Environmental, Social, and Corporate Governance (ESG) Strategies for Energy Transition Success

Executive Overview

Henry Ford insisted his factory workers be paid enough to afford the Model Ts they were making. His policy sped up the rate at which the gas pedal replaced the buggy whip. Similarly, with the energy transition now underway, environmental, social, and corporate governance (ESG) policies accelerate the rate at which feet are lifting off gas pedals.

Some industrial companies see ESG as a carrot. Worse yet, others see it as a stick. ARC’s research has shown it is better to take the driver’s seat, with proactive approaches where long-term business strategies include ESG-related goals, because such shifts in perspective can help turn obstacles into new business opportunities.

A certain business maturity is required to see near-term risks and rewards for what they really are. In the energy transition, these ESG carrots and sticks are best seen as short-term detours on the road to new destinations. This new perspective is one where ESG is part of a core long-term vision—a vision that naturally lights the right directions for discovery of new business value, because it is a way of being, rather than a mere set of activities. An ESG strategy is ideally based on a company’s leaders having answered the following question in the affirmative: Are you conducting your business in a way that will leave the next generation of leaders in a sufficiently healthy environmental, societal, and governmental situation to be willing and able to carry your company’s business forward in the best possible way?

Adherence to environmental performance standards has short-term business benefits beyond the positive environmental impacts. It is a widely accepted fact that industrial companies adopting environmental performance standards typically see parallel improvements in their operational performance, time to manufacture, and efficiency of their workforces, along with optimization of material and energy utilization.

Wider recognition of the value of ESG has led to an increase in executive compensation plan bonuses for meeting annual ESG-related standard performance goals. It has also led to inclusion of similar bonuses in compensation plans for a wider range of employees in many industries.

ESG’s Role in Corporate Risk/Reward

Major decisions by hedge fund managers and investors, along with related decisions about large infrastructure projects, involve evaluations of corporate risk. The views of credit rating agencies, insurers, and other key influencers are all impacted by perceptions of a company’s legitimacy and credibility based on ESG performance.

With the energy transition’s diverse impacts across every major industry, there is an increased level of sensitivity about real risk, but also about what we may call “perceived risks,” which are unpredictable and are not always as fact driven as traditional risk assessments.

Perceived risks involve the public’s perceptions. As a result, the respected opinions of experts are no longer the only consideration for finance and insurance industry evaluations. Expert direct risk evaluations now coexist with evaluations of a company’s perceived risks due to the influence of public opinions about the company.

Alongside expert evaluations, considerations about perceived risks based on an organization’s ESG positioning from a branding point of view have become influential. Decision-makers now look at the level of trust or distrust on the part of the public regarding an organization. Based on the general public’s ESG-driven perceived risks, these influential decision-makers now question whether people will continue to be willing to buy the organization’s goods and services or hold shares of the organization's stock. There are significant benefits for an organization that the public regards as being more trustworthy. A much-deserved higher level of trust is being won by organizations due to their having stronger ESG-driven branding. Increasingly, such branding will hinge on actual ESG performance—not just future-oriented sustainability promises, or emissions reduction plans, or social justice commitments.

Most importantly, organizations with strong ESG branding will tend to recover from the impacts of incidents such as an accident with environmental consequences. They will also tend to continue to be viewed as being less risky after the negative event than a company with a poor ESG-driven sustainability posture.

There is also a clean and positive pathway forward for companies with a history of poor ESG postures and brand perception. They can even benefit from a newfound long-term risk hedge by using ESG reporting to reposition the negatives from their past if they do so in a transparent way. While it is more easily said than done, such companies must pro-actively demonstrate the measurable actions they are taking to improve.

A company’s ability to recover from an event which damages its ESG performance is hampered by the loss of goodwill associated with it becoming publicly known that the company is actively engaged in political lobbying for anti-ESG positions. This loss of goodwill extends to situations that include company membership and C-level personnel from the company being on the board of industry lobbying groups that have overt anti-environmentalist agendas.

Energy Transition Complications Across Industries

Increasingly, companies in different industries are competing in new arenas, not only with one another but also to vie for a better position in a much more complex financial, economic, and politically charged landscape in the marketplace of ideas. Navigating the energy transition well, and communicating plans to ensure clear expectations are set, are central to success to manage this mix of complex market dynamics.

Consider the complexity of energy transition for industrial and energy market segments. The world’s utility infrastructure and industrial facilities were economical to build only because their typical life spans were 30-70 years. If instead the costs and lifespans were one tenth as much, the energy transition required now could be addressed by traditional business plans and short-term economic models. It could also be accomplished without risky “all-or-nothing” forks in the road where the fate of entire industries and economies and societies potentially hang in the balance.

While challenges associated with the energy transition can become business opportunities, markets associated with ESG are not straightforward. The real work is now underway to ensure top-down sustainability commitments can be met while successfully addressing bottom-up realities.

Market complexities stem from the need for new regulatory models, and the need for industries to step up with more proactive and trans-parent approaches. Incumbency is of no benefit to companies during the energy transition if incumbents do not innovate and create new solutions to meet ESG challenges. All are at risk of having profitable prospective opportunities taken away by new market players or transforming industries, such as oil and gas companies seeking to find new markets during the energy transition. In these volatile markets, digital transformation competencies can help.

Table of Contents

• Executive Overview
• ESG’s Role in Corporate Risk/Reward
• Energy Transition Complications Across Industries
• Leveraging Digital Transformation for ESG Performance
• Six Industrial Energy Transition Opportunities
• Seismic Industrial Shifts Will Need to Occur
• Benefits of Greater ESG and Energy Transition Transparency
• ESG Impact on Brand Perception and Talent Wars

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