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Proposal for Environmental, Social, and Governance (ESG) Assessments

Several majors could make a play for Permian producer Endeavor Energy

IEA warns of oil supply lagging demand without significant investment

Permian producers prepared for dip in oil prices to last into 2019

Stocks Rocked the House Post Midterm Elections


Proposal for Environmental, Social, and Governance (ESG) Assessments

A potential new ESG evaluation framework and scoring methodology is being developed for corporate issuers (referred to herein as the "ESG assessment tool" or the "tool"), and S&P Global Ratings is seeking feedback. The methodology is to evaluate a company's impact on the natural and social environments it inhabits, the governance mechanisms it has in place to oversee those effects, and potential losses it may face as a result of its exposures to such environmental and social risks. These losses (or increased costs) could stem from a variety of sources including potential increased/changed regulations, litigation, manmade or natural catastrophe events, and resource scarcity/degradation, among others. We believe these potential impacts, in turn, could weaken a company's business risk and financial risk profiles over time, unless properly managed, including effective mitigation strategies. The ESG assessment tool is not a credit rating.

In May, S&P Global Ratings expressed support for initiatives being promulgated by the United Nations Principles for Responsible Investment (UN-PRI) that recognize the needs of investors for greater clarity on how ESG factors are considered in credit analysis. This reflects our commitment to transparency in the way in which we consider ESG factors when determining credit ratings, and support for industry efforts to encourage consistent public disclosure by issuers on ESG factors that may impact creditworthiness.

Our proposed ESG assessment tool is not part of our credit rating methodology. However, we do consider certain related factors, as set forth in "Management And Governance Credit Factors For Corporate Entities And Insurers" (M&G), published Nov. 13, 2012, which includes reference to the management of environmental and social risks and the oversight of these risks by a company's board of directors. The proposed ESG assessments would be offered separately from our credit ratings to provide greater transparency into ESG risk.

We propose ranking rated issuers on a five-point scale based on our view of the degree to which each issuer has greater or lesser exposure to ESG risk over the medium to long term. We define medium term as the next two to five years, and long term beyond five years. We expect to assign different weightings to the medium-term and long-term horizon, and propose greater weighting toward the medium term. This reflects our view that medium-term risk is more discernable, and that the impacts of these nearer-term risks are more assessable in terms of risk to creditworthiness.

We are considering basing our ESG assessments on four main pillars, or subfactors:

  • Subfactor A: Environmental Risk Profile (E)
  • Subfactor B: Social Risk Profile (S)
  • Subfactor C: Management and Governance (G)
  • Subfactor D: Environmental and Social Risk Management

The proposed framework would also consider incorporating a mitigation history modifier for subfactors A and B, so we could differentiate a company with a strong environmental and social mitigation history over a given time period (we are proposing the past 10 years, on a rolling forward basis) from one with weaker mitigation risk, as seen in the number of E and S related adverse events during that period. This historical view would be balanced and weighted against the forward-looking perspective of our fourth pillar, the environmental and social risk management assessment.

We are proposing to give the four subfactors different weightings based on our view of their importance relative to the other subfactors. We are endeavoring to make these subfactor weightings the same for all issuers, so that the results of the ESG assessment tool can be comparable across different industries and peer groups.

We look forward to receiving your responses to our questions, and any additional observations, and discussing our approach with investors, issuers, governments, multilaterals and intermediaries.

To access the survey feedback platform, please click on the following link or paste it into your browser: www.spratings.com/esg.



Several majors could make a play for Permian producer Endeavor Energy

Oil majors Exxon Mobil Corp., Chevron Corp., Royal Dutch Shell PLC and ConocoPhillips are all considering making first-round bids for Texas-based oil producer Endeavor Energy Resources LP.

Including debt, Endeavor, which holds more than 300,000 acres in the prolific Permian Basin, could be valued at $12 billion to $15 billion. Core acres are located in Martin, Midland, Upton, Glasscock, Reagan and Howard counties. The company's net production in the second quarter was 64,000 barrels of oil equivalent per day, 75% of which was oil.

Many of the majors have highlighted their renewed interest in the U.S. shale plays. Having announced plans earlier this year to triple its Permian oil production to 600,000 barrels per day by 2025, Exxon is viewed by many as the most logical would-be buyer of Endeavor. Back in 2014, Exxon inked a seven-year deal with the producer to expand its presence in the basin.

Exxon's third-quarter shale oil output from the Permian was up 57% on the year due to the ramp-up to the current 38 rigs in the Midland and Delaware basins. The company's third-quarter Permian production increased 170,000 boe/d, or 11%, on the quarter.

While Chevron could be a contender, the company already has a sizeable position in the Permian, analysts said. "Chevron is another possibility although we think its existing position of 1.7 [million] acres (0.5 million Midland and 1.2 million Delaware) is likely adequate, with the focus likely to be more on acreage swaps and trades to core up its position," RBC analyst Biraj Borkhataria wrote in a Nov. 13 note.

Analysts said ConocoPhillips and Shell are less likely to emerge as bidders.

"Despite the company's positive disposition to the play, we would not expect Shell to bid for such a large package given the company has been clear that inorganic activity is included within its $25 [billion] to $30 [billion] capex framework per annum, meaning limited headroom to execute such a large deal," Borkhataria said.

Should a sale occur, it would follow a rash of Permian-based transactions, including Concho Resources Inc.'s purchase of RSP Permian for $8 billion and Diamondback Energy Inc.'s purchase of Energen Corp. for $9.2 billion. Additionally, on Oct. 31, BP PLC closed on its $10.5 billion acquisition of BHP Billiton Group's U.S. shale oil and natural gas assets.

In emailed requests for additional details on a sale, officials from Endeavor, Exxon, Shell and ConocoPhillips declined to comment. An inquiry to Chevron was not immediately returned.

Endeavor, which is family owned, agreed to explore a sale after receiving inquiries from prospective bidders, although the family reportedly would prefer an IPO next year so it could retain control. JP Morgan Chase & Co. and Goldman Sachs Group Inc. were reportedly selected to arrange the possible transaction.



IEA warns of oil supply lagging demand without significant investment

The International Energy Agency warned in its World Energy Outlook 2018, released Nov. 13, that without sufficient oil production investment, the world faces a possible oil supply gap during the early 2020s.

"Oil and natural gas will be part of the energy system for decades to come — even under ambitious efforts to reduce greenhouse gas emissions in line with the Paris Agreement," the report said.

Under existing and planned policies included in the report's new policies scenario, trucking and aviation demand will drive global oil consumption to 102.4 million barrels per day by 2025. Meanwhile, the IEA projects currently producing oil fields will supply just 68.0 MMbbl/d.

"The level of conventional crude oil resources approved for development in recent years … is only half of the level needed to meet demand growth in the [new policies scenario]," the report said.

"If these approvals do not pick up sharply from today's levels, U.S. tight oil production would need to triple from today's level to over 15 [million barrels per day] by 2025 to satisfy demand," the report said. "With a sufficiently large resource base, this could be possible. But it would require levels of capital investment that would far surpass the previous peaks in 2014."

Among trends to 2040, the IEA outlined a "major shift in the geography of oil demand."

According to the report, developing economies will see oil demand grow by 18 MMbbl/d from 2017 to 2040, offsetting a demand decline of 10 MMbbl/d in developing economies.

The IEA projects global oil demand from trucking will grow by 3.9 MMbbl/d, while global oil demand from petrochemicals grows by 4.8 MMbbl/d.

At the same time, the IEA expects oil use in cars will peak in the mid-2020s. It projects approximately 300 million cars on the road by 2040 will avoid 3.3 MMbbl/d of oil demand that year, while efficiency improvements in nonelectric cars will avoid more than 9 MMbbl/d of oil demand in 2040.

The IEA projects automotive demand for oil will decline by 5 MMbbl/d from 2017 to 2040 in advanced economies, offsetting demand growth of 5.4 MMbbl/d in developing economies.



Permian producers prepared for dip in oil prices to last into 2019

Mindful of the lessons learned during the 2014-2016 oil and gas price collapse, large independent producers in the Permian Basin are shielded from the current U.S. oil price slide, thanks to conservative budgeting, new access to Brent crude pricing at the Houston Ship Channel and greater efficiency.

The price of West Texas Intermediate crude oil bounced back above $60 per barrel on the morning of Nov. 12, a slight improvement over the end of the previous week but still well below the $76.40/bbl reached in early October. If prices remain near $60/bbl, that will be more than enough for most producers to see healthy returns, as many have budgeted for prices at $50/bbl or below. Even though prices spiked more than $20/bbl above anticipated levels for several months, Permian producers largely made only slight increases to budgets as they looked to the long term.

"The industry has been conservative in oil price assumptions," Williams Capital Group LP analyst Gabriele Sorbara said. "I would say a majority of 2018/2019 budgets are contemplated on $50-$60/bbl WTI."

EOG Resources Inc., one of the largest producers in the region, assembled a capital budget for 2018 assuming oil prices at $40/bbl and gas prices at $2.50/Mcf, and the company intends to take a similar approach in 2019.

"We're not going to increase capital at the expense of efficiencies and returns. We will develop our assets and spend capital at a pace that will optimize our learning curve and allow sustainable improvement to our well productivity and cost structure," EOG CEO William Thomas said. "Any production growth is strictly the result of disciplined capital allocation to high-return assets. … We are continuously resetting the company to deliver strong returns, even in a low to moderate oil price environment."

When capital budgets for 2018 were assembled, most Permian producers assumed that WTI would hover around the $50/bbl level for much of the year. Even though they recognized far more revenue during the second and third quarters than initially anticipated, they seem content to stay the course at similar levels for 2019.

"What matters for companies is the long-term expectation," said Raymond James & Associates analyst Pavel Molchanov, who anticipates that most companies will continue to build budgets based on prices near $50/bbl. "The futures pricing for 2019 is pretty close to what it was a year ago."

Unlike the situation facing Permian producers during much of the price collapse, many independents have a new advantage, in spite of pipeline constraints: exports to Europe and Asia through the Houston Ship Channel. The exposure to offshore markets and Brent crude prices has allowed them to increase their revenues, as Brent crude was trading at more than $71/bbl on Nov. 12.

Pioneer Natural Resources Co. CEO Timothy Dove said during the third-quarter earnings call that his company would stick to its $3.4 billion budget for 2018 and is likely to take a similar course in 2019. But Dove said Pioneer is now able to avoid the consequences of a WTI price drop due to large amounts of its Permian crude being exported.

"We are now essentially a Brent-priced company if you talk about our oil sales," he said.

Another lesson learned from the price collapse was a continued push for efficiency, with producers using new technologies and methods to cut costs while increasing production. During Anadarko Petroleum Corp.'s third-quarter earnings call, executives said the company's more efficient operations would allow it to recognize "double-digit" production growth while maintaining a budget anticipating $50/bbl prices.

Apache Corp., which is increasing its Permian operations with the development of the Alpine High play, said it would operate in 2019 with a capital budget of $3 billion, lower than in 2018. "If changes in expected cash flow dictate, we have the flexibility to reduce our activity levels accordingly," CEO John Christmann said. The move by Apache and other producers to follow long-term price expectations and not become overly exuberant over higher prices earlier this year may have allowed companies to hold steady heading into 2019.

"Capital spending should be either stable from what it is this year or modestly higher, but no one should expect cuts in capital spending from recent levels because this year's capital programs always lagged behind the uplift we saw in prices we saw in the summer months," Molchanov said.



Stocks Rocked the House Post Midterm Elections

After the S&P 500 logged its 9th worst Oct. on record, losing 6.9%, it has bounced back 2.6% month-to-date through Nov. 9, 2018. Though the monthly returns for the eight Novembers following the historically bad Octobers were only positive twice – in 1978 (President Jimmy Carter midterm year) and 1933 – the fact there was a midterm election this year may help the chance of a solid rally if history repeats itself. Historically, the S&P 500 has been positive in most periods after the midterm elections.

In the months of Nov. and Dec. during historical midterm election years, the S&P 500 gained 14 of 22 times in Nov. and in 15 of 22 times in Dec. with a combined 2-month gain in 17 of the 22 midterm election year-ends. In percentage terms, the S&P 500 gained in 64% of midterm election Nov. months and 68% of the following month that when combined into a 2-month return resulted in gains 77% of the time. Also, the magnitude of the average gains in the 2-month period was 6.1%, more than the magnitude of the average loss of 4.1%.