On the 20^th July 2021, the Climate Council in partnership with Addleshaw Goddard hosted a roundtable discussion with sustainable energy industry leaders, titled: Through the ESG lens: Navigating the M&A market in the 20s. The virtual roundtable welcomed attendees from a broad range of expertise and we would like to thank our sponsor Addleshaw Goddard, together with; Masdar, Octopus Renewables, Gulf Energy Development Public Company, SIMEC Atlantis Energy Limited, Berkeley Energy, Capital One, Falck Renewables, BNP Paribas Asset Management, NatWest, European Energy A/S, Natixis, Rystad Energy, Shell and Blackrock for their participation.

Climate change and the energy transition are the global topic of our times – society must adapt and accelerate the sustainability objectives set about in the Paris Climate Agreement. Central to this conundrum is the need to shift away from the carbon-intensive processes that drive our economies. Yet while the pressure only increases to act, there remains an air of uncertainty over how businesses can exhibit sufficient commitment to sound environmental, social and governance practices – in order to mitigate the risks and provide due diligence to financiers and investors.

Our Partner's Opening Remarks

Our moderators for the roundtable, partners in Addleshaw Goddard’s Energy & Utilities and Infrastructure & Energy practices, set out the thesis for the conversation with some broad industry truths. In 2020, mutual funds and EFTs had invested roughly $300 billion in sustainable funds and assets, finding its way up boardroom agendas the world over. However, in order to align with the objectives in the Paris Climate Agreement, a total of $27 trillion will be needed by 2050. Pressure on finance and investment sectors have had a positive reaction in recent years, leading to owners overseeing $90 trillion in assets becoming signatories to the UNPRI goals.

How these issues relate to the gist of the thesis is through the emergence of Environmental, Social and Governance (ESG) disclosures and how they affect mergers and acquisitions in the energy sector. The former is ‘a collective label on which a company’s efforts can be measured and assessed, as one would another performance metric, which in turn performance measurements influence strategic decision making.’ Consumer behaviours and the increased regulation environment are driving much of the change, and while ‘social’ and ‘governance’ criteria are pressing, it is the environmental criterion that has taken centre stage.

 

What are the key ESG factors that are increasingly influencing M&A transactions?

The consensus was clear, for any M&A transaction considering ESG, the main criteria was the environmental impact and emissions exposure of the investment. Following that, the social element had to show there was no ‘abuse’ of the community and stakeholder engagement sought positive outcomes. The governance has always been important, but may be looked at more from a shareholder’s perspective than an investment decision.

For companies to become attractive options for purchase, asset owners must ensure that ESG plans are in-place and that they have processes to monitor and update their targets if needs be.

One attendee with strong ESG credentials asked his contemporaries what a deeper ESG demands and framework may look like, eliciting an interesting concern on the decommissioning of renewables projects. The view was that, while both solar and wind have fallen steeply in manufacturing and operating costs, was if the LCoE accurately considering steep decommissioning, recycling or repurposing costs. This notion was contrasted against the ‘legacy’ emissions of the oil majors and the potential for future generations to question if renewables manufacturing and processes were truly ‘green’.

The concern was deferred by another who described their strict due diligence processes, supply chain codes of conduct and contractual commitments that helped to mitigate these issues. They accepted that this was not pragmatic for most. And complicating transactions with too much due diligence can deter prospective buyers.

 

How to effectively identify ESG risk and thereafter supply chain risk? And how to address it?

On this subject, a start is to ensure that ‘the trajectory of a portfolio aligns with the 2⁰C current climate scenario and to progressively decrease from there. As one makes their portfolio ‘greener’, it is their duty to monitor how revenues can be used to continually improve standards.

Identifying the full spectrum of ESG mandates can be prohibitive to assessments, usually only considering the downside risk of an investment. However, ‘in many cases, there are a number of opportunities to gain from higher carbon taxes. Or gain from competitors having to explain high-emissions assets. An advantage, from a cost perspective, is real money.’

Other factors do come into play; timing, improving operations and the value chain, education of personnel – together developing a better position to manage risk over their peers.

The reality is that many risks may still be unseen and it is in the best interests of asset owners to be progressive about targets in anticipation of future regulatory change. COP26 in November is expected to introduce material announcements that may influence markets across the globe. One attendee saw cross-border carbon taxes as a significant possibility coming from the summit.

In finance, risk was described as having previously been assessed according to the Purchase Price Allocation, yet in many cases this was now ESG. But issuing debt via green bonds and sustainability-linked assets was making transactions more complex to complete. M&A actors have seen an increase in requests from investors seeking entire transactions portfolios that have diversified; liquid and illiquid assets, risk and return dimensions with solid ESG frameworks.

A fund manager enthused the importance of due diligence and for investment teams to exhibit how they will manage their ESG-related risk. Referring to the previous point on ESG opportunities, productivity and efficiency can only be improved through sound measurement processes.

When looking at companies, their ESG legacy is somewhat insufficient. More so it is their current trajectory for operations and how they’re transitioning to greener practices. One belief was that ESG was fundamentally changing how we consider climate change action, as it creates a competitive dynamic that has led to a reconsideration and restructuring of systems.

 

Question to the floor: Climate change is such a big issue, should it be taken out and considered as an issue on its own?

The belief is that some of the reporting legislation is certainly being pushed in that direction and has incited a reconsideration of the steep task ahead in regards to climate change. This did not need to remove the “E” from ESG, as environmental concerns do exist removed from the climate conundrum. Therefore, it is imperative that “E-side” ecological concerns, not linked to climate transition adaptations, are not overlooked.

The environmental aspect is the most difficult aspect to achieve, as there is the hard and fast objective to reach net-zero emissions (or as close as possible). For one participant, ‘fundamentally, climate change deserves its own place, but the other factors are needed to support the climate change aspect.’ As such, ESG provides the right foundations for accelerating climate action.

Asset owners need to show competency across the board. The governance aspect has not been discussed as deeply, but if a company’s governance is not sound then the ‘E&S’ will not be believed either. And while ‘E&G’ have measurable targets to achieve, the ‘social’ side is more qualitative than quantitative – making it more difficult to assess.

All points considered, climate change is already mainstream (buyers or sellers will be making climate risk a central focus of new business strategies) and ESG should be too. ESG should be imbedded in all processes not as an add on but as normal/mainstream/key focus/in normal processes. There can be no other way.