Our oil & gas sector principles: targets and actions

Responsible management of oil & gas assets and infrastructure is crucial to a Paris-aligned transition. In the first part of this blog, we outlined our expectations of companies regarding disclosure, strategy and diversification. In this blog we’ll cover our principles for how oil & gas companies can set appropriate production targets during the energy transition, why divestment isn’t a panacea, and the complexities of Scope 3 emissions.

Alongside sharp reduction targets for operational emissions,¹ some short-cycle development of oil & gas fields may still be required² to account for the imbalances in energy supply.

We expect companies to set robust operational emissions targets with time-bound milestones, and to demonstrate alignment of their actions with net zero through disclosure of the location, lifespan, carbon intensity and costs of the assets in question. Additionally, we would like to see disclosure of potential flexibility in alternating production against a range of relevant scenarios.While the sale of carbon-intensive assets might improve a company’s own emissions trajectory, we believe responsible divestment standards are vital to ensuring responsible subsequent management of those assets. Otherwise, the real-world impact on emissions could be neutral or potentially worse.³

Scope 3 emissions: where ambition meets reality

Around 90% of the greenhouse gas emissions associated with oil & gas companies are classified as ‘Scope 3 downstream’, categorised as use of sold products (e.g. transportation fuels or gas for electricity generation). It is therefore imperative for oil and gas companies to include Scope 3 emissions in disclosures and targets. Nevertheless, we acknowledge that Scope 3 calculations rely heavily on judgement and estimation, with an accepted standard methodology still lacking, making comparisons difficult.⁴

‘Scope 3 downstream’ also introduces the concept of responsibility for emissions from burning oil and gas – a responsibility that can be contested. In the absence of low-carbon alternatives (namely, biofuels or hydrogen) for consumers and the necessary policy support for implementation, imposing overly ambitious short-term Scope 3 targets can equate to substantial changes in business models and a winding down of current operations, risking an imbalance between supply and demand. Imposing such inflexibility on companies subject to the non-linear demands of the energy transition could create unintended consequences and, as noted above, divestment to unreliable operators could in fact worsen global emissions.

Our stance is that oil and gas companies do have responsibilities here, to work with key customers across the value chain on initiatives that would lead to reductions in their respective emissions, and by not encouraging fossil fuel use beyond levels consistent with a ‘net zero by 2050’ scenario. Attention should be focused on the business models of heavy users of fossil fuels.⁵

A net zero energy transition will require substantial cuts to unabated emissions from fossil fuel use. However, fossil fuels are still required today, as energy demand continues to increase. Finding the right balance between the key components of the energy transition equation in a rapidly changing landscape is crucial for the economic viability of businesses in a carbon-constrained economy, in addition to playing an integral role in the global race to net zero.

Action: across the board

As responsible investors, we believe we have a vital role in ensuring companies have appropriate leadership and strategies to drive and navigate the energy transition; engagement with policymakers is also crucial to clearing structural and institutional blockages to the energy transition. Through engagement with these different stakeholders, all of whom must play their part in the energy transition, we believe our investment stewardship approach of engagement with consequences remains dynamic, and focused firmly on reducing ‘real world’ emissions.

Key risks

Source: LGIM views as at 16 May 2024. Assumptions, opinions and estimates are provided for illustrative purposes only. There is no guarantee that any forecasts made will come to pass. It should be noted that diversification is no guarantee against a loss in a declining market.

Sources

1. Scope 1 and 2, including methane, which can be the driving force of emissions at some locations if not identified and managed properly.

2. Source: https://iea.blob.core.windows.net/assets/41800202-d427-44fa-8544-12e3d6e023b4/TheOilandGasIndustryinNetZeroTransitions.pdf

3. Source: https://business.edf.org/wp-content/blogs.dir/90/files/Transferred-Emissions-How-Oil-Gas-MA-Hamper-Energy-Transition.pdf 

4. See LGIM Blog post (with associated paper) Scope 3: Omission impossible by Nick Stansbury, Toby MacKean and Charlie Miller, 2023.

5. See LGIM Blog post Why we’ve increased our focus on demand-side engagement by Lewis Ashworth, 2023.