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Mexico’s state oil company Pemex (headquarters pictured above) ranks low on an environmental, social and governance (ESG) metrics. (Photo: Mexican Government).
Wednesday, March 9, 2022

Latin America’s Oil Companies & ESG Targets

Pemex is not well positioned to meet any ESG commitments, experts say.

Inter-American Dialogue

Mexican state oil company Pemex exceeded its greenhouse gas emissions in 2020, and the company was ranked 253 out of 261 in an environmental, social and governance (ESG) ranking of oil and gas companies by Sustainalytics. Meanwhile, Colombian state oil company Ecopetrol has been seeking to sell carbon-neutral oil that is offset by carbon credits from Colombian renewable-energy projects. How well are state-oil companies in Latin America and the Caribbean advancing toward ESG targets? What are the differences in challenges relating to ESG that face state-controlled energy firms as opposed to private companies? What specific steps should state-owned energy producers in the region take to strengthen their ESG practices, and what are the financial implications for them if they fall short?

Jose Vicente Zapata, partner at Holland & Knight LLP: The differences between state-oil companies’ ESG strategies and progress have grown significantly over the past few years, particularly given the diverse approaches of governments in the region. In some instances, representations on ESG simply seek to mitigate negative effects on investments while effective implementation is quite limited. In other cases, advances are more robust in documenting needed changes and proposing sustainable programs, but again, implementation is lacking. In more exceptional scenarios, efforts have extended to assessing operations in oil and gas exploration and production. For example, companies such as Ecopetrol in Colombia undertook a ‘materiality analysis’ to assess which of its oil and gas practices are critical and how each affects its performance in terms of value generation and reputational risk.

The reviews differentiated between legal obligations and voluntary commitments and resulted in a comprehensive and effective ESG plan. Generally speaking, efforts that address climate change, the management of water resources and territorial development stand out. Unfortunately, politics are more likely to influence the ESG practices of state-controlled energy firms, resulting in more of a focus on ‘labeling’ rather than effective ESG implementation. At a time when oil prices are again at a high, stateowned energy producers in the region need to move beyond documenting ESG and apply sustainability principles both to financing requirements and operations with measures to ensure accountability. Effective implementation requires immediate investments that, if not undertaken, will continue to trigger a lower market value and increase negative pressures, despite the region’s growing energy needs.

Karla Schiaffino, Americas senior analyst of risk insight at Verisk Maplecroft: As Pemex and Ecopetrol have illustrated, the ESG performance of state-run oil firms differs across the region due to conflicting incentives. Over the last five years, greenhouse gas emissions of two of the largest operators, Pemex and Petrobras, have decreased, in line with the general trend among private counterparts to decarbonize operations. But state oil companies face added pressure from governments, which do not always help them achieve these targets. Pemex stands out for struggling to convince bondholders of its commitment to ESG.

Since the beginning of the Andrés Manuel López Obrador administration, the president has made clear his intentions of expanding Pemex’s role across the oil and gas sector. AMLO’s plans for the oil firm include ramping up refining, which will weigh on Pemex’s ESG metrics by increasing its carbon footprint.

Pemex exemplifies how the misalignment of ESG targets between the company—especially those without private participation—and a government can undermine ESG performance. Moving forward, state oil firms will need to play an active role in the region’s energy transition. For Pemex, for instance, this may begin with setting a clear strategy to meet ESG metrics and comply with the same environmental, social and corporate governance standards as its private partners.

Failure to do so can not only jeopardize Pemex’s standing in the markets, but also expose Mexico’s finances—which have been historically linked to Pemex’s performance.

For companies such as Ecopetrol, which has private participation, weak ESG performance will reduce its attractiveness for investors.

Nicolás Mariscal, chairman of the board of directors at Marhnos Group, and vice president of the Mexican Chamber of Construction Industry: Pemex could do much more to meet ESG standards. Three points are of concern in this regard. On the environmental side, there is a substantial increase in bunker oil production to generate electricity; the Mexican type is the worst, as it contains 3.5 percent or more sulfur, way above what international standards deem to be safe. On the social side, bunker oil production is tremendously dangerous to human health. Every year, 25,000 Mexicans die prematurely due to its use. And on the governance side, the company’s five independent counselors—a figure established as recently as 2005 to improve corporate governance—were all elected during the current administration and tend to have no experience on energy issues (three resigned in 2019).

As environmental, social and governance issues are of the utmost importance, it is good news that ESG metrics contribute to accelerating growth and impact. And even though such standards don’t have the force of law, they do create public pressure and allow investors to have more information and make better decisions. And this is one more reason why a percentage of state-controlled energy firms should be publicly traded: so that they not only submit to transparency and accountability standards, but also to ESG scrutiny from investors and the public.

David Shields, oil-industry analyst at Energía a Debate: Mexico’s state-run energy firms have shown no interest in working toward achievement of the nation’s emission-reduction goals, established under the Paris climate accords, which aim to produce 35 percent of energy from clean sources by 2024. On the contrary, greenhouse-gas emissions Pemex and the Federal Electricity Commission (CFE) have been increasing.

Indeed, the two companies’ projects complement each other to increase such emissions. Pemex refineries produce ever more heavy residual oil, which the CFE burns to generate electricity. If the CFE did not take this fuel from Pemex, there would be almost no alternative market for it. The López Obrador government has strengthened its political control over the economy by means of strengthening the state-run firms instead of pursuing environmental goals. There is even ongoing discussion of a power-sector reform bill that would, in practice, promote greater use of fossil fuels. In this context, it is hard for private-sector firms to comply with their own ESG commitments, including renewable energy generation, which is actively discouraged by current public policy. Both private and public-sector firms in Mexico could well face tariffs and litigation under free-trade agreements in coming months. The country’s policy failures in energy and environmental practices are likely to reverberate throughout the Mexican economy, making ESG compliance an almost impossible task for global investors. As a result, many companies may well see no alternative to disinvesting and leaving the country.

Carlos de Maria y Campos S., partner at Galicia Abogados in Mexico City: Mexico was previously preparing to integrate ESG considerations into its energy projects and related financing. But President Andrés Manuel López Obrador’s administration wants to take the country in the opposite direction and has been either slow or inexplicably reluctant to take the necessary steps to move toward these requirements.

Now, Pemex is not well positioned to meet any ESG commitments or even formulate a clear path toward integrating ESG standards. Tasked with being Mexico’s cash cow and burdened by massive debt, there is little room for Pemex to invest in sustainable development policies or to make the necessary investments to bring the company up to 21st century standards. Considering the administration’s position on the environment, renewables, transparency, accountability, sound governance, public participation or any other elements that make up the ESG framework, we shouldn’t expect an ESG approach to be applied to any aspect of Pemex. When compared with Colombian state oil producer Ecopetrol’s plans to offset oil sales with carbon credits, Pemex appears to be behind the curve. The Mexican government seems entrenched in an outdated business model that was pervasive during the 1980s oil boom: betting on fossil fuel with little to no regard for environmental impact, or community or Indigenous consultations. It is evident that this model is not sustainable in the long run and will hinder Pemex from international funding or access to credit—or only getting credit at high premiums. It may also expose Pemex products to emissions taxes in many jurisdictions, making it difficult for the state oil firm to compete globally.


Republished with permission from the Inter-American Dialogue's weekly Energy Advisor


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