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Brian See, portfolio manager, CIBC Asset Management.

So what is ESG in an energy context, or more specifically, how do we implement ESG in an energy fund? Well, first of all, ESG stands for environment, social and governance. And when we think about those factors, there’s a few key items that pertain to those three categories.

The environment aspect mainly is focused on climate change and net carbon footprint as well as greenhouse gas emissions and overall climate change from the extraction of fossil fuels. The S part of it, or the social licence, mainly deals with health and safety on projects and, probably more importantly, human rights and community relations for oil projects. And then finally, G, for governance. We tend to focus more on executive compensation, incentive comp as well as a board composition and gender diversity.

So when we think about the environment component in ESG investing as it relates to an energy fund, what we’re really talking about here is the net carbon impact, greenhouse gas emissions and overall climate change. When we think about the environment, we can further decompose it into the short term and the long term. And so what I mean by the short term is that consumers today still consume oil. Oil continues to grow and consumers still need it in today’s world.

So the focus then in the short term is more on companies that are performing well on a relative basis within their sectors and making the biggest year over year changes in terms of their net carbon footprint. A specific example of that is the Canadian oilsands. While these projects do emit carbon, a lot of the companies are actually taking extensive measures to reduce those carbon footprints and limit their greenhouse gas emissions. If we look back 10 years ago, oilsands was at the bottom end of the quartile range in that they were the worst polluters. 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. Now they’ve actually moved their carbon footprint to more of middle of the pack and continuing to improve as technology continues to advance.

So these are some of the initiatives that we are looking at in the short term as we assess oil companies in an energy fund under ESG lens. As we move into the long-term perspective, we are going to be transitioning to a decarbonization of the world and that reliance on fossil fuels will be less and less as we get out to 15, 20 and 25 years down the road. And so what that means is renewable energies such as wind and solar will continue to take market share and supply a lot of the power generation in the world today. And this is because these forms of renewable energy I’ve seen their cost curves fall to a level where they’re actually competitive with fossil fuel generation and will continue to be a big part of the energy mix as countries, governments and companies all push toward renewable energy.

An interesting way to look at the long-term mix is, while today two-thirds of the energy mix is fossil fuels today and one-third is renewables, as we get out in the long term by 2050, those numbers actually flip in reverse—where it’s two-thirds renewables and one-third fossil fuels. So this is more of the longer-term trends that we see when it comes to the environment in an ESG lens.

So the companies we favour that are actively trying to reduce their carbon footprint are actually a lot of the large super majors such as Royal Dutch Shell, Total and BP. These companies have made investments in natural gas fuels to decarbonize a lot of the oil investments that are ongoing in the world. They’ve also made investments in electric vehicles and solar as an initial investment to take part in the long-term trends as we move to a more renewable energy generation mix.

The social aspect or social license of ESG investing in energy fund has to do with mainly health and safety, specifically operations for a company. But probably more importantly is the human rights and community relations. Now it’s an important aspect because fossil fuel extraction does impact the community and the people living in those areas. So, for example, such as building a pipeline, it’s important that 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. 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—not just for the company, but for all the stakeholders involved in the project.

The G stands for governance and how this pertains to ESG in an energy fund is we focus specifically on board composition, executive comp, or incentive comp. And as it relates to energy companies, one of the things we’ve honed in on is management comp or incentive pay.

In the past, companies were incentivized to effectively grow production and reserve growth and the industry collectively as a whole had zero return on capital. Now this was masked because commodity prices were increasing and returns weren’t the focus at that time. But as the world shifted and commodity prices fell, companies had to do significant changes to their cost structures and compensation packages.

One of the things that investors such as ourselves have influenced companies is to align compensation to more reasonable standards and more specifically push incentive compensation, not tied to top line production growth or reserve growth, but more tied to return on invested capital and a focus more on shareholder-friendly initiatives such as free cash flow, generation debt reduction and share buybacks. 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.

Funds:
CIBC Energy Fund
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