By Tim Baines and Paul Forrester

Law360 (January 26, 2021, 5:07 PM EST) --

Tim Baines

Paul Forrester

When asked about the top environmental, social and governance, or ESG, risks in oil and gas, many would point to concerns like health and safety, environmental harm, climate change, and activities in particularly high-risk jurisdictions.

From a legal perspective, we do not disagree. But our key concerns come from a different angle.

They stem less from the subject matter of ESG disclosures themselves, and more from the underlying processes and procedures that are implemented to reduce the possibility of ESG disclosures leading to future legal liability. This is particularly important given the increasing importance of such disclosures in the oil and gas sector.

Did you do what you say you did?

Many oil and gas companies make varied and wide-reaching claims about their ESG performance. This can be by way of formal ESG or sustainability reports, or from other publicly made statements.

Oil and gas companies join voluntary initiatives — often ones without hard legal consequences — all the time. Our experience tells us that not all statements are fully audited before they are made, and that not all businesses live up to the letter or spirit of the initiatives for which they sign up. This opens them up to liabilities down the line.

Of particular concern is the increasing emphasis on climate risk disclosure. A number of regulators across the globe are now formalizing requirements to make disclosures in accordance with the Taskforce on Climate-related Financial Disclosures, or TCFD. For example, the U.K. has announced its intention to make TCFD-aligned disclosures mandatory across the economy by 2025, with a significant portion of mandatory requirements in place by 2023.

Similarly, on Oct. 29, 2020, Hong Kong's Securities and Futures Commission issued a consultation paper on management and disclosure of climate-related risks by fund managers, including proposed amendments to the fund manager code of conduct that would require fund managers to consider climate-related risks in their investment and risk-management processes.

The amendments would also require fund managers to make appropriate disclosures to meet investors' growing demands for climate risk information and combat greenwashing. Further developments like these will clearly put increasing pressure on oil and gas companies from the point of view of scrutiny of public disclosures.

When was your last ESG audit?

By this we do not mean: How many health and safety breaches were committed last year? What we are most concerned about is: When did you last take an in-depth look at whether the business lives up to (1) its internal policies and (2) any external initiatives in all ESG-related matters?

This cuts across a very broad range of activities, so a meaningful audit should not be a tick-box exercise. We are not the only ones who think this. An August 2020 article featured by the Harvard Law School Forum on Corporate Governance[1] stated:

Notwithstanding the [U.S. Securities and Exchange Commission]'s position that it will not — at this time — mandate additional climate or ESG disclosure, companies must still be mindful of the potential legal risks and litigation costs that may be associated with making these disclosures voluntarily. Although the U.S. federal securities laws generally do not require the disclosure of ESG data except in limited instances, potential liability may arise from making ESG-related disclosures that are materially misleading or false.

Of course, this article predated the recent U.S. presidential election. President Joe Biden has already rejoined the Paris Agreement, and has announced that he will make addressing climate change a top priority of his administration, describing it as "the existential threat of our time."[2] So ensuring that all the ESG ducks are in line is increasingly significant.

Who checked it?

Internal advisers and consultants not familiar with the broader legal regime surrounding ESG-related obligations are unlikely to be able, on their own, to make sure that a company is genuinely in compliance. We predict that this will become increasingly important as regulatory pressure increases.

For example, the European Commission announced in early 2020 that it would present a legislative proposal on mandatory human rights and environmental due diligence in early 2021. It is anticipated that this legislation will require companies to establish an adequate human rights and environmental due diligence compliance system, and to carry out appropriate supply and value chain due diligence. It will be difficult to do so without some kind of external assurance mechanism.

What did you say about your global approach?

In a globalized world, with far-flung operations, it can be tempting to proudly announce that you take the same rigorous approach to ESG compliance globally. We understand that in practice ,this is very difficult to achieve, and from a legal perspective it can be an impossible goal to live up to.

Communications may need to be more nuanced. For example, in the U.K. case of Vedanta Resources PLC and Konkola Copper Mines PLC v. Lungowe and Others, a claim was brought by 1,826 Zambian villagers against Vedanta Resources PLC, a U.K. mining company, and its Zambian subsidiary, KCM, for the discharge of toxic matter into waterways from a mine operated by KCM.

In that case, it was found that:

[T]he published materials in which Vedanta may fairly be said to have asserted its own assumption of responsibility for the maintenance of proper standards of environmental control over the activities of its subsidiaries, and in particular the operations at the Mine, and not merely to have laid down but also implemented those standards by training, monitoring and enforcement, [are] sufficient on their own to show that it is well arguable that a sufficient level of intervention by Vedanta in the conduct of operations at the Mine may be demonstrable at trial.

This opens up the scope for courts determining that a U.K. parent company may owe a duty of care for the activities of its overseas subsidiaries, including — but not limited to — matters relating to ESG, and highlights the importance of being careful about statements made in respect of international compliance.

Have you thought about future scenarios?

Many oil and gas businesses have now adopted alternative courses for their businesses, including in respect of an increasingly carbon-constrained world. Targets, on their own, only go so far. We think that what investors are most focused on is the extent to which you have really thought this through, modelled different scenarios, and are readying yourself for the future.

Without doing so, sources of both debt and equity are likely to become more scarce. While climate scenario analysis under TCFD guidance is still being refined, early attempts to quantify potentially stranded assets due to an energy transition range from $1 trillion to $4 trillion.[3] This has been described as an "existential concern" for affected companies.[4]

A report from Aviva Investors Holdings Ltd. stated:

Pressure on oil companies to transform their businesses in line with climate goals is coming not just from environmental groups but large institutional investors too. With many countries indicating they intend to electrify their transport networks at an accelerating pace as climate change rises to the top of the political agenda, oil companies are being stung into action.[5]

We fully acknowledge the substantial financial and other risks to an oil and gas company in transforming its business. However, there may be no choice. As reported by Bloomberg,[6] Total SE announced an $8.1 billion write-down after the push to curb carbon emissions and the coronavirus pandemic challenged assumptions about the viability of some oil and gas assets and the timing of peak demand.

The bulk of the impairment, about $7 billion, applies to Canadian oil sands, which are costlier and more carbon-intensive than conventional fields. This follows BP PLC and Royal Dutch Shell PLC, which have warned that they could write down almost $40 billion between them in the second quarter.

Bloomberg's view is that the size of the impairments shows how the global health crisis, combined with the push to slow climate change, is "shaking the industry's foundations." As reported in The Guardian, the world's largest listed oil companies have wiped almost $90 billion from the value of their oil and gas assets in the last nine months, as the coronavirus pandemic accelerates a global shift away from fossil fuels.[7]

However, being stung into action may not be such a bad thing. In the words of Wells Fargo Asset Management:

By establishing a convincing path forward and by rebuilding support with its network of stakeholders, integrated energy can drive a shift in the market's awareness of its value-creation potential. This prospect is already becoming evident in Equinor, Galp, and a range of other integrated energy firms.[8]

Do you know what the S in ESG stands for?

And do you know that it, too, can be measured, reported on and verified? The social side of ESG is often ignored, and sounds relatively innocuous. But getting matters such as the use of child labor and low worker pay wrong can inflict just as much damage to a business as a serious environmental spill.

There can be a concerning disconnect between human rights commitments and processes and impacts on the ground. Many companies require a great deal more human-rights-related due diligence and audits to address the disconnect between their public-facing commitments and real human rights impact.

In any event, going forward, companies should expect greater attention on their public statements about social matters from investors, stakeholders and consumers.

And what about the B?

At the risk of adding another letter, it is increasingly recognized that, hand in hand with a climate crisis, the world is confronting a biodiversity loss crisis. Of course, addressing this matter is far from the exclusive preserve of the oil and gas industry.

But equally, it will not be possible for the oil and gas industry to avoid making progress in this area in the coming years. As stated by the executive director of the International Petroleum Industry Environmental Conservation Association:

Our members recognize biodiversity makes a significant and vital contribution to society from ecological, cultural and economic perspectives. Loss of biodiversity and damage to land and marine ecosystems impact the ability to regulate our climate, access water, improve food security and so on. It is essential that activities in or near sensitive environments are responsibly managed.[9]

Conclusions

We have set out above a number of factors which we think should be considered by the oil and gas sector when making ESG disclosures. We think that it is a business risk not to do so, and that by better considering these matters, oil and gas companies can optimize their performance.

This is particularly important as institutional investors have started to go a step further by directly associating ESG performance with a response to the energy transition. In the words of Federated Hermes, a self-described global leader in active, responsible investing:

[T]he energy transition is an existential long-term risk for oil and gas companies, as the move away from fossil fuels towards low-carbon technologies impacts demand for hydrocarbons. … As active, responsible credit investors, we believe a holistic understanding of corporate transition risks and actions to mitigate them is vital. We seek this by integrating environmental, social and governance (ESG) factors and engagement insights into our investment decisions.

We could not have said it better.

---

Tim Baines is counsel and Paul Forrester is a partner at Mayer Brown LLP.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] See https://corpgov.law.harvard.edu/2020/08/03/legal-liability-for-esg-disclosures/.

[2] See https://www.washingtonpost.com/politics/2020/12/19/were-crisis-biden-says-us-needs-defeat-climate-change-he-introduces-team-priorities/.

[3] See Carbon Tracker's 2 Degrees of Separation series, including its 2019 report "Breaking the Habit," available at https://www.carbontracker.org.

[4] See https://carbontracker.org/reports/fault-lines/, and related infographic at https://carbontracker.org/wp-content/uploads/2020/10/Fault_Lines_Infographic-1.pdf.

[5] See https://www.avivainvestors.com/en-gb/views/aiq-climate-change/.

[6] See https://www.bloomberg.com/news/articles/2020-07-29/total-takes-8-1-billion-writedown-as-pandemic-devalues-oil-gas.

[7] See https://www.theguardian.com/business/2020/aug/14/seven-top-oil-firms-downgrade-assets-by-87bn-in-nine-months.

[8] See https://www.wellsfargoassetmanagement.com/assets/public/pdf/insights/investing/the-aspirational-investment-case-for-integrated-energy.pdf.

[9] See https://www.ipieca.org/news/biodiversity-can-t-wait/.

For a reprint of this article, please contact reprints@law360.com.