Can you be a responsible investor and invest in oil and gas?

There’s no getting around it – fossil fuels are terrible for the environment. In fact, the Intergovernmental Panel on Climate Change (IPCC) suggests they’re the main cause of global warming.

Oil releases a huge amount of carbon when burned – approximately a third of the world’s total carbon emissions. And several oil spills have had a devastating impact on our ocean’s ecosystem in recent years. Meanwhile extracting oil and gas disrupts wildlife and has been known to pollute local air and water supplies.

So that’s it then. Responsible investors shouldn’t invest in oil and gas stocks.

Or should they?

When you own a share in a company, you get certain rights including a say on how the company’s run. You can attend shareholder meetings and vote on management’s proposals, or if you can’t attend you can cast a proxy vote. This gives you a chance to have a say in how sustainable practices are handled in future. That’s even more important for companies that have a large footprint on the environment around them.

In contrast, if you avoid a company’s shares, someone else buys them. They might not care about the company’s impacts as much as you do. They might be happy to see the company run in the same way, without any care for environmental, social or governance (ESG) issues.

You could argue that if enough investors avoid buying shares, it makes it harder for the company to raise new money. But this doesn’t matter much if the business doesn’t need to raise money.

In extreme cases, companies ignored by investors could see large international investors and private equity firms buy the firm and take it private. It would then face even less restrictions and transparency requirements.

The transition to cleaner energy is underway, but it’s going to take time and avoiding oil and gas companies won’t change that. In fact, it’s likely these companies will be part of the solution.

They’re some of the biggest investors in renewable energy and a greater part of their business could be focused on these areas in future. They have the scale and technical knowhow to increase the chances of success.

The important point for investors is to focus on those they believe are taking a genuine approach to sustainable solutions, and perhaps avoid those making limited progress.

One important caveat. We’re not saying all responsible investors should invest in oil and gas stocks. You’ll need to do your own research and work out for yourself whether any oil and gas companies fit in with your investment objectives and attitude to risk. There isn’t one right way to invest, even as a responsible investor, and some might still want to avoid oil and gas stocks for ethical reasons.

Investing in an individual company is higher risk and isn’t right for everyone. Your investment is dependent on the fate of that company. If it fails, you risk losing your whole investment. Investors should only buy and hold individual shares as part of a well-balanced, diversified portfolio.

---

Finding the green amid the black stuff

There are good reasons why you might want to invest in an oil and gas company. Not least is the fact some big names in the industry are offering prospective dividend yields of over 5% – not guaranteed or a reliable indicator of future income. Choosing to invest in an oil and gas company with a good record on ESG issues can help reconcile an investment with ethical concerns. But it could in the long run be good for your wallet too.

Companies that manage ESG risks well are less likely to face fines, major financial scandals, or serious reputational damage. All of that is good news for investors.

Data provider Sustainalytics measures precisely this in its freely available ESG risk ratings. Its corporate risk ratings measure “unmanaged ESG risk” of companies and ranks them across the global market.

These ratings consider both unmanageable risk and also the management gap.

Unmanageable risks are an inevitable part of doing business. In oil and gas that might be a hurricane damaging a deep-sea oil rig and causing an oil spill. Management gap refers to risk that could be effectively manged but isn’t – the lack of an anti-corruption policy for example.

Clearly no company can address the unmanageable risks in their business, and in oil and gas these are considerable. But investors might prefer to support those that do take necessary steps to reduce ESG risk where possible.

Consider the world’s 10 largest, listed oil and gas producers below. We’ve included both their absolute ESG Risk Rating and how they’re classified by Sustainalytics relative to the whole investable universe.

You’ll notice most of these companies fall into the High or Severe ESG risk categories. That reflects the fundamental ESG challenges that go with operating in the oil & gas space. However, there’s nonetheless a clear distinction between the different stocks – not all are considered equally risky.

These types of ESG ratings can be a useful tool, particularly in an industry like oil and gas where the risks are substantial. However, they shouldn’t be your only consideration when making an investment decision.

A single valuation metric (a price/earnings ratio for example) isn’t much use without further research to understand if that valuation is justified. Similarly a company with a high ESG rating still needs a good business model and an attractive valuation to be a good investment. This article isn’t a recommendation to buy, sell or hold any investment.

Sustainalytics ESG Risk Ratings

Source: *S&P Global, †Sustainalytics, 25/03/2021. Companies listed in alphabetical order.

---

How can investors increase their impact?

If you want to have more impact on the companies you invest in, you could invest through a fund. When you invest through a fund, votes are pooled with other investors. That means the fund manager can influence companies on a range of issues – including strategy, how well the company’s run and risk management. They can also encourage companies to adopt better ESG practices.

The bigger a fund manager’s stake, the more bargaining power they have. Some fund managers increase their bargaining power further by working with other managers and collectively negotiate with companies to achieve shared goals.

The key is to invest with fund managers who share similar views to you. You can usually find out more about a manager’s approach to engagement on their website. Some might also produce engagement reports which outline the progress they’ve made on their engagement objectives throughout the year.

Investing in these funds isn’t right for everyone. Investors should only invest if the fund’s objectives are aligned with their own, and there’s a specific need for the type of investment being made.

Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.

Engagement in action – Legal & General

Legal & General is a global asset manager and looks after around £1.3trn of investors’ money. When they speak, companies tend to listen. We like their commitment to encourage good ESG practices among the companies they invest in.

In 2020, Legal & General engaged with 665 companies on issues from climate change and diversity to management’s pay and corporate strategy.

Legal & General has had lots of engagements with oil & gas companies in recent years. Notably, the firm teamed up with other shareholders to submit a proposal calling on BP to outline its response to climate change. The company later announced a package of industry-leading carbon reduction targets.

Legal & General’s Future World range of funds incorporates their ‘Climate Impact Pledge’. It’s their commitment to assess and engage with some of the world’s largest companies on how well they manage the implications of climate change.

They’ll only sell a company’s shares from the Future World range of funds as a last resort if it consistently shows a lack of awareness of climate change after thorough engagement. This acts as an incentive for companies to engage in constructive dialogue with the Legal & General team. The exclusion list is reviewed on an ongoing basis, so excluded companies can re-join the fund if they improve.

The Legal & General Future World ESG Developed Index fund features on our Wealth Shortlist. Alongside the exclusions under the Climate Impact Pledge, it increases investments in companies that score well on a variety of ESG criteria – from the level of carbon emissions generated, to the number of women on the board and the quality of disclosure on executive pay. It also reduces how much it has invested in companies that don’t score as well on these measures.

The fund employs some negative screens on top of this. It won’t invest in tobacco companies and pure coal producers. But also makers of controversial weapons or persistent violators of the UN Global Compact Principles (a UN pact on human rights, labour, the environment and anti-corruption).

The manager has the flexibility to invest in derivatives which, if used, adds risk.

This article isn’t personal advice. All investments can fall as well as rise in value so you could get back less than you invest. If you’re not sure if an investment is right for you, ask for financial advice.

FIND OUT MORE ABOUT LEGAL & GENERAL FUTURE WORLD ESG DEVELOPED INDEX INCLUDING CHARGES

LEGAL & GENERAL FUTURE WORLD ESG DEVELOPED INDEX KEY INVESTOR INFORMATION