Energy under ESG and security spotlights

2 May 2022

With the war in Ukraine ongoing and the price of oil residing around $100 a barrel, the issue of energy security is growing increasingly prevalent, say investment experts.

Simon Gergel, manager of Merchants Trust, said: “Previously, the discussion in the energy sector centred around meeting net zero targets but this year people have started to realise that we need to think about energy security.

“Reducing carbon emissions must remain a priority but it’s also about ensuring we have a resilient supply of energy and that means a diversity of supply. Renewables, nuclear power and biomass should make up a significant portion of our energy supply, but clearly in the context of decreasing global energy security, so should fossil fuels and natural gas.

“The distribution network of our energy supply, the grid and the storage of gas, is also fundamentally important. We must consider that it’s the major energy companies of the oil and gas sector that provide the infrastructure and expertise to support this network.”

The amount of Russian oil flowing into other countries has fallen since the start of the Russia-Ukraine war following a raft of restrictions on Russian imports. Before sanctions were announced, more than half of Russia’s oil exports went to Europe and accounted for around 8% of total UK oil demand.

The tight supply-demand dynamics are expected to keep prices elevated, with energy stocks currently trading at attractive multiples.

Rob Crayford, joint portfolio manager of CQS Natural Resources Growth and Income, commented: “Oil and gas prices were elevated before the war as tightening fundamentals had driven prices higher. Despite what global politicians say, this was mainly due to poor energy policy globally, which has then been exacerbated by the fallout of Russia/Ukraine.

“The reality is that the weak position Europe has put itself in due to energy security was a likely contributor to Putin’s timing on Ukraine.”

Over the longer-term, however, the focus is expected to shift away from fossil fuels to renewable resources, highlighted by Germany stating it will stop buying Russian oil by the end of 2022. This will likely result in more investment from non-OPEC producers and greater political support in the West to combat production declines, say experts.

Martin Turner, manager of Miton UK MicroCap Trust, said: “Over the medium to longer term, we expect a permanent change in attitudes to sourcing energy of all kinds, including accelerated investment in renewables as a long-term solution and a pragmatic approach to domestic and international conventional energy resources.”

ESG is also becoming a growing consideration for the energy sector, as companies continue to transition to cleaner sources of energy.

Gergel says: “Consideration of ESG risks is fully integrated into our investment process. For oil and gas in particular, while many call for divestment, we think that those companies selling off problematic assets achieves nothing. The assets would simply fall into private hands, where there is less scrutiny over their impact. The big energy companies are crucial to the energy transition in our view, as you need big companies to support it.”

Rob Crayfourd, joint portfolio manager of CQS Natural Resources Growth and Income, added: “Environmental practices of our companies have been an increasing focus for a couple of decades, primarily due to being critical in them maintaining their licence to operate and achieve licences. This means by good environmental processes, they retain local support and also that of the government within the country they operate.

“They are often critical to social programmes, especially in emerging markets, where they often pay a sizeable component of a country’s tax revenues, supporting basic domestic services such as health care and education.

“I would add, whilst being vilified as fossil fuel, gas has been the largest contributor to reducing carbon emissions, with coal-to-gas switching since 2010 having saved 500 million tons of CO2 emissions.”

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