To: The CEO
From: The Board
You face myriad challenges to get through the week, the quarter and the year, from COVID-19 to labour shortages, from supply chain issues to massive disruptions brought on by war. Your energy and attention, and that of your senior direct reports, are properly focused on protecting our people, meeting the needs of our customers and ensuring that we keep the lights on—in some cases, literally.
At the same time, we recognise that we have an important role to play in helping you deal with a set of issues that require the creation of a long-term strategy. For in the long term, you must also focus on the security of supplies, managing the energy transition and understanding where to invest so your organisation can be resilient in the face of the coming disruptions. Chief among those disruptions are the rising demands (and opportunities) presented by environmental, social and governance (ESG) issues. The movement to decarbonize the energy, utilities and resources sectors, which has gained traction since the COP26 climate change talks, has been infused with new urgency. There’s a greater need to focus on energy storage, expanding cross-border energy infrastructure, and investing in renewables, energy efficiency measures and renewable-hydrogen infrastructure.
There’s a powerful tension at work here. The typical CEO tenure of a large publicly held company is about five years. But you are being asked to make commitments that may not take full effect for 15, 20 or 30 years. These will bind the actions and strategy of your successors—and perhaps their successors. That’s where we, the executive board, can assist you. We know we need to start planning for a comprehensive long-term transformation that can create sustainable advantages and deliver lasting value. This is about far more than anticipating new regulation and compliance, or dealing with the immediate need to guarantee short-term security of supply. It’s about satisfying the demands of investors, customers, your employees and society at large so that the business you run is fit for a very uncertain future.
Plotting a path to net zero at a time when the world is crying out for secure and accessible energy supplies is perhaps the toughest strategic challenge every organisation in our industry faces today.
Despite the current spike in the demand for (and price of) crude oil, refined products, natural gas and power, all companies in the sector know decarbonisation is coming. Many of the governments in markets in which we operate are enacting increasingly strict limits on emissions. Globally, more than 130 countries have pledged to meet net-zero targets by 2050, and companies that want to extend their licence to operate will have to do the same. But only 22% of companies responding to PwC’s latest CEO Survey currently have committed to net-zero goals.
To navigate the current energy crisis while also preparing for a low-emission future, we need to develop a plan now to achieve net zero in our own operations. A successful decarbonisation plan requires putting clear, actionable steps in place. How realistic is the timeline we are setting? Are we prepared to examine, with our partners in the value chain, Scope Three emissions, which in many instances have the greatest global impact? Investors are asking more pointed and detailed questions about all our emissions. Answering them forthrightly will enable us to build trust. At present, there are too many assumptions and not enough structured data to answer them with confidence.
Many large integrated energy companies already have started employing low-carbon strategies, because they know they need to move quickly and have both the financial resources (bolstered by recent oil and natural gas price increases) and the infrastructure expertise to adapt. Other, medium-sized energy companies such as Denmark’s Ørsted and Finland’s Neste have reshaped or are reshaping their entire business models around renewables.
Whatever strategic route you find the most compelling, planning the pace and path of the long-term transition needs to start right now.
What is our core strength, and how can you use it to your advantage in the energy transition?
Over the past 100 years, our sector was built on expertise in science, engineering and developing truly revolutionary technology. Those strengths are needed now more than ever. But our people, products and technology need to be applied to the big picture of the energy transition rather than to making short-term, incremental improvements to power plants, upstream activities or mining operations.
Developing new products and services by trusting in our company’s technological, engineering and science expertise can help determine the pace of transition. In the short-term, that might mean developing a new suite of emission-reduction and energy-efficiency products to support other energy companies, as Baker Hughes has done. The oil services company is transforming its own business to support the digital transformation of the energy sector, employing technologies such as the internet of things, data analytics and artificial intelligence.
Or it might mean embracing circular-economy thinking and practices. With petrochemical production set to account for nearly half of the growth in global oil demand by 2050, many of the world’s largest chemical companies, including Dow, SABIC and Chevron Phillips Chemical, are racing to partner with recycling start-ups. The most innovative chemical companies are planning for the long term by investing in bio-plastic processes and positioning themselves to be key players in the large-scale production of electric vehicle (EV) batteries or green hydrogen. BASF, for example, predicts its battery materials revenue will reach more than €7 billion by 2030 as EV production grows.
Leaders in the utilities sector are focusing on mobility, building consumer-serving infrastructure like EV charging stations even as they innovate around new revenue models and investments like green hydrogen production and equipment. In the UK, for example, EDF Energy is partnering with Nissan to create a commercial vehicle-to-grid (V2G) charging service for EV fleet operators.
The energy transition is breaking down the traditional barriers that have protected different parts of the energy sector for so long. Now is the time to grasp the opportunity to reimagine what our business could be, the relevant capital needs and revenue models and the potential partners with whom you’ll collaborate.
Developing new products and services might not be enough to help drive the energy transition at the pace needed for success. What is your strategy for using deals to bolster our ESG position?
In 2021, deal volumes and values in the energy, utilities and resources industry increased over the prior year by 8% and 67%, respectively, according to PwC. One clear trend driving this activity is the growth of ESG-related mergers and acquisitions (M&A).
One potential path is to split lower-emissions parts and higher-emissions parts of the business into separate companies, as Ford has announced it will do. Others are using capital to diversify their operating units. Total, the oil company that rebranded itself as TotalEnergies in 2021, has acquired wind and solar units.
Partnerships are also becoming more common. BP has invested in a joint venture, Lightsource BP, to develop solar farms around the world. Occidental Petroleum partnered with Canadian start-up Carbon Engineering to build a carbon capture and storage (CCS) plant that will store 500,000 metric tons of CO₂ each year. Anglo-Dutch energy giant Shell, meanwhile, is partnering with German power company RWE to produce and distribute green hydrogen in Germany and the UK.
Other energy sectors know they will need to partner in order to thrive. Utilities will need to increase their access to renewable energy sources in order to maintain supplies. In the chemical sector, companies are acquiring wind farms and entering into partnerships to secure access to hydrogen supplies. In 2021, BASF agreed to buy 49.5% of Swedish power company Vattenfall’s planned 1.5GW offshore wind farm in the Netherlands.
As you start to reimagine your own business, everyone else is doing the same with theirs.
Many sectors of our industry operated for a long time without any real competition—electrical grids, transportation companies and heavy industry once depended almost entirely on fossil fuels for their energy needs—but that’s changing. The electrons and molecules that power our systems increasingly derive from renewables and hydrogen, and the race to net zero will attract competitors from other energy and utilities sectors as well as from fast-moving and innovative new entrants.
Given the potential of green hydrogen, a host of players are investing in harnessing no-emission power to produce transportation and industrial fuels. The Hydrogen Council, a global trade body promoting the industry, now boasts over 130 corporate members. Deep-pocketed integrated energy companies are moving into the utilities market. Consumer-facing powerhouses like Starbucks are seeking to leverage their large retail footprints to become suppliers of energy for electric vehicles. Energy technology companies, meanwhile, are providing new services and equipment to provide carbon capture and storage capabilities for oil, gas and coal companies.
Utilities, too, are well placed to compete in new areas of the decarbonised economy. As pressure rises to electrify trucks, cars, ships, bikes and heating systems, utilities’ experience in both infrastructure and customer service puts them in a potentially strong position to build on existing customer relationships.
Investors are demanding urgent action on two fronts: they expect to see healthy quarterly returns, but they are also demanding that leaders lay out long-term plans, especially around ESG and the journey to net zero. The formation of the Glasgow Financial Alliance for Net Zero—a group of 450 financial firms across 45 countries responsible for assets of over US$130tn—in 2021 highlights the momentum for decarbonisation. Against this backdrop of systemic change, we need to be sure that we’re looking at the value of the company’s assets through the same lens that investors are.
From this point on, the cost of capital for those embracing ESG metrics and standards will be far lower than for those not being proactive. A 2020 study by MSCI, a financial analysis and ESG ratings firm, found that, over a four-year period, companies with high ESG scores, on average, experienced lower costs of capital compared to those with poor ESG scores, in both developed and emerging markets.
It’s not enough simply to articulate a comprehensive strategy. You will have to show that you are making progress in meeting aggressive goals and provide transparent and comprehensive reporting. Increasingly, investors will expect to see your non-financial ESG metrics fully integrated into your financial reports. CEOs historically maintained credibility with investors by reliably reporting profits every quarter. Now there is a different set of reporting expectations that must be met.
Like everything in the world of ESG, the reporting landscape is evolving and maturing quickly. The International Sustainability Standards Board (ISSB) was created in 2021 to provide a comprehensive global baseline of high-quality sustainability disclosure standards to meet investors’ information needs. In March, two of the most prominent ESG reporting frameworks, the IFRS Foundation and the Global Reporting Initiative (GRI), agreed to align their capital market standards for sustainability disclosure.
Do you know what the relevant metrics are, and do you have adequate reporting systems to meet them?
We know you spend a great deal of time thinking about your customers’ needs. But can you say with confidence that you know what those needs will be in five years? Are you prepared not only to meet those future needs but shape them?
Certainly, customers will need energy to power their homes, transportation and daily life. But how much of that demand will shift from refined fossil fuels to electricity? How will they want to access that energy? How will they want to pay for it? And have you envisioned a decentralised marketplace where they might be in a position to sell energy back to you?
Five years ago, few would have predicted the enormous surge in consumer demand for electric vehicles. In 2021, global EV sales grew 80%, spurred by more than 40 countries around the world pledging to phase out the internal combustion engine before 2050. Toyota and Volkswagen alone are going to invest a combined $170bn on EVs over the coming decades. Fewer still would have predicted that a city as large as Paris would enact a plan to ban non-essential motorised vehicles from its central districts—a move that is likely to be repeated elsewhere as urban areas tackle climate change and quality of life.
In the past, infrastructure often preceded consumer adoption. Oil companies’ investment in gas stations laid the foundation for the car transportation network we take for granted today. Increasingly, it seems that infrastructure is now following consumer demand and will have to race to get ahead of it. That’s why energy companies like BP are rushing to invest £1bn into expanding EV charging networks across the UK.
Macro conditions such as the “great resignation” and millennials’ preference for a purpose-driven workplace are putting a great strain on companies as they seek to retain and attract the talent that will enable long-term strategic initiatives.
Some in the existing workforce—often veterans of the carbon-economy boom years—feel under-appreciated and often lack the motivation to embrace the fundamental change taking place in their sector. One recent survey found that nearly half of oil and gas professionals expect to leave the industry in the next five years. At the same time, a new generation of talent who might once have gravitated to the energy sector now are choosing to work for technology companies because they are reluctant to be associated with fossil fuels.
Convincing a veteran workforce that the future of the business lies beyond fossil fuels will be challenging. Attracting the brightest talent to join a journey towards net zero that will require significant technological, scientific and engineering expertise should not be quite as difficult. Are you developing a workforce strategy that looks beyond retention to understand the skills, capabilities and culture your successor will need in order to thrive in ten years?
The seven ESG themes we’ve identified above will have a profound effect on the fortunes of our company over the coming years. While your immediate priority is to address the many current issues confronting the business and the sector as a whole, we also believe the company can take concrete steps to future-proof itself and be in a position to turn ESG challenges into opportunities. We, the board, are here to support you on this journey.