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July 25, 2002
Oil and Gas Company Environmental Risk Should Concern Investors
    by William Baue

Innovest and the World Resources Institute released reports this week that illustrate how environmental risk can affect the shareowner value of oil and gas companies.

This week investors learned more about the potential effects of environmental risk on shareowner value at oil and gas companies, as two separate reports confirmed and complemented each others' conclusions. Yesterday, the World Resources Institute (WRI), a Washington, DC-based environmental think tank, released a report that projects how oil and gas company management of climate change and access to petroleum reserves could affect shareowner value. The day before, New York City-based Innovest Strategic Value Advisors, a firm that researches corporate intangible value, released an oil and gas industry report that correlates above-average environmental and social performance with superior financial performance.

"Investors ignore environmental issues at their own peril," said WRI Economist Duncan Austin, who co-authored the WRI study. "A company's environmental performance is relevant not just for shareholders wishing to invest responsibly, but for any shareholder interested in the return on their investment. Environmental issues can have a significant impact on a company's bottom line and stock price."

The overlap of the two reports facilitates comparison. Ten companies, including Royal Dutch/Shell (ticker: RD), BP (BP), ExxonMobil (XOM), TotalFinaElf (TFE), ChevronTexaco (CVX), and Occidental Petroleum (OXY), are covered in both reports.

The WRI report, entitled Changing Oil: Emerging Environmental Risks and Shareholder Value in the Oil and Gas Industry, focuses on climate change and access to petroleum reserves in environmentally sensitive areas. For each of these two issues, the report proposes several different scenarios and extrapolates the potential effects on shareowner value at 16 oil and gas companies.

For example, the United States has not determined whether it will sign the Kyoto Protocol, an international agreement to reduce greenhouse gas (GHG) emissions. The report considers the implications of different possibilities, from full U.S. participation to U.S. noninvolvement as well as the most likely scenario whereby the U.S. does not participate but enacts voluntary measure that reduce GHG measures more modestly. The report uses a shareowner valuation methodology that won the 2000 Moskowitz Prize for outstanding quantitative performance in the socially responsible investment (SRI) field.

The Innovest report, entitled The Integrated Oil & Gas Industry: Uncovering Hidden Value Potential for Strategic Investors, also addresses the issues climate change and access to reserves in sensitive sites at 17 companies. However, the Innovest report also covers a much broader range of issues, applying its EcoValue'21 rating methodology to 60 different aspects of business opportunity and management strategy.

The two reports diverge in their time orientation: the WRI report projects future stock performance, while the Innovest report assesses performance over the past five years. Taken together, the reports offer a comprehensive analysis of shareowner value at oil and gas companies that encompasses both directions on the time line.

The WRI report concludes that Occidental, Repsol (REP), and Unocal (UCL) stand to lose six percent of shareowner value over the coming decade due to their positions on climate change and access to petroleum reserves in sensitive sites. Burlington Resources (BR), Valero (VLO), and Sunoco (SUN) stand to experience little or no change in shareowner value over these environmental risks because they are less exposed to them, according to the WRI report.

Innovest's EcoValue'21 assigns a numerical score to each company based on its environmental and social rating. Innovest then determines the industry's average score, and divides its list of companies into those receiving above-average scores and those receiving below-average scores. Over the five-year period from June 1997 to June 2002, the above-average companies, including BP, Royal Dutch/Shell, and Suncor (SU), outperformed the below-average companies, including ChevronTexaco, Conoco, and Occidental, by approximately 17.3 percent. The above-average companies also outperformed the below-average companies in many other aspects, including operating profit per share (44 percent), price to book ratio (a five year average of 33 percent) and price to cash flow (a five year average of 49 percent).

In addition to this quantitative analysis, Innovest seeks to identify a causal link between sustainability and market performance.

"[W]e have intensified the search for 'the smoking gun', i.e., the areas where sustainability-related activities demonstrably and directly influence earnings and returns," the report states. "[T]he overall gestalt of a firm's sustainability profile is eminently suitable as an indicator of management quality and overall propensity to outperform competitors," the report concludes.


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