Oil field oil workers at work
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Companies have flexed their ESG credentials plenty over the past few years, especially as the market rewarded them with premium valuations for energy transition assets. Now that investor interest in sustainability has settled down, however, firms are less interested in keeping these assets integrated.

TC Energy in July announced plans to split into a pair of public companies, with the primary aim of appealing to two investor bases. The merits of cleaving off different parts of a business in order to increase shareholder value was covered in a previous article. In short, investors may prefer growth- or income-oriented companies; or, depending on the state of the market, they may choose specialized or more diversified entities. More recently, however, some splits have addressed ESG attributes.

TC Energy intends to spin off its oil pipelines to existing shareholders sometime in the second half of 2024. The remaining business will focus on lower-carbon natural gas pipelines and energy solutions (including nuclear and hydrogen). While TC Energy’s official script remains focused on the financial benefits of the transaction, it’s implied by the company and well understood by the market that the intent is to appear more ESG friendly.

TC Energy settled on walking a fine line between extoling its ESG attributes while not alienating investors less focused on environmental issues. Others, like Teck Resources, lean the opposite direction.

After selling its oilsands assets, Teck Resources is fixed on hiving off its coal segment to focus on energy transition metals such as copper and zinc. The company’s strategy to improve its exposure to environmental concerns has been clear — even doubling down by criticizing unwelcome suitor Glencore PLC’s history on ESG issues.

Working in the opposite direction is Algonquin Power & Utilities. Following a strategic review and dividend cut early this year, the company announced in August that it’s seeking buyers for its renewable energy assets as it instead focuses on its regulated utilities. The renewable assets are more attractive from an ESG standpoint, and the implication is that a private buyer will be better positioned to grow the business while free of the public-markets oversight that can influence ESG investments.

So we have three companies using three strategies when it comes to dealing with ESG-focused businesses: keep, sell and quietly split. This lack of consensus is tied to the recent decline in value for energy transition assets. The return on equity from regulated utilities is roughly 200 basis points higher than on unregulated renewable assets, but the push for ESG meant that the lower-earning assets received premium valuations — until recently. The iShares Global Clean Energy ETF is down by over 27% in the past 12 months (as of Aug. 31) due to a combination of waning investor interest and questions over profitability across the sector, especially as costs for renewable megaprojects rise.

No longer can companies ride the wave of ESG sentiment by simply owning partial exposure to energy transition assets. It’s become difficult for public companies to escape the short-term focus forced on them by the market, even when it comes to longer-term issues like ESG strategy. Teck was pushed into action by unsolicited takeover bids, and Algonquin faced pressure from multiple activist investors.

For advisors, however, there’s no need to chase short-term market reactions. Taking a step back, this looks like a typical market pause after the initial exuberance regarding future energy transition needs. The next leg up is coming, and staying the course on energy transition investments will pay off as macro pressures subside, cost issues resolve and demand becomes clear again.

Mark Rosen, CFA, MBA, CFE, heads ARC Research, providing independent equity research to investment advisors across Canada.