Investors are asking oil and gas companies for greater disclosure regarding sustainability practices. Even larger companies in the industry are not exempt. Shareholders at ExxonMobil Corp.’s recent annual meeting voted to pass a proposal that asks the company to conduct a climate “stress test” to measure how regulations to reduce greenhouse gases (GHGs) as well as the advent of new competing energy technologies may impact the value of its oil assets. This illustrates a developing trend in investor sentiment wherein climate change is increasingly viewed as a substantial risk that warrants greater transparency from oil and gas companies.

Oil and gas companies as a whole are placing greater emphasis on the inclusion of sustainability information in their reporting, but the information they are currently providing lacks depth and insight into the company. Using broad terms and generalities is a common tactic that results in a lack of specificity as to how these companies are equipping themselves to handle environmental, social and governance (ESG) issues and to what extent they are mapping out strategies for the future. One of the largest hurdles oil and gas operators will encounter is how to appropriately account for their drilled cuttings.

“Reporting is a means for organizations to show their commitment to transparency and to show their progress toward meeting certain goals. … [and] to improve companies’ abilities to prepare sustainability reports and disclosures that are meaningful to stakeholders,” according to a recent article in the American Association of Drilling Engineers.

The desire for additional information should not be viewed as a punitive objective. All companies have unique strengths and weaknesses, and this information would benefit investors since they would have more information to better judge their investments. For example, an investor might have a strong preference to choose a company strictly based on the fact that it maintains a very conscientious approach toward managing its environmental impact and its waste management practices, but conversely that same company might be weaker on employee safety issues. Investors might balance their portfolios by making other investments based on placing a high value on remarkable safety records. Most companies view sustainability reporting as unsolicited surplus information that could be adversely utilized by investors looking for a reason to reduce or eliminate their investment in that company. While some companies may have reason to be cautious, most have substantial untapped opportunity to exhibit their particular set of strengths within the industry.

What investors don’t know yet

Let’s use the example of drilled cuttings. Until companies better understand the composition of their drilled cuttings, there will not be meaningful reportable information for investors. The Sustainability Accounting Standards Board (SASB) issued provisional standards for reporting sustainability information to help guide companies through the reporting process. Even though waste management is not currently included as a SASB sustainability topic, drilled cuttings indirectly fall into several other categories. Companies should take heed that even though the topic was not directly listed, they will still need to report how their waste affects GHG emissions, air quality, water management, biodiversity impacts, community relations and management of the legal and regulatory environment. It is scientifically proven, but perhaps not common knowledge, that all of the abovementioned issues are directly tied to drilled cuttings and contemporary disposal practices. As an example, the limit of chlorides in drinking water is 250 mg/l, but the weight of chlorides generated per horizontal well can range from 4,000 lb to 170,000 lb, or 2.5 tons to 85 tons. To dilute these chlorides to a level considered safe for drinking water would require between 2.6 million gallons and 8.9 million gallons of water. To put that in perspective, an Olympic swimming pool contains 660,430 gal of water, so each horizontal well drilled would require enough water to fill between four and 136 Olympic swimming pools just to dilute the chlorides. As rules and regulations regarding drilling waste, and specifically drilled cuttings, become more robust and narrow in scope, investors will have more information available to them that historically has been unreported.

Considering short-termism

The phenomenon of short-termism can best be described as an operational strategy employed by executives to focus more exclusively on shorter term financial objectives at the expense of creating opportunities for longer term value creation, which often has been done for the sake of satisfying investor demands.

“Surveys indicate that the overwhelming majority of CFOs would destroy economic value to meet short-term earnings targets,” according to a recent article in the Financial Analyst Journal.

Executives often cite an erratic market and persistent demand for financial capital as a key driver, forcing them to make decisions that might not be congruent with sound long-term business strategies. Companies must understand that the investor landscape continues to evolve and thus necessitates their own strategic evolution. Investors are becoming less myopic, looking farther into the future and to invest in companies that will not only be a good longterm investment but also will be an environmentally responsible choice for the betterment of future generations.

As an illustration, investors historically have generally made investment decisions based on maximizing yield, or return. Little thought was given to the stability of the company or the methods employed to earn those profits. The new generation of investors is diverging from this traditional mindset by placing a greater emphasis on a more holistic set of valuation principles and investing in companies they believe in. This new generation willingly accepts a lower short-term rate of return in exchange for a solid ESG structure and innovative strategies for future success.

Fiduciary responsibility

The scope of fiduciary duty that trustees have with their investors is changing. Maximizing financial returns is not a guiding concept enshrined in the definition of fiduciary duty. Indeed, fiduciary duty encompasses not just what is good for today’s investor but what is beneficial for future investors and the economy as a whole. Some are arguing that professionals are in breach of their fiduciary obligations by making short-sighted investments in companies that do not have strong ESG policies.

A 2005 U.N. report stated, “In our opinion, it may be a breach of fiduciary duties to fail to take into account ESG considerations that are relevant and to give them appropriate weight, bearing in mind that some important economic analysts and leading financial institutions are satisfied that a strong link between good ESG performance and good financial performance exists.”

Even if financial disclosure laws may be slow to evolve, there is clearly a natural move in societal thinking toward inclusion of ESG performance in investing. Protecting future investments, mitigating risk and creating overall economic growth potential is an integral part of providing returns for future investors. Individuals entrusted with fiduciary duty need to ensure that an oil and gas company’s waste management practices and resource allocation are also given due weight along with other financial considerations.

When companies don’t want to disclose

The SASB created provisional standards that are set to be released in first-quarter 2018 to provide guidance to companies on the disclosure of sustainability topics that are material to their industry. However, at this time there is no mandate that requires companies to disclose all material information. Investors are asking for more information, but until the Securities and Exchange Commission requires sustainability reporting to accompany financial reporting, reporting will continue to lack the insight that investors desire. Companies are often quick to provide news of achievements but are not so apt to freely volunteer information that may be viewed in a negative light. If companies do disclose information that could be perceived negatively, they often use generalized terms and cite vague industry standards.

While the concept of sustainability accounting has been around for a while, the execution is still in its infancy. The SASB uses an algorithm that searches trade journal articles, industry publications, bulletins, etc., and tags keywords that appear with some frequency. Once a word is tagged, the SASB will review the concept for consideration of materiality and inclusion in its standards. It uses this method to better gauge what is of interest to the public and investors. The SASB already tagged the environment group as being the defining dimension for the nonrenewable resources sector. The environmental dimension includes topics such as GHG emissions, air quality, energy management, fuel management, water/waste water management, biodiversity impacts and waste/hazardous waste management.

Where does this leave the future?

The Financial Accounting Standards Board (FASB) said, “To assess an entity’s prospects for future net cash infl ows, existing and potential investors, lenders, and other creditors need information about the resources of the entity, claims against the entity, and how efficiently and effectively the entity’s management and governing board have discharged their responsibilities to use the entity’s resources. Examples of such responsibilities include protecting the entity’s resources from adverse economic variables such as price and technological changes while ensuring that the entity complies with applicable laws, regulations and contractual provisions. Information about management’s discharge of its responsibilities also is useful for decisions by investors, lenders and other creditors who have voting rights or otherwise infl uence management’s actions.”

The FASB and SASB recognize that disclosed information needs to be material, error-free and neutral, comparable across an industry, verifiable, reported in a timely fashion, and understandable to the average investor. Oil and gas companies will most likely be confronted with their drilling waste issues. If it doesn’t appear on the SASB radar for review first, then this issue will find its way into the public domain as a result of civil litigation. To avoid getting caught playing defense through the court of law and through the court of public opinion, oil and gas operators ought to take a more prudent and proactive approach to managing risks associated with drilled cuttings and their attendant liabilities.

References available.

Have a story idea for Industry Pulse? This feature looks at big-picture trends that are likely to affect the upstream oil and gas industry. Submit story ideas to Group Managing Editor Jo Ann Davy at jdavy@hartenergy.com.