Even though investors acknowledge environmental megatrends in the sector – including carbon risk, competition from renewables and geopolitical risk – ultimately, the biggest impact on valuation models are still the traditional profitability drivers.

We held a workshop at our 2014 annual meeting to find out which factors – ESG included – were actively analysed and integrated into valuations of energy companies and if these valuations were impacting investment decisions. However, participant recognition of megatrends for the sector seem to indicate that environmental factors will have a stronger influence on valuations in the near future.

The workshop revealed that while three of the five megatrends of the energy sector identified by the participants were ESG themes – including carbon risk, competition from renewables and geopolitical risk – carbon costs was the only ESG issue integrated into valuations by almost all the groups. Investors did not consider social and governance issues as key factors.

The biggest impact on the participants’ valuation models are the traditional profitability drivers including: production costs; product diversification (i.e. reducing the exposure to conventional O&G); oil price and the competitive position of a company’s business model compared to its peers.

However, participant recognition of megatrends for the sector seem to indicate that environmental factors will have a stronger influence on valuations in the near future. Along with carbon risk and competitiveness of renewables, the environmental megatrends energy efficiency, the rise of electric vehicles and water scarcity are debated amongst managers and analysts as future industry drivers. Although, these environmental factors are still often ignored in fundamental analysis.

Through the responses to questions on the hypothetical O&G company, we were able to ascertain that participants largely believed that the oil majors had not put in place sustainable business strategies. They believe oil majors are too exposed to conventional oil and there is not enough investment in renewables. The majority of the participants also believed that investment in unconventional oil and gas was not the right strategy.

Judging by the unwillingness to invest into our hypothetical company, it seem that investors are willing to carry through their ESG analysis into their investment decisions.

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    Do ESG megatrends influence investment decisions?

    March 2015