Lipstick, meet pig: US frackers’ hopeless ESG beauty parade won’t wash with investors

American shale oil producers are unleashing a torrent of ESG obfuscation on capital markets in a desperate pitch to green investors. It is destined to fail.

The US fracking industry is redoubling efforts to convince investors that the energy transition will not put it out of business. Amid last month’s frenzy of defensive merger and acquisition deals in the North American shale patch, companies responsible for not insignificant amounts of natural gas flaring, venting and methane leaks—not to mention the production of huge volumes of oil and gas for unabated consumption—made some heroic claims to excellence in environmental, social and governance (ESG) matters.

The most egregious was probably the assertion that the merger of ConocoPhillips with Concho Resources would create a “Paris-aligned” US onshore oil and gas company. This is based on the premise that by achieving ‘net zero’ operational (Scope 1 and 2) emissions by 2050, the pro-forma company will be able to keep fracking oil-rich shale rocks without capturing or offsetting any of its end-use (Scope 3) emissions for another 30 years. Such an assumption seemed flawed even before China, Japan and South Korea each joined the growing list of countries to commit to ‘net zero’ emissions targets.

ESG featured in investor material seeking to justify other mergers. Devon Energy and WPX said they “share an uncompromising commitment to ESG leadership”, while Parsley Energy and Pioneer Natural Resource believe merging will bestow upon them “enhanced ESG capabilities”, as the two companies have “best-in-class [ESG] practices”.

There is some encouragement to be found in companies doing something about their environmental impacts, or at least being aware of the issue. But tackling only peripheral, low-hanging fruit—such as switching a fracking rig to run on renewable electricity instead of diesel ten years from now—fails to move the needle on the urgent task to get global emissions onto a steep downward trajectory right now.

Flaring up: US gas flaring reached new highs in 2019 (photo courtesy Sierra Instruments)

Lack of vision

The ESG commitments being trumpeted by independent US oil and gas operators vary by company, but are in general rather uninspiring. ConocoPhillips aims to reduce its Scope 1 and 2 operational greenhouse gas (GHG) intensity by 35-45% from a 2017 baseline by 2030 and reduce its methane emissions intensity by 10% by 2025. The company also has an “ambition” to end routine natural gas flaring by 2025, but is not troubling itself with Scope 3 emissions because these are, to paraphrase, beyond its control and somebody else’s responsibility.

ConocoPhillips’ GHG intensity actually rose in 2019 and its targets statement suggests the company is at best indifferent towards further increases over time:

“First, there are still 11 years before the target end date, and we would expect GHG intensity of our older fields to increase. (As natural gas and oil fields deplete, more energy is required to produce the same or lower volumes, while newer fields utilizing modern technologies are likely to operate at lower intensities.) Second, some of our reported emissions are the result of applying standard emissions factors which may underestimate or overstate our actual emissions. We expect industry technologies around emissions detection and monitoring to advance over the next 11 years to reflect actual performance more accurately, which could also increase or decrease our intensity. Third, our portfolio will continue to change over time and, depending on the intensity of new production, our future intensity could increase or decrease.”

The statement does not explain why ConocoPhillips has not ruled out acquiring assets that would increase its GHG intensity, seeing as this would undermine efforts elsewhere to achieve its own target. Similarly, the company seems happy to sell cleaner assets and hold onto dirtier ones; part of the GHG increase in 2019 arose from the disposal of ConocoPhillips’ UK business unit, “which was comprised of lower-intensity offshore developments”.

Photo by Daria Shevtsova from Pexels

Lowering the bar

Parsley Energy’s “environmental stewardship” statement is similarly underwhelming. The company is content to “participate in the climate conversation by continually engaging key stakeholders”, and believes that having “capital efficient” and “short-cycle” projects in its portfolio somehow bestows upon it “climate resiliency”.

On natural gas flaring, Parsley works “diligently” to “minimize” the practice and takes “precautions to avoid venting or flaring gas whenever possible”. When it does flare, it uses “engineered and right-sized flares to optimize the combustion of any flared gas”. Unfortunately, this is still happening rather a lot: Parsley’s own data shows its flared volumes as a percentage of total gas production more than doubled over two years, from 1.15% in 2017 to 2.78% last year.

Oil and gas companies like to reference falling GHG intensity to demonstrate they are taking meaningful action on emissions. This is usually measured in terms of million tonnes of carbon dioxide-equivalent gases emitted per million barrels of oil-equivalent produced (mtCO2e/Mboe). This is a clever statistical ruse: emissions intensity can fall even if gross emissions rise, as long as production growth is proportionally greater than growth in GHGs.

Parsley’s data illustrates this point well. Its GHG emissions intensity fell from 14.28 mtCO2e/Mboe in 2016 to 11.61 mtCO2e/Mboe last year. But its Scope 1 operational GHG emissions are marching relentlessly northwards, from 295,621 mtCO2e in 2016 to 720,687 mtCO2e in 2019. That’s a 144% increase in GHGs in three years.

Divergent paths: Parsley Energy’s emissions intensity is falling, even as its own operational emissions rise

‘The most hated sector of the market’

This is just the beginning. The American hydraulic fracturing industry is poised to unleash a torrent of ESG obfuscation onto capital markets. The Independent Petroleum Association of America (IPAA), the industry’s trade body, recently launched an “ESG Center” in partnership with global business advisory firm FTI Consulting to help members develop “authentic and effective” ESG programmes.

This is the same trade association that Norwegian semi-state oil company Equinor quit earlier this year due to its “lack of position” on climate change. The IPAA also supported the Trump administration’s rollback of Obama-era methane emissions regulations that was so contentious it divided the fossil fuel industry and made unlikely bedfellows of ExxonMobil and the Environmental Defense Fund (as discussed previously in Energy Flux).

The IPAA itself explains succinctly why oil and gas companies need an ESG programme: without one, they will progressively struggle to access debt markets and attract equity, both public and private, and even some insurance products. They might even find themselves unable to operate effectively:

“More than anything, ESG is risk management… Building an authentic, dynamic and tailored ESG program is a critical business imperative. [It] can protect [companies’ social] license to operate, enhance market reputation, and position operators to access and compete for capital as well as credit.”

The problem for the shale industry is that access to finance has already dried up. This belated push to burnish questionable environmental credentials cannot reverse recent years of brutal Wall Street losses from bankrolling unconventional oil and gas extraction—which the pandemic-induced oil price crash is exacerbating.

The fracking industry’s litany of economic failings are well documented. A memorable moment in that tale came last year, when Concho Resources scaled back production targets after its Dominator project in the Permian basin in Texas failed to deliver. This inspired a cutting remark from Mizuho Securities USA analyst Paul Sankey:

“How companies still, after all these years we have wailed and gnashed our teeth, manage to over-promise and under-deliver, remains an infuriating mystery… Do we really need to repeat, that a company, much least in the most hated sector of the market, with a premium valuation, must never, ever, over-promise and under-deliver?”

Nursing burnt fingers, Wall Street slammed its doors shut on the failing US fracking sector long before the pandemic, when Brent crude was hovering around USD 60 per barrel. Fast-forward 18 months or so and the industry is now making a pitch for investment from ESG-focussed funds, even as Brent struggles to cling onto USD 40 per barrel and the phrase ‘net zero’ competes with ‘Covid-19’ for column inches.

Photo by Karolina Grabowska from Pexels

The shareholder is always right

The ESG onslaught might convince some despondent shareholders that there is maybe one less reason to cut your shale losses. It also makes the struggling shale minnows that are looking for an exit more palatable to their bigger potential suitors, who must answer to increasingly clamorous institutional investors. All-stock merger deals invariably require shareholder approval.

All of the mergers agreed in October were all-stock transactions, with no cash element. This is telling, as it eschews the need to tap capital or debt markets that are, as discussed above, not enamoured with the bloated and underperforming shale sector. The primary rationale for all-stocks mergers is to achieve ‘synergies’ (i.e. save money) by cutting jobs, overheads and capital requirements. Wilkie Colyer, CEO of Contango Oil & Gas, offered a rare moment of candour when he described his company’s merger with rival Mid-Con Energy Partners thus:

“This transaction is simply the next step, and certainly not our last, in our stated goal of consolidating a sector that is in dire need of it.”

Frenzied consolidation combined with a sudden zeal for ESG matters are the hallmarks of an industry facing twin existential crises of economic and environmental viability. The nature of the threat was illustrated by the French government’s recent decision to stop energy company Engie from buying American liquefied natural gas (LNG) from US export hopeful NextDecade, citing the emissions intensity of the upstream shale gas that would feed the proposed Rio Grande LNG export plant in Texas.

Regular readers of Energy Flux will be aware of how the European Commission’s Methane Strategy could, if implemented forcefully, reverberate up the gas value chain and into the US upstream. The strategy has now been released, and promises to be tougher on oil and gas emissions than an earlier draft. But Paris is evidently not waiting for Brussels to legislate; while there is probably a lot of geopolitics behind Engie’s snub to US LNG, it gives a good indication of the direction of travel in energy-importing markets in the EU.

Some US LNG advocates argue that building infrastructure to capture, ship, liquefy and export associated gas produced at shale oil wells in the Permian or Eagle Ford basins would reduce instances of flaring. This is a very clever argument that amounts to holding the climate to ransom: ‘buy our LNG or we will keep flaring gas’. Others argue that the prevalence of increasingly ESG-aware operators in these basins means the problem will disappear over time. Maybe, but you can’t have it both ways.

Moreover, even if the emissions from producing and transporting US shale gas to Europe could be eliminated, the political wagons are circling against its usage. EU regulations are reportedly being drafted that would prevent financiers from branding investments in natural gas pipelines or power plants as ‘sustainable’. This would limit, although not preclude, capital from flowing into such projects and will probably mean a higher cost of capital from a more limited pool of investors, which would hurt the gas generator’s competitiveness against alternative power sources.

None of this is to say there is no role for LNG in Europe, from the US or anywhere else. But it does illustrate how the goalposts are moving more quickly than many companies are willing or able to adjust. Sooner than many realise, only the ‘cleanest’ hydrocarbon molecules will find a route to market—and even then will face intense competition from greener energy sources.

Photo by Element5 Digital from Pexels

Get out and vote

Texans go to the polls tomorrow in a high-stakes election that has garnered only limited media coverage: the choice of a new member of the Texas Railroad Commission. This body regulates the state’s sprawling oil and gas industry and has never once refused an application to flare gas, whatever the justification given by operators.

The Republican nominee—Texan oilman Jim Wright—has reportedly “been found in violation of state environmental and permitting rules more than 250 times by the very agency that he hopes to join”. He faces off against Democrat attorney Chrysta Castañeda, who is standing on an anti-gas flaring platform. The choice facing voters is stark, much like in that *other* election happening tomorrow.

A resounding Democrat victory in both polls could bring some overdue tough love to the US shale scene. The Trump administration shot the sector in the foot by rolling back methane regulations. Unilateral emissions deregulation is problematic for an industry whose customers are located in another jurisdiction that is leading the world on energy and climate policy.

Rather than optimistically hoping individual companies will voluntarily draw up robust ESG programmes that deliver real emissions savings, state regulators and federal legislators need to take the lead by setting tough standards that are aligned with the expectations of investors and customers.

The most effective regulatory measures would cost-effectively weed out the dirty operators first, and quickly raise the bar for all. Self-regulation rarely succeeds, and the growing ranks of ESG investors won’t be fooled by half-measures.

Seb Kennedy | Energy Flux | 2nd November 2020