How ESG factors into energy funds

With the U.N. climate summit in New York this week, and climate change a leading issue in the federal election, you may be fielding more questions than usual about environmental, social and governance (ESG) investing.

Even energy funds are beginning to factor in ESG components, says CIBC Asset Management portfolio manager Brian See, who manages the CIBC Energy Fund.

Here’s what fund managers are watching.

Environment

The environmental component of an energy fund relates to greenhouse gas emissions and their impact on climate change. In the short-term, consumers still use oil, See says, so ESG analysis comes down to companies reducing their net carbon footprint. He credits oilsands companies with making recent improvements in this regard.

“If we look back 10 years ago, oilsands [companies] were at the bottom end of the quartile range, in that they were the worst polluters,” See says.

“But due to advancements in technologies—mainly solvent usage, autonomous haul trucks and better tailings management—they’ve actually been able to change the impact that they’ve had on the environment.”

He says oilsands companies have moved to the middle of the pack when it comes to carbon footprint, and will continue to improve as technology advances.

Looking out 15 to 25 years, decarbonization will be a bigger priority and consumers will rely less on fossil fuels, he says. Renewable energies like wind and solar will gain market share as costs come down.

Today, two-thirds of the energy mix is fossil fuels and one-third is renewables, he says, but those numbers will flip by 2050. On this criteria, See favours major oil firms such as Royal Dutch Shell, Total and BP, which are reducing their carbon footprint.

“These companies have made investments in natural gas fuels to decarbonize a lot of the oil investments that are ongoing in the world,” he says. “They’ve also made [initial] investments in electric vehicles and solar […] to take part in the long-term trends as we move to a more renewable energy generation mix.”

Social

The social component of ESG in energy funds is primarily about human rights and community relations, See says. Many Canadians are familiar with the term “social licence” as applied to pipeline construction.

“We assess the companies building these pipelines to ensure that they’re building these assets in a safe, reliable and fair manner for all stakeholders,” See says. “This is a key component to our assessment of companies, because if projects are done correctly and on time, it’s beneficial for everyone involved.”

Governance

Governance covers board composition and executive compensation, particularly incentive pay.

“In the past, companies were incentivized to effectively grow production and reserve growth, and the industry as a whole had zero return on capital,” See says. “This was masked because commodity prices were increasing and returns weren’t the focus at that time.”

As commodity prices fell, companies have had to change their compensation packages. See says fund managers are influencing companies to align compensation to more reasonable standards. In particular, this means making incentive compensation tied to return on investment capital, free cash flow and other shareholder-friendly initiatives, rather than on top-line production growth or reserve growth.

“We think these are just more prudent and important metrics for shareholders, and we also think it will ultimately lead to better stock price performance in the long term for these companies and investors as a whole.”

This article is part of the AdvisorToGo program, powered by CIBC. It was written without input from the sponsor.