• Greenhouse gas (GHG) emissions and innovation……….31
• ESG performance overview...…………..………...……..…35
7. Analysis.….……….……….. 39
• Governance approach across regions………….………39
• Relationship between governance in the energy transition and firms’ ESG performance………..43
• Few countries responsible for a major share of the global CO2 emissions in the fossil fuel industry………...……….46
8. Conclusion………..…..….……….……….. 48
9. Limitations…..…..…..….……….…….……….. 50
10. Bibliography…………..…...……...……….. 51
Figures and tables
Tables 1. Economic and financial instruments………...……….11
2. UK policy instruments mix..……….……….12
3. Global GHG emission from 1988 to 2015.……….22
4. Global GHG emission in 2015.……….23
5. Policy instruments mix in China……….25
6. Scope 1 and 2 reduction opportunity by 2030...……….33
7. Scope 3 reduction opportunity by 2030.……….34
8. ESG performance metrics.……….36
9. ESG assessment…..……….38
10. Variables and outcomes………..……….42
Figures 1. Gas demand expectation by 2030.……….……….24
2. Gas growth associated with pollution reduction...………..………….…….26
3. LNG production capability……….……….29
4. Top projects reserved by the seven sisters..……….……….30
5. Seven sisters’ gas exposure……..………..……….31
6. Scope 1 GHG emission intensity for different development types...32
7. Total GHG emissions scope 1……...……….33
8. ESG performance linkage to annual executive bonus...……….39
9. Causal identification………46
The impact of governance in the energy transition on the environmental, social and corporate governance (ESG) performance of the highest emitting fossil fuel companies
Introduction
Policy instruments are designed and implemented aiming at correcting one or multiple market failures that are relevant to society and the environment. The market failures this research will analyze are the negative externalities such climate change, air pollution triggered by an oversupply of CO2 emissions around the world (Florini & Sovacool, 2009). Governments address this policy issue in different styles: through a highly regulative approach, a market oriented approach and by fostering innovation (Borrás & Edquist, 2013). This paper will analyze these variables in depth in order to unveil any causal relationship.
The adoption of the Paris Agreement for instance, opened a window for more ambitious regulation targets around the world (Andresen, Skjærseth, Jevnaker, & Wettestad, 2016). The Paris Agreement has as a main objective to keep the rise of temperature below 2° C for this century and to ensure firms’ performance reporting throughout a framework of transparency (United Nations, 2018). Policy makers in their efforts to meet the Paris Agreement’s objectives have set high sustainability standards to most of the industries in the private sector (Andresen, Skjærseth, Jevnaker, & Wettestad, 2016). Further, the major fossil fuel companies not only need to meet these goals, but also add value to their organizations in a sustainable manner to be able to continue operating (CDP, 2017). In 2015, CEOs of 10 major oil companies committed to a “Climate Change Agreement”, which consisted in reducing the carbon footprint of their businesses (Bernstein, 2018).
Governments promoting the production and use of Liquefied Natural Gas (LNG), biofuels, and hydrogen as renewable energy sources has been crucial energy transition’s aspects (Bernstein, 2018). These actions describe to a certain extent, governments’ and oil corporations’ efforts to switch from traditional oil and coal to greener alternatives aiming at reducing CO2 emissions. Policy makers and politicians are nowadays setting their objectives taking into account GDP aspects as well as performance indicators that include Environmental, Social and Corporate Governance (ESG) targets (Bernstein, 2018).
This study will focus on Environmental, Social and Corporate Governance (ESG) performance data of the highest emitting oil/gas companies globally, comparing the most relevant peers/competitors’ performance in the industry. Although all the elements encompassed within the ESG criteria will be considered, this paper will pay special attention to CO2 emissions data given that it will determine who the most relevant oil and gas
companies are and under which jurisdiction they operate. The aim is to find empirical evidence of the level of effectiveness of governance in the energy transition within the countries previously mentioned reflected in ESG performance data, taking into account the tri-sectoral dynamics among the role of corporations, society and the government.
Research question
To what extent has governance in the energy transition fostered an ESG performance shift among the major fossil fuel companies?
Based on this positive question, the independent variable “governance in the energy transition” will be disentangled by closely analyzing and conceptualizing the different levels and approaches through policy mixes addressing climate change among the selected cases. These streams will encompass highly regulative governance, self-governance and innovation oriented governance. This way, the operationalization at each distinctive category will allow a more thorough understanding of the different ESG performance outcomes that they may lead. Environmental, social and corporate governance (ESG) performance will be the dependent variable. ESG performance reflects the capability to maintain competitive advantage alongside new challenges and trends (Bassen & Kovacs, 2008). Moreover, it is seriously taken into account for investment decisions when analyzing opportunities and long-term risk factors (Bassen & Kovacs, 2008). ESG are the three key concepts basis of the Principles for Responsible Investment (PRI), which is operationalized within a framework established by the United Nations to promote and monitor sustainable and ethical practices in diverse industries (PRI, 2018).
Relevance to Public Administration and Economics and Governance track
Although there is vast scholarship regarding ESG performance such as “The Paris Agreement: Consequences for the EU and Carbon Markets?” (Andresen, Skjærseth, Jevnaker, & Wettestad, 2016) and “ESG Integration and the Investment Management Process” (Duuren, Plantinga, & Bert , 2015), the focus remains on the description of the spatiality of low carbon economy implications within the energy transition process.
The findings and conclusions of this study will enhance the understanding of the basic concepts and processes encompassed within different styles of governance in the energy transition and the market failures they addresss, from an economics of regulation perspective. The intent is to build useful information about governance in the public administration to take
into account for further academic research, environmental projects and legislation. Likewise, the social and academic relevance of this research lies on the analysis of academic studies, recent data and conclusions from main ESG analysts and data collectors in the industry such as Bernstein, CDP and MSCI, which will illustrate any progress in the energy transition across countries and over a given period of time. Also, this paper will consider recently disclosed performance data released in the Annual Reports and Sustainability Reports from the companies that will be studied.
Theoretical framework
Through a deductive method, this paper will analyze literature that can enhance the understanding of the energy transition processes in different regions of the world. The theoretical framework will disentangle a range of concepts that will allow a more precise analysis of governance, its variations across countries and the outcomes that they may generate within different streams that this paper will developed. The impact that governance in the energy transition may have on ESG performance, if any, will be differentiated and closely studied across regions. In this sense, this paper will start by analyzing governance theory from a general perspective to then, narrow down the literature to more specific styles of governance. The style of governance will be studied corresponding to the type of policy instruments mix used to approach and manage the energy transition. Likewise, this research will explore further literature that sheds light on the interactions between the government and the industry, as well as the constraints that they may face to reach cooperation according to the governance regime of the country or region studied. Finally, in order to achieve a thorough analysis of the effects that governance in the energy transition may have in different countries and to reveal any causal chain, this paper will expand on literature that enables a revision of the evolution of the industry’s behavior vis-à-vis the economic elements that characterize and are encompassed within a transition.
Governance in the energy transition
Also addressed as “transition management”, which constitutes a more modern manner of governance for sustainability ( Voß, Bauknecht, & Kemp, 2006). It encompasses the direction and the speed that energy transition would be aiming at through a number of steering mechanisms and very importantly, through innovation. The main idea would be to achieve the objectives that have been designated by society through political processes as well as
transformed and integrated sectorial policies ( Voß, Bauknecht, & Kemp, 2006), which can potentially vary among countries.
Lehmann (2012) argues that climate change and pollution externalities signify more than just a market failure and that in reality; they also encompass a failure in the governance from the public and private sector to reach efficiency and sustainability goals in the energy industry. Also, Borrás and Edquist (2013) argue that governance nowadays would be the role of government switching from merely being a “provider and regulator” to become a “coordinator and facilitator”. This would be done by designing and implementing a set of policy instruments that will evolve according to changes in policy issues and policy innovation over time. Most of these instruments would be especially voluntary and non-coercive, also refereed as soft instruments (Borrás & Edquist, 2013, p. 1516).
Florini and Sovacool (2009) argue that governance in the energy transition will continue to be highly disjointed and to consist of a set of actors holding a range of legitimate authority to design regulation hard and soft, which many times their coexistence will be inconsistent or even contradictory. Also, they do not forecast a scenario with a predominant organization or regime at the national, international, nor global level that will be able to conduct the energy transition governance with energy policies for the benefit of all the stakeholders involved (Florini & Sovacool, 2009).
Moreover, governance in the energy transition within its variations is influenced by socioeconomic shifts within regions, a necessity to relieve constraints in order to change to greener sources of energy, as well as the acquisition power of the targeted consumers. Other influencing factors could also be of relevance such as citizen mobilization, ONGs, international pressures or biomass scarcity (Leach, 1992).
Florini and Sovacool (2009) conclude that the energy transition requires assertive governance in order to effectively address two main market failures: the first one would be public goods, defined as products and services that are non-excludable and non-rival in consumption as their main characteristics (Florini & Sovacool, 2009). Given that a public good or service is vulnerable to the free rider problem, there is little incentive to produce it; moreover, there are public goods or services that anyone can consume, but they are rival as in the case of common pool resources (Florini & Sovacool, 2009). The second market failure would be externalities, described as one party causing a negative or positive effect on another party without paying for the damages or claiming for any benefit (Florini & Sovacool, 2009). In this sense, governance assumes an imperfect market that requires intervention to get out of the status quo; such intervention would need to consider the social cost and benefits that come along
with any actions taken (Hoekstra, Steinbuch, & Verbon, 2017). Furthermore, the private sector plays a fundamental role for governance in the energy transition since part of the gaps that would need to be corrected such as the negative externalities, come from this sector (Lehmann, 2012).
Governance in the energy transition across regions will not only be based on well-defined goals to reach innovation objectives nor based on a specific policy issues and their activity-related problems. It would rather consist of a more realistic dynamic between a set of variables; in which policy continuation, interest groups lobbying and leadership of the fundamental actors will play defining roles (Borrás & Edquist, 2013).
Policy instruments mix
Policy instruments are generally defined as the means that a governmental authority uses to support or avoid social change by setting some particular objectives, as it could be to foster innovation and facilitate its processes (Borrás & Edquist, 2013). These instruments are created taking into account a specific policy problem, the context and time in which it takes place, and the political and ideological approach of the government in power (Borrás & Edquist, 2013).
Moreover, policy instruments become systemic when they are implemented as a mix mainly to address two situations: 1) a market failure that encompasses high transaction costs such as non-compliance by the main oil and energy companies in the case of climate change or when damages are distributed heterogeneously among regions and 2) a multiple market failure such as pollution externality and asymmetric information by the fundamental stakeholders (Lehmann, 2012). Instruments mix are also categorized corresponding to the governance style of a country, which this paper will categorize in three different streams: 1) Highly regulative approach through binding instruments and enforcement, 2) self-governance through rather soft instruments and 3) innovation oriented though economic and financial instruments (Borrás & Edquist, 2013, p. 1515).
1. Highly regulative approach: the first group involves measures that are binding and that are supported by enforcement. Non-compliance would be punished by administrative sanctions or criminal responsibility, which are considered essential for carrying out a regulatory instrument (Borrás & Edquist, 2013). Speed (2016) argues that this approach can be clearly seen in China, where the most relevant coal and oil companies are state-owned; moreover, the state is capable of controlling prices within the energy-intensive industry, the policy instruments to regulate it and the enforcement methods designed to ensure its compliance.
2. Self-governance oriented: The second group governs through soft instruments that are rather voluntary and consist mainly of agreements, recommendations, voluntary codes and partnerships; in addition, they are not backed up with enforcement and they are not binding (Borrás & Edquist, 2013). The United Kingdom for instance, has carried out a rather market-based approach towards the climate change externality since the 80’s (Speed, 2016). Further it is argued that companies pursue voluntary codes such as responsible investment for different reasons: “a desire to do good, have a positive impact on the world, and be a benefit to society. Responsible investing is a way to reduce risk, and avoid legal issues, negative publicity, or reputational damage” (Bernstein, 2018, p. 11).
Management systems
Management systems emerge as a mean that facilitates the conduction of companies’ operations to meet standards that fulfill the demands coming from stakeholders and regulators (Abad , Dalmau , & Vilajosa, 2014). In order for corporations to meet the standards requested by stakeholders and public entities, they would need to increase the number of operational tasks and even their human capital; hence, the efficiency of a company would be directly affected (Abad , Dalmau , & Vilajosa, 2014). This way, implementing a comprehensive management system will potentially enhance the capacity of oil and gas corporations to meet quality, environmental and occupational health and safety standards at their own pace (Abad , Dalmau , & Vilajosa, 2014). It is also argued that the larger the corporation is, the most complex it will be for it to implement an integrated management system, as it also requires external audits that usually are costly (Abad , Dalmau , & Vilajosa, 2014).
This approach argues that corporations will set appropriate ethical behavior standards, which will lead to socially acceptable outcomes (Berliner & Prakash, 2014). A thorough integration of management systems in a company’s operations will increase its likelihood to reach optimal results and benefits (Abad , Dalmau , & Vilajosa, 2014).
The ISO 9001 quality standard, the ISO 14001 environmental management standard and the OHSAS 18001 the occupational health and safety standard are international private certification standards recognized and adopted by around 30 transnational economies (Berliner & Prakash, 2014). This mechanism enables participants to make and demonstrate their environmental commitments more transparently (Berliner & Prakash, 2014).
3. Innovation oriented approach: Finally, the third stream would be governance through incentives or disincentives to influence socio-economic activities in a determined manner, especially aiming at fostering innovation (Borrás & Edquist, 2013). It is common that OECD
countries intend to promote innovation and achieve climate change targets by implementing more than one policy instrument: “price based” setting a guaranteed price for renewables; “quantity based” setting a specific amount of electricity from renewables that must be purchased; or “hybrid” setting a limit of the total costs to reach the objectives (Sorrel & Sijm, 2003, p. 429). Some of the policy instruments to reach the mentioned objectives may include: “information programs, labeling schemes, tax allowances, subsidies, regulatory standards, and market-transformation programs” (Sorrel & Sijm, 2003, p. 431). These instruments present contested cost and benefits, which requires each case to be analyzed based on its merits (Sorrel & Sijm, 2003). Borrás and Edquist (2013) provide some examples of economic and financial instruments:
Table 1: economic and financial instruments
Source: (Borrás & Edquist, 2013, p. 1516)
Moreover, it is argued that without the government supporting and steering innovation and R&D, private companies would not invest enough for it given that on one hand, there is a high level of uncertainty and intangibility of the results while on the other, innovators will have to face high costs in the short-term for new technology and may not be able to claim the social returns of the investments (Sorrel & Sijm, 2003).
Economic'means'in'cash Positive'incentives'(encouraging'and'promoting): Cash%transfers Cash%grants Subsidies Reduced3interest%loans Loan%guarantees Disincentives'(discouraging'and'restraining): Taxes Charges Fees Customs%duties Tariffs Economic'means'in'kind Positive'incentives: Government%provision%of%goods%and%services Private%provision%of%goods%and%services%under%government%contracts Vouchers
In the case of the interaction between the EU Emissions Trade Scheme (ETS) that aims at a zero emission objective for 2057 and other supplementary policies, it is argued that their coexistence can be due to a necessity to create a payment for polluting, to foster innovation, and to find a balanced government income where subsidies and R&D funding must be recovered with taxes in other areas (Sorrel & Sijm, 2003). In addition, government intervention through policy instruments has the potential to reduce transaction costs, to moderate the intervention and influence of the different interest groups and to diminish asymmetric information and opportunism in the industry (Sorrel & Sijm, 2003).
Sorrel and Sijm (2003) suggest that there are already a vast number of policies addressing climate change, and that the additional implementation of a cap-and-trade system aiming at an emission target at the least cost will lead to new challenges. However, in some cases where the carbon ETS has the potential to enhance an existing policy mix, governments may be reluctant to apply it due to uncertain results and risks that it may entail (Sorrel & Sijm, 2003). In the following table, we can see the interlinked functionality that is indicated between the UK policy instruments and the EU ETS: “the negotiated agreements provide exemption from the energy tax as well as forming part of the trading scheme. Similarly, there is trading interaction between the carbon-trading scheme and the instruments for promoting renewable electricity and household energy efficiency” (Sorrel & Sijm, 2003, p. 433).
Table 2: UK policy instruments and the EU ETS
source: (Sorrel & Sijm, 2003, p. 433).
Category)) Name Direct) Indirect) Trading
Carbon/energy+taxes++++ Climate+Change+Levy+ ✓ ✓ Negotiated+agreements++++++ Climate+Change+Agreements+ ✓ ✓ ✓ Emissions+trading+ UK+ETS—cap@and@trade+scheme+ + + ✓ ✓ ✓ Emissions+trading++ + UK+ETS—project+scheme++ ✓ ✓ ✓ Industrial+pollution+control+ IPPC+Directive++++ ✓ ✓ Support+for+renewables+++ Renewables+Obligation++ ✓ ✓ Promotion+of+energy+efficiency++++ Energy+Efficiency+Commitment+ ✓ ✓
These interactions could end up in two policies for the same target, which can have an impact on interest groups or on the overall policy instrument mix (Sorrel & Sijm, 2003). Some of these effects could be that the companies qualified for energy tax will experience an increase on the electricity price given that generators would be partaking on the EU ETS (Sorrel & Sijm, 2003). Sorrel and Sijm (2003) also argue that it is difficult to replace a policy instrument for another, even when the new one seems to provide more benefits. This could be due to institutional establishments, blame avoidance or when there has been an important investment for a specific project or policy. Hence, it is likely that the existing policy instruments will remain after ETS is implemented, even if they do not contribute to reaching the objectives set (Sorrel & Sijm, 2003).
The regulation dilemma
Most of the biggest oil and gas companies have voluntarily joined programs which main aim is to reduce GHG emissions and pollution; programs where it is necessary that industries self-regulate and make use of management systems (Potoski & Prakash, 2004). These programs in cooperation can bring significant positive results for private companies as well as for governments in reaching their objectives; however, the risks lie on the fact that failure would also affect all parties involved (Potoski & Prakash, 2004). The societal benefits from a regulatory measure will thus, reflect the preferences of the decision makers from the private and public sector (Potoski & Prakash, 2004).
These programs are not fully accepted by environmentalists that argue that they are merely permissions for big corporations to pollute. Environmentalists argue that since big corporation main objective is to create profits, they will not comply with costly regulations unless they are binding and backed up with enforcement (Potoski & Prakash, 2004).
Likewise, for cooperation to commit in the policy making process, it will be necessary to create an environment of trust among the fundamental actors from both sectors. This is often difficult as both parties have different interests that they intend to protect (Potoski & Prakash, 2004).
The regulation dilemma consists on the interactions and dynamics between the public and private sector for reaching cooperation: although the incentive to cooperate is technically high and cost and benefits are carefully analyzed to ensure a win-win situation for both parties, there is still an sentiment of distrust and risk since both, the government and the private sector can act opportunistically based on self-interests (Potoski & Prakash, 2004). This distrust between regulators and companies will be detrimental for cooperation (Potoski & Prakash,
2004). Firms could take advantage of a voluntary program and use it as a license to contaminate with a legitimate permission and learn to evade environmental regulation to abuse the system, while governments may use disclosures made in good faith by the companies to prove them guilty of an allegation (Potoski & Prakash, 2004).
From a government’s perspective, the dilemma can be seen from two different angles: a strict deterrence approach versus a cooperative approach (Potoski & Prakash, 2004). Deterrence implies monitoring and enforcement, which are costly and in most cases their budgets are insufficient (Potoski & Prakash, 2004). Moreover, corporations would be obliged to disclosed their emissions data and regulators will set the standards they will have to meet, including their emission limits and technologies that they will have to adopt (Potoski & Prakash, 2004). This approach will not be the most beneficial for companies as it will also be costly for them, and their productiveness and efficiency will be negatively affected, resulting in an increased likelihood that they will intend to evade the regulation as well as in an increase in the pressure among al the parties involved (Potoski & Prakash, 2004). A cooperative approach nevertheless, would attempt to correct the gaps seen in the other approach by creating an environment of negotiation and trust between firms and regulators (Potoski & Prakash, 2004). Enforcement would go to a second place and the basis would be on creating more flexible measures and incentives for companies to achieve the changes both parties are interested in (Potoski & Prakash, 2004).
From a corporation’s perspective, the dilemma can also be seen from two different angles: “evasion and self-policing” (Potoski & Prakash, 2004, p. 154). If choosing evasion, then firms will risk being sanctioned if they consider that the have more to win by leveraging an opportunity to not complying with a given regulation. Whereas, if choosing self-policing; then, companies will voluntarily and closely screen their operations and the emissions they release to correct any gap that they may find in meeting a standard already set, and expecting not to be punished unless the gap found is significant (Potoski & Prakash, 2004).
A win-win situation can be considered when the regulatory body chooses the cooperative approach and the firm chooses the self-policing compliance option (Potoski & Prakash, 2004). A government will be able to achieve more ambitious outcomes at the same time of reducing costs since compliance will not be based on enforcement. Whereas firms will be able to comply with regulation at lower costs, optimizing their production and increasing their profits (Potoski & Prakash, 2004).
Transition theory
The transition theory addresses the different kinds of market failures such as externalities and asymmetric information (Shum, 2017). Public policies have a key role in the transition processes and are introduced in various forms such taxes, subsidies, prohibitions and other measures that could incentive research and development (Shum, 2017). Transition encompasses “co-evolving markets, networks, institutions, technologies, policies, individual behavior and autonomous trends”. (Derk, Brugge, & Mattijs, 2008, p. 296).
Transition theory is based on adaptive systems, which involve the interaction of adaptive agents allowing a more thorough understanding of the complexity of a societal system as an adaptive system (Derk, Brugge, & Mattijs, 2008). It is argued that a transition is not incremental; it is rather systemic and has an impact on the economy of a country and has the potential where even new institutions could emerge (Shum, 2017).
The transition theory is an approach that can be used to analyze changes in the production of energy supply, which takes into account “strategic niche management” (SNM) with a focus on the economic aspects, “technological innovation systems” referring mainly to new technologies (TIS), and “the multilevel perspective” (MLP) that refers to the simultaneous changes that occur in a transition; three aspects that will more likely begin with niches (Hoekstra, Steinbuch, & Verbon, 2017, p. 3.3). SMN encompasses macro economic aspects, political economy and geopolitics. TIS involve engineering advances, production modernization and the adoption of alternative procedures. Lastly, MLP can include energy supply infrastructures, city design and the use of land (Shum, 2017).
The Dutch energy system can be considered as a complex adaptive, formed by various elements: “the physical, institutional, economic, mental and technological”, which are all interconnected (Derk, Brugge, & Mattijs, 2008). Finally, for a better overview of the energy system, it is necessary to conduct an analysis that will take into account its historic development (Derk, Brugge, & Mattijs, 2008) and the fundamental changes that can be observed in technologies, processes, policy instruments and organizations (Shum, 2017).
Hypotheses
• The three streams of policy instrument mixes have had a significant positive effect on the ESG performance of the highest emitting oil and gas companies globally.
• Governance in the energy transition in China, Russia and Saudi Arabia has the most significant effect on CO2 emissions outcomes at the aggregate level.
Research Design
Research Method
This paper will conduct a non-experimental time-series and cross-sectional study based on various sources that complement one another, allowing a thorough analysis on the basis of the theoretical framework. Through a deductive most similar system approach, this paper aims at finding evidence of the effects that governance in the energy transition and its different approaches have on firm's ESG performance around the world (Toshkov, 2016).
Governance in the energy transition will be the explanatory variable in the cases studied; its characteristics and style will differ across cases. ESG performance will be the dependent variable, which will be constant and operationalized in all the cases. Also, this paper assumes negative externalities as confounders, which will be studied in all the cases. Grounded on that, cases are chosen based on their similarity and relevance to the variables studied. In this line, the cases selected are only firms in the fossil fuel sector who are responsible for the major part of the global CO2 emissions in the industry. In addition, this research will pay special attention to CO2 emissions, which will be analyzed separately and in detail by company and the region of its jurisdiction for the past 30 years to improve the validity and reliability of data collected and of its analysis (Toshkov, 2016).
Causal inference
In order to unveil causal inferences and in accordance with Toshkov (2016), this paper will realize comparisons among cases, as well as within-case evidence analyses for each of the firms and its country of jurisdiction, as it can uncover causal mechanisms. "Process tracing and within-case analysis can compensate for the deficiencies of the small N comparisons"; thus, this paper will pay attention to the evolution of the application of policy mix across countries (Toshkov, 2016, p. 268). In addition, this paper will take into account cases that do not support the energy transition in order to compare results on the outcomes and to establish more sound causal inferences.
The strategy developed to determine whether there is a causal inference between the variables will be by conditioning. The confounders in this case, aligned with the literature are assumed to be negative externalities such as climate change and air pollution. Conditioning will be conducted through a balancing approach by analyzing the characteristics of the cases, the different values of the explanatory variable and the outcomes across the cases in a given period of time (Toshkov, 2016).
Data collection and analysis
The paper will be structured in the following steps: first, the collection of ESG performance data for the past 30 years at the global level that includes GHG emissions and that will be broken down across the most relevant companies; second, data collection of policy across countries to obtain evidence of its evolution across countries if any; and finally, an analysis of the energy transition case, its governance delivery through the three streams described in the theory and the variables that determine the different outcomes across countries as it is observed in the case.
For the first step in collecting global ESG performance data across companies, this paper will utilize information from three recent reports developed by prestigious social and environmental performance analysts such as CDP, Bernstein and Goldman Sachs. This data will show the evolution of the sustainable performance of the major oil and gas corporations over the last 30 years that will be then contrasted with the evolution of policy instrument addressing the energy transition in order to analyze any associations or causal mechanisms. Then, for the second step, this paper will collect information of policy instruments addressing climate change and energy transition for the past 30 years also based on the same sources than for the ESG data performance since the reports are quite thorough in analyzing data over that period of time.
To illustrate the evidence of the ESG performance data as well as policy instruments found across the cases, this study will expose the information in forms of tables, graphs and numerical indicators due to the complexity of the elements and quantitative data taken into account within the cases.
The analysis section will be conducted primarily based on the findings of the quantitative ESG performance and policy instruments information from the mentioned reports. This approach is expected to provide empirical evidence of the impact that governance in the energy transition has had on the ESG performance across the cases chosen, which is the fundamental objective of this paper. It will be crucial to structurally breakdown information from the sources used in order to contrast the data for determining any association or causal mechanisms among the variables studied.
Also, causal mechanism(s) for this analysis can be subject to bias since the focus will be on few companies (Toshkov, 2016). Thus, as manner to address threats and interference, this research will conduct within-case analysis in depth for the countries selected. This way, validity can be enhanced, and risks of reverse causality can be reduced (Toshkov, 2016).
Independent variable: Governance in the energy transition
Differently from single policies as a basis, governance through a policy mix has the capability to enable reaching effective pollution abatement levels, reducing transaction costs and correcting more than one market failures simultaneously (Lehmann, 2012). This approach to address market failure issues such as climate change and pollution is often recommended by academic and scientific literature (Lehmann, 2012).
Governance through policy mixes including self-regulation complement one another to reach specified objectives. Asides from introducing taxes to reduce environmental damages, governance in the energy transition through policy mixes aims at setting limits of emissions allowed through policy instruments as in the case of the Emissions Trading Program in the USA, which was introduced by the Environmental Protection Agency (Oates & Baumol, 1988). Moreover, it is argued that governance requires a thorough economic cost-benefit analysis for achieving an effective design of policy instruments such as subsidies, deposits of damaging elements, emission authorizations, monitoring strategies, among others (Oates & Baumol, 1988).
The measurement of this variable will be based on the policy instruments used for its implementation in the countries where the cases will take place. This paper categorizes three different streams in order to analyze the governance approach across different countries according to the policy instrument mix developed in a specific region (Borrás & Edquist, 2013). The first stream is through a highly regulative approach, based on binding policy instruments, property rules and strict enforcement. The second stream is a self-regulative approach, with market-oriented strategies that are usually not binding, agreements and partnerships. Finally, the their stream is an innovation oriented approach, though through policy instruments such as economic incentives, taxes, emission-trading systems as the “EU ETS”, administrative sanctions, etc. This data can be collected from governmental official websites, in the companies` Annual Reports and Sustainability Reports, and in the main ESG rating agencies` reports.
Dependent Variable: Environmental, social and corporate governance performance
This paper pays attention to the different ESG values rather than CO2 alone to enhance robustness and reduce likelihood of reverse causality, as firms’ decisions to improve performance may not be always reflected in the short-term; however, they can be observed in the corporate governance and social factors (Bernstein, 2018). Also, analyzing cases in depth, the reliability and validity of operationalization can also be enhanced (Toshkov, 2016).
Environmental aspects are mainly measured by greenhouse gas (GHG) emissions that are calculated quantitatively using the market-based approach in line with the GHG Protocol Corporate Accounting and Reporting Standard. Likewise, CO2 emissions will be classified by scopes depending on their condition of direct or indirect emissions. The method used to estimate emissions based on the Intergovernmental Panel on Climate Change (IPCC) “Guidelines for National Greenhouse Gas Inventories” is computed with the following equation: “Emissions = Σ EFp • Pp”, where “P” would be production “EF” would be the emission factor and “p” would be the product (CDP, 2017, p. 500).
Social performance is measured with quantitative and qualitative data concerning gender diversity and equality, social investments, and local communities’ engagement actions where the private as well as the public commit, among other elements in the social sphere. Social issues are not an exclusive concern of the government, but also the private sector would need to take into account society and engage with them in their projects and operations to prevent disruptions in the supply chain, allegations that could harm their reputation or lawsuits followed by millionaire sanctions, which would consequently, affect the efficiency and the profitability of their businesses (CDP, 2017).
Finally, corporate governance performance is measured with quantitative and qualitatively data based on the corporate governance’s commitments and accountabilities for Environmental and Social strategies and actions. In addition, whether the remuneration disclosures of the executive and nonexecutive board of the companies are linked to these strategies and actions will also be taken into account since those are considered as best practices in the industry (Bernstein, 2018). Such performance data can be collected from governmental official websites for statistics, in the companies` Annual Reports and in Sustainability Reports, and in the main ESG rating agencies` reports.
Confounders: negative externalities
In has been argued in the literature that a negative externality occurs when a party causes harms to a another party and does not cover for its costs (Florini & Sovacool, 2009). Further, Lehmann (2012) argues the key role of the private sector as they are capable of correcting the negative effects. He also argues that a government designs and implements policy mixes to address these externalities, which in this case are air pollution and climate change. This will be observed in all the cases that recognize and support an energy transition with variations on the approach, which is in line with the transition theory (Shum, 2017).
Air pollution: Scientist have developed several studies concerning air quality, so that countries can monitor their air pollution levels and design manners to address the issue. The particle that causes the air pollution is called PM2.5 and it can be harmful to the human respiratory system when the concentrations are high, leading to multiple diseases. Also, energy sources are found to be a major trigger for this microscopic particle. The World Health Organization (WHO) developed a guideline recommending 10 µg/m3 (one-millionth of a gram per cubic meter air) annual mean and 25 µg/m3 24-hour mean as a maximum (World Health Organization, 2005).
Climate change: refers to the change in temperature of the planet and it generally measured by calculating the average temperature of the planet’s surface. Measured with the Celsius temperature scale, findings show that the temperature has risen 0.9°C compared to the 1900’s (Lindsey & Dahlman, 2018). The U.N. World Meteorological Organization argues that if variables remain constant, a rise of 3 to 5°C is expected by the end of the century; most likely resulting in rising sea levels and natural catastrophes that will affect the entire world. Moreover, the Secretary-General Petteri Taalas argued that in order to prevent that, temperature rise would need to be limit to 1.5 or 2°C, which will require drastic actions to reduce the consumption of fossil fuels (Reuters.com, 2018).
The case
Governance in the energy transition and the major oil and gas companies
Since 1988 to 2016, the extraction of fossil fuels has experienced a huge acceleration reporting even higher emissions (833 gigatonnes of carbon dioxide-equivalent) than those reported 237 years before since the industrial revolution from 1761 to 1998 (820 gigatonnes of carbon dioxide-equivalent), exacerbating global warming manifestations (CDP, 2017, p. 7). This acceleration starting in 1988 is due to a large share of coal production and its expansion during the industrialization era, resulting in an important increase on the global emission intensity (CDP, 2017).
Although climate change is still in 2019 a subject that is extensively debated, scientists and policy makers agree that the one of the main causes for the increase of the global temperature is the emissions of greenhouse gases (GHGs), including “carbon dioxide (CO2), methane (CH4), water vapor (H2O) and nitrous oxide (N2O)” (Goldman Sachs, 2018)
Oil companies were responsible for 1% of the global GHG emissions in 2017 resulting from scope 1 and 2, which are the direct and indirect emissions of a company (Goldman Sachs,
2018, p. 2). These emissions are released from faring, leaks or fugitive releases and the consumption of energy for production (CDP, 2017). Most importantly, the biggest impact is caused by the scope 3 emissions, which are generated by the consumption of the goods produced by the oil companies, with 9% of the global GHG emissions that are accounted to the Scope 3 category (Goldman Sachs, 2018). Scope 3 includes the emissions released from the consumption of sold products (CDP, 2017). Definitions for scopes can vary depending on the companies’ exposure of businesses.
The International Energy Agency’s (IEA) make estimates of emissions using three different scenarios: The first one is under current policies, using a counterfactual scenario that shows where the existing policies will take us if no further measures are adopted. Secondly, under a new policies scenario, which integrates possible effects of policies that have been announced by governments. Nevertheless, neither of these two scenarios would reach the 2° C goal. Finally, the third scenario would be consistent with the mentioned goal: the Sustainable Development Scenario (SDS) that suggest a reduction of the share of coal from 28% (2015) to 18% (2030) (Goldman Sachs, 2018).
In line with the IEA’s Sustainable Development Scenario (SDS), Scope 1 and 2 that are 14% of total GHG emissions can be reduced by around c.24% by 2030. This can be done by increasing the production of gas and renewable energy. Another approach could also be by reducing flaring, methane emissions and carbon-intensive extraction processes (Goldman Sachs, 2018, p. 9). This data unveils the importance of the role of governance in the energy transition within the countries where the major global coal producers and consumers are. CDP (2017) argues that 91% of the global GHG emissions in 2015 is caused by the fossil fuel industry. They also forecast that if there is a continuity on the extractions of oil sands, tight oil, heavy oils and others for the following 28 years; then, the global average temperature will rise 4°C. This will most likely result in the disappearance of various living species, natural disasters and even in high levels of world hunger (CDP, 2017).
The table below shows a ranking of 12 companies responsible for the highest global GHG emissions from the period of 1988 to 2015. This data can allow us to visualize the evolution of the companies’ performance, if there is any. On the table, we can observe that China Coal, Aramco and Gazprom are responsible for 204, 715 metric tons of carbon dioxide equivalent (MtCO2e) from 1988 to 2015, which is 22,7% of the total emissions of a list of the 100 highest emitting gas/oil companies that all together are responsible for 70,6% of global GHG emissions in the industry (CDP, 2017).
Table 3: Global GHG emissions from 1988 to 2015
Source: CDP (CDP, 2017, p. 14)
The next table shows a ranking of 12 companies responsible for the highest global GHG emissions in 2015 alone. We can observe that Aramco and Gazprom are still listed as the highest emitting companies. In this case, China Coal is not on the list anymore given that it was broken down in different companies such as Shenhua Group responsible for 2.4% of the global GHG emissions in 2015. Moreover, making a combination of the emissions from Shenhua Group with the other fossil fuel companies in China, their total GHG emissions would position them before Gazprom on list of the 100 highest emitting gas/oil companies that all together are responsible for 72,1% of the global GHG emissions in 2015 (CDP, 2017). Producer Cumulative/198832015Scope/1/GHG,/MtCO2e
Cumulative/198832015/ Scope/3/GHG,/MtCO2e Scope/326/GHG,/MtCO2e Cumulative/198832015 Scope/1+3/GHG,/ MtCO2e Cumulative/198832015 Scope/1+3/of/global/ industrial/GHG,/% China&(Coal) 9,622 119,312 128,933 14.3 Saudi&Arabian&Oil& Company&(Aramco) 4,263 36,298 40,561 4.5 Gazprom&OAO 4,652 30,569 35,221 3.9 National&Iranian&Oil&Co 2,468 18,037 20,505 2.3 ExxonMobil&Corp 1,833 15,952 17,785 2.0 Coal&India 892 15,95 16,842 1.9 Petroleos&Mexicanos& (Pemex) 2,055 14,749 16,804 1.9 Russia&(Coal) 1,216 15,524 16,74 1.9 Royal&Dutch&Shell&PLC 1,212 13,805 15,017 1.7 China&National& Petroleum&Corp&(CNPC) 1,479 12,564 14,042 1.6 BP&PLC 1,072 12,719 13,791 1.5 Chevron&Corp 1,215 10,608 11,823 1.3
Table 4: Global GHG emissions in 2015
Source: CDP (CDP, 2017, p. 15)
Big oil corporations have demonstrated certain reactiveness towards the rapid occurrence of regulation in the energy sector, especially after the Paris Agreement. However, the energy transition entails important necessary changes in the corporate`s objectives and culture. These changes imply a gradual underinvestment in oil production and refining, as well as a diversification of their portfolio incorporating cleaner energy investments (Goldman Sachs, 2018), which can be triggered by highly regulative and self-governance approaches (Borrás & Edquist, 2013).
China for instance, has doubled its natural gas production, setting a trend in Asia where other countries such as India, Japan, South Korea, Taiwan and Thailand are taking similar actions to replace coal for cleaner energy sources (Bernstein, 2018). Conversely, the production of coal coming mainly from state-owned companies has tripled since 2000 to around 4 billion tonnes, which is almost half of the production worldwide. While in Russia, the production of coal has augmented 70% from the 90s to 2015, putting the country on the 6th place of world ranking for coal production (CDP, 2017).
Further, it is important to highlight the role of investors in the energy transition. The emissions released by 100 companies from 1988-2015 were 635 gigatonnes of carbon dioxide-equivalent (GtCO2e), from which 9% were from private investor-owned (e.g. ExxonMobil, RDShell, BP, Chevron, Peabody, Total, and BHP Billiton), whereas 59% were
Producer 2015,Scope,1,GHG,,MtCO2e 2015,Scope,3,GHG,,MtCO2e 2015,Scope,1+3,GHG,,MtCO2e Scope,1+3,of,global,2015 industrial,GHG,,% Saudi&Arabian&Oil&Company&(Aramco) 215 1,735 1,951 4.6 Gazprom&OAO 108 1,03 1,138 2.7 National&Iranian&Oil&Co 166 870 1,036 2.4 Coal&India 54 971 1,025 2.4 Shenhua&Group&Corp&Ltd 79 922 1,001 2.4 Rosneft&OAO 83 694 777 1.8 China&National&Petroleum&Corp&(CNPC) 81 544 625 1.5 Abu&Dhabi&National&Oil&Co 61 523 584 1.4 ExxonMobil&Corp 54 523 577 1.4 Petroleos&Mexicanos&(Pemex) 53 477 530 1.3 Royal&Dutch&Shell&PLC 48 460 508 1.2 Sonatrach&SPA 89 404 492 1.2
from State-owned companies (e.g. Saudi Aramco, Gazprom, National Iranian Oil, Coal India, Pemex, and Petro China) and 32% from public investors-owned (CDP, 2017, p. 8).
Highly regulative approach – innovation and conversion to gas
In china for example, recent policies to foster a switch from coal to gas has resulted in an increase of c.6% to c.15% of the energy mix, increasing the demand for gas and LNG globally (Goldman Sachs, 2018). This switch from coal to gas has triggered a significant decrease in air pollution across China, especially in the northern regions, where there is a strong focus on implementing gas projects to replace coal-fired-boilers (Bernstein, 2018). This trend is expected to continue as it is illustrated in the following graph, having an increase in the demand for gas of 340bcm by 2020 and up to 600bcm by 2030, becoming the 15% of the country’s energy mix (Bernstein, 2018, p. 31).
Graph 1: Gas demand expectation by 2030
Source: (Bernstein, 2018, p. 33)
A scientific study of the 16 major programs in China designed to improve socio-environmental conditions concluded that China started to invest at major scales and take highly regulative measures towards an energy transition driven by a necessity to react towards the social, environmental and economic effects of natural disasters. Some of the catastrophes were dust storms, floods and droughts that were caused by unsustainable practices and “an overexploitation of natural resources” (Brett & Lei, 2018, p. 1).
The indications of a switch from coal to gas is argued to be carried out by a set of mix binding policies, as well as subsidies that were designed to encourage innovation and strengthen this new trend as gas is less polluting and there is potential for domestic natural gas to increase its production along the demand (Bernstein, 2018). It is also argued that these subsidies to
encourage gas production are necessary given that coal production is cheaper for suppliers; also, because companies would be reluctant to change to a more costly source without any kind of back up from governmental entities given that profitability is uncertain (Bernstein, 2018). Some examples would be the policy called “Blue sky defense war against pollution” that consisted in constraining and forbidding in some regions the consumption of coal for producing goods such as steel and iron. It initially started in northern China and that expanded all the way to the west given its presumed success. Likewise, the “2017 winter pollution control plan” through a policy mix with strict enforcement to ensure compliance, had as main objective to direct citizens of specified regions to change their heating system sourced from coal to a system that uses either electricity or gas as its source (Bernstein, 2018).
On the following table, we can find further details of the coal-to-gas conversion process in China, which indicates the major measures that the government has taken in order to restrain coal production as well as its consumption.
Table 5: Policy mix in China
Source: Government websites and Bernstein analysis (Bernstein, 2018, p. 35)
The Bernstein’s analysis (2018) argues an association between gas growth with a reduction of pollution due to a significant improvement of the air quality reported in the data collected from the regions where gas production and consumption increased. The air quality reported under the PM2 framework shows that although the relative success that China is experiencing in reducing its air pollution “from over 80ug/m3 in 2015 to 51ug/m3 in 2018 TTM”, the gap
Policy Date About.the.policy
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Beijing(and(surroundings Mar%17 Prohibition(of(coal(in(specific(regions 13th(Five%year(plan(for(energy( development( Dec%16 Aim(to(increase(gas(consumption(from(6%(in(2015(to(10%(in( 2020(and(15%(in(2030(through(a(system(mixed(with(green( certificate(income,(financial(subsidies(and(the(trade(carbon( market
to reach air quality levels under the World Health Organization (WHO) guidelines is still important (Bernstein, 2018).
Graph 2: Gas growth associated with pollution reduction. “Regions with strong incremental gas growth generally performed better in reducing pollution”
Source: Government websites and Bernstein analysis (Bernstein, 2018, p. 37)
Climate change and air pollution has also affected Russia and Saudi Arabia. Environmental catastrophes in Russia and Saudi Arabia have had an important impact on socio-economic models since the 90’s. In Russia for instance, the government has designed and implemented policy mixes followed by strict enforcement, so that major emitting firms reduce their emissions. Nonetheless, it is argued that the implemented policy mixes are conformed of contradictory measures and inefficient monitoring mechanisms, which have led to poor results (OECD, 2006). The state-owned company Gazprom announced in 2018 a project to provide hydrogen to some of the EU countries it now provides gas. They aim at becoming one of the biggest hydrogen producers, with an opportunity to reduce their emission to 38% (Bloomberg, 2018). Finally, another case this paper identifies is Saudi Arabia. The government developed 9 laws addressing socio-environmental concerns. These laws were designed with strict enforcement as they argued to be aiming at rapid results. Some of them are the following: “The Ambient Air Standard 2012, Standard on Emissions from Mobile Sources 2012, National Ambient Water Quality Standard of 2012, Technical Guideline of 2012 on the Prevention of Major Accidents, Standard on Waste Transportation 2012” (Blueandgreentomorrow.com, 2019, p. 1). Moreover, Saudi Arabia announced to diversify its
economy, reducing its dependence on oil through its “Vision 2030” program (Climate action tracker, 2018). Saudi Arabia started to conduct a few projects to switch their energy sources from fossil fuels to renewables. This projects in which national and international companies will participate, include a US$30–50 billion “renewable energy tender program” as well as a $200 billion solar power development that expected to be the biggest in the world (Climate action tracker, 2018). However, even though Saudi Arabia has accepted climate change as a reality, it is also important to note that they have not accepted to report under IPCC in COP24 meeting that took place in Poland (Climate action tracker, 2018). In addition, they have not complied with publishing a baseline scenario that is requested in the Paris Agreement for the target they established to reduce their emissions to 130 MtCO2e by 2030 (Climate action tracker, 2018).
Self-regulative governance observed
The first European environmental action program was designed a year after the creation of European Economic Community (EEC) in 1972, initially triggered the need to set minimum standards to confront environmental externalities that affected all the member countries, as well as to relieve trade constraints in a common market within the EEC (Johnson & Corcelle, 1989). Today, differently from the USA or Saudi Arabia, the approach towards climate change the EU is having has evolved; for instance the European Commission (EC) manages one of the largest funds worldwide dedicated to incentive low carbon technology innovation called the EU Innovation Fund (European Commission, 2019). The main projects that the Innovation Fund covers are the following: “carbon capture and utilization (CCU), construction and operation of carbon capture and storage (CCS), innovative renewable energy generation and energy storage; with a reserve of 10 billion euros approximately (European Commission, 2019). CCS consists in capturing carbon dioxide and permanently storing it in geologic formations underground (ExxonMobil, 2019). Moreover, firms are encouraged to support and attach to voluntary codes that aim at enhancing sustainable practices and their organizational performance such as the United Nations’ Universal Declaration of Human Rights, United Nations Global Compact, Organisation for Economic Co-operation and Development (OECD), Guidelines for Multinational Enterprises, Transparency International Business Principles on Countering Bribery, Principles for Countering Bribery, World Bank’s “Zero Routine Flaring by 2030” Initiative, Methane guiding principles, Building Responsibly Principles among others (Royal Dutch Shell, 2019).
Firms’ context: In accordance with the objectives of this approach, firm’s investments to switch from traditional oil to natural gas are expected to increase together with the demand, through a rather market oriented governance approach (Borrás & Edquist, 2013). Accordingly, investors’ engagement and influence in the energy transition through its decisions at the corporate level have the potential to minimize carbon emissions, which can be done in cooperation with the government to reach a given objective (CDP, 2017). This can be done by taking different actions such as disclosing relevant data following specific international standards, designing objectives and strategies aiming the 2°C Paris Agreement goal, engaging investors and the board of directors in reaching the objectives effectively among others (CDP, 2017).
Companies would need to carefully design their strategies to comply with governmental measures, as the energy transition becomes a reality impossible to avoid for anyone (CDP, 2017). In this sense, large oil and gas companies adopted the Science Based Targets Initiative in 2015 to ensure that their goals and strategies were aligned with the Paris Agreement objectives (CDP, 2017). In order to reach these objectives, oil and gas companies would have to progressively decrease the emissions released when producing their goods and most importantly, the emissions released by users when consuming them (CDP, 2017). Moreover, some of the means to reduce their emissions will be by increasing their investments in research and development of new technologies as in the case of Carbon Capture and Sequestration, and by diversifying their portfolio to reduce the production of fossil fuels and replace them for cleaner sources such as solar, wind and hydro (CDP, 2017). However, the demand for energy is expected to rise over the years, as it is associated with an also expected growth in population (CDP, 2017).
So far, big oil companies are reducing their investments and/or divesting from carbon-intensive projects such as the Canadian Oils Sands and the Artic; also, they are increasing their share in projects that could lead them to meet the energy transition objectives and standards they are aiming at (Bernstein, 2018). These investments can be on liquefied natural gas (LNG), petrochemicals and renewables, which have significantly increased in the last 10 years with 4% of the global energy consumption in 2017 (Bernstein, 2018).
Royal Dutch Shell is the company with the largest share in LNG production with investments that double the market average, while ENI and Equinor with the smallest share, as it is shown in the following graph (Bernstein, 2018).
Graph 3: LNG production capability
Source: Company data, Goldman Sachs Global Investment Research (Goldman Sachs, 2018, p. 23)
Creating a path to Innovation: Major oil corporations such as those considered the “Seven Sisters” (RDShell, BP, TOTAL, ENI, Equinor, ExxonMobil, Chevron) are expected to switch from traditional fossil fuels to natural gas given that its carbon intensity released is substantially lower than the one from traditional oil, with a difference of c.300 kgCO2eq/boe from LNG while c.490 kgCO2eq/boe from oil (Goldman Sachs, 2018). In the following graph, we can observe the evolution of the mentioned companies’ portfolios since 2000 to estimations for 2019, where LNG has already gained an essential positioning in their businesses.
Graph 4: “Top Projects reserves by the Seven Sisters”.
Source: Company data, Goldman Sachs Global Investment Research (Goldman Sachs, 2018, p. 22)
A positive association between returns from the traditional oil and gas businesses with innovation is suggested, as they will have more funding coming from the traditional businesses that can be destined for developing new strategies and technologies (Goldman Sachs, 2018). It is also argued that the energy transition has the potential to lead to higher returns: on one hand, investments in renewables, Carbon Capture and Storage can dilute returns for the oil companies given that they are costly and whether they will be profitable or not is uncertain. On the other hand, this can be compensated with returns from the oil, gas, LNG and refining businesses as the demand for these goods has been consistently increasing; however, it is also uncertain as there are risk factors that could negatively affect revenues from these sources (Goldman Sachs, 2018). This is when innovation oriented governance plays an important role in fostering and defining new techniques and technologies through economic incentives that can ensure revenues from innovation and reduce uncertainty of the outcomes (Borrás & Edquist, 2013).
The Goldman Sachs’s study shows the overall increase of gas production among the major companies in the industry and provides evidence to argue that gas and LNG will play an important role in the energy transition since the emissions they produce are less invasive than the traditional oil (Goldman Sachs, 2018). This is illustrated in the following graph where it
can be observed that the gas supply in the industry has significantly increased in the past 20 years.
Graph 5: “Seven Sisters gas exposure” (as % of total oil and gas production)
Source: Company data, Goldman Sachs Global Investment Research (Goldman Sachs, 2018, p. 22)
Greenhouse gas (GHG) emissions and innovation
GHG emissions is probably the most important factor within the environmental category of the ESG variable and can be disentangled in three scopes: scope 1 concerns direct emission, scope 2 concerns indirect emission and scope 3 are the emission released from sold products (Goldman Sachs, 2018).
Scope 1 and 2 GHG emissions: Saudi oil for instance has the lowest carbon scope 1 GHG emissions worldwide from its oil production, while Canada heavy oil and West Africa are on the opposite side with the highest direct GHG emissions (Goldman Sachs, 2018, p. 12). Also, the Middle East and Africa are said to be the regions with high probabilities to be adversely affected by climate change, especially if no actions to reduce emissions are taken (Climate action tracker, 2018). In the next graph, it is indicated that Saudi oil reports the lowest direct carbon intensity in the oil industry for 2018.
