Friday, 2 August 2013

Canadian Oil & Gas Stocks - Does better Corporate Sustainability & ESG mean better performance?

There's no doubt about it, oil and gas companies attract more than their share of attention, much if not most of it critical. Whether it's disastrous spills, carbon emissions, native land rights, water quality, air quality, ecological effects on flora and fauna, land reclamation, extractive technologies like fracing, the companies are in the thick of serious highly-visible issues. Yet their many products are essential to our way of life and the stocks of the companies form a substantial part of any broad equity mutual fund or ETF and of every Canadian's pension whether it is private plans or the Canada Pension Plan's Investment Board. The investor faces the question not of whether to participate but on what basis.

Going beyond broad funds that pay no attention to Environmental, Social and Governance (ESG) factors, the investor with a goal to do Socially Responsible Investing (SRI) in Canada will find some mutual funds (see 2012 list from NEI Investments) and one ETF - iShares Jantzi Social Index® Fund (TSX symbol XEN) - that do select only companies following a "higher standard of environmental and social performance", as XEN's profile puts it. However, such funds may be constrained to a certain size and exclude worthy companies in a sector. An investor thinking of buying individual stocks may also want to know more about the details which explain inclusion or exclusion since the fund companies publish nothing of their actual assessments for competitive or proprietary reasons. Finally, the paper The Impact of Corporate Sustainability on Organizational Processes and Performance by Harvard Business School researchers, cited in our recent review of corporate sustainability of Canadian consumer stocks, found that accounting and stock performance by resource extraction companies was also particularly influenced by ESG factors.

We therefore decided to examine ESG at the 15 largest (by market cap) oil & gas producers with significant operations in Canada.

The ESG corporate sustainability factors
As with the consumer stocks, we included three key factors that the Harvard paper found to influence performance:
1) Board of Directors committee with a sustainability mandate
2) Executive compensation tied to ESG performance
3) Formal stakeholder engagement processes
Our research method for these items was the same too - reading the annual Management Proxy Circular from Sedar or on the company website and looking for the company's Corporate Sustainability report, either on its website or from the Global Reporting Initiative database, which has been spearheading standardized comprehensive reporting on a worldwide basis for ESG.

We also gathered other evidence that a company has been taking sustainability seriously:
4) Published, annual, up to date corporate sustainability reports, preferably audited and submitted to GRI
5) Recognition by ESG assessment organizations such as Corporate Knights Global 100 for 2013,or the Dow Jones Social Index (whose holdings are not publicly disclosed by the index provider, so the information comes from companies themselves touting their selection)
6) Membership in voluntary environmental reporting organizations like CDP and Extractive Industries Transparency Initiative (EITI)
7) Constituent of XEN and thus approved by the Jantzi methodology
8) High rating in the Board Shareholder Confidence Index published by the Clarkson Centre for Business Ethics and Board Effectiveness - The governance dimension does not seem to be part of the Jantzi methodology for XEN and we discovered that a couple of XEN holdings - Penn West Petroleum and MEG Energy Corp - have poor scores. For the investor, good governance by a company is a prime matter of concern. It helps ensure that management, the Board and major shareholders treat all shareholders fairly and behave honestly.

Corporate performance factors
To see to what extent good or bad ESG has been associated with accounting and investor success for these companies, we gathered profitability ratios -
a) Return on Equity (ROE), from the Globe and Mail's WatchList, and
b) Return on Assets (ROA) from Morningstar Canada.

We also gathered from the WatchList a single metric that any investor would care about -
c) Total Return (i.e. capital gains plus dividends) for the last five years - for each stock and for several benchmarks, including the Canadian energy sector ETF iShares S&P / TSX Capped Energy Index Fund (XEG).

Our comparison table below reveals some interesting and surprising results. As is perhaps appropriate, green text in cells means good.

Most oil and gas companies are doing a pretty good job on ESG
Eleven of fifteen companies have multiple green entries. Only four companies don't seem to be paying much if any attention to ESG - Baytex (BTE), Tourmaline (TOU), Crescent Point (CPG) and MEG Energy (MEG). It is a puzzle to us how MEG could be justified as a holding for iShares' XEN. Other companies, like Husky and Canadian Natural Resources, look to be stronger candidates.

The oil and gas stars of ESG are Cenovus (CVE), Suncor (SU) and Encana (ECA), with green across the table. Talisman (TLM) and Imperial Oil (IMO) are not far behind.

But looking at the performance figures gives us a shock.

Performance seems unrelated to ESG!
The bottom of the performance table, whether sorted by ROE as it is, or by ROA or Total Return, is occupied by ESG-star Encana. Conversely, right near the top is ESG bad-boy Baytex. Maybe our time frame isn't long enough and good ESG practices will prove themselves eventually. Maybe even Encana will turn itself around. The latest quarterly results announced a small net profit.

Using the results
Depending on your viewpoint, you could either say that attempting to pick oil and gas stocks based on ESG ratings is a waste of time or, that picking successful companies that are also highly rated for ESG is quite feasible.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

Postscript: TD Economics' Special Report The Greening of the Canadian Economy reviews the environmental performance of the Canadian unconventional oil industry and finds it generally good.

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