Oil and Gas Are Here for the Long Run. So Are Related ESG Risks.

Historically, energy and economic development have been tightly linked. But the cheap and abundant fossil fuels that significantly improved living standards have come at a cost to the environment. Thus, growing opposition from multiple stakeholders is likely to continue.

Despite that resistance, oil- and gas-based fuels will remain an important part of our long-term energy mix for decades. That makes investing in oil and gas tricky, especially for investors who want exposure to critical parts of the economy. For such investors, being fully aware of the risks, and paying close attention to valuation, is crucial. Among such names, Equitrans Midstream ETRN and Energy Transfer LP ET are worth a look.

Why will demand for oil and gas remain strong? While renewable energy technologies offer great potential for decarbonization, such as electric vehicles, not all oil demand can be easily electrified. Sectors like shipping, aviation, and petrochemicals are harder to decarbonize. Any alternative non- or low-carbon fuel and feedstock alternative is unlikely to reach cost parity with fossil fuels anytime soon. Consequently, while we forecast a peak in global oil demand in 2030, we expect it to remain robust through 2050, down by just 11% relative to 2019.

Oil and gas companies face an array of environmental, social, and governance risks from stakeholders. These include the public, which is increasingly concerned with the environmental impact of fossil fuels; policymakers that have decarbonization goals for their economies; and shareholders that are increasingly aware of carbon-emissions-related ESG risk and impact. We list some of these risks below.

Oil and Gas ESG Risks Extend Beyond Carbon Emissions

The risk posed by carbon emissions, particularly scope 3, is the central focus of the ESG discussion. But other ESG risks also warrant attention.

1) Non-greenhouse gas emissions, or pollutants. Many of the oil and gas industry’s processes emit significant volumes of non-greenhouse gases such as nitrogen oxides, sulfur oxides, and particulate matter. Given the associated public health concerns, the oil and gas value chain is particularly susceptible to a future tightening of air quality standards. In particular, the storage and transportation, drilling, refining and marketing, and petrochemicals segments of the oil and gas value chain are most exposed to the potential tightening of air quality standards.

2) Community relations. “Not-in-my-backyard,” or NIMBY, considerations are a key risk for new oil and gas projects given the risk that exploration, transportation, and other downstream activities potentially pose to ecosystems, human health, and/or to Indigenous communities. The potential for escalating costs from delays or cancellations places return profiles of new oil and gas projects at risk.

3) Occupational health and safety. This exposes oil and gas companies, particularly upstream, to potential increased costs and reputational damage. For example, the U.S. oil and gas extraction workforce faces an annual fatality rate 3.5 times greater on average than the broader U.S. workforce.

Two Cheap Oil and Gas Stocks

Despite the various ESG challenges, oil and gas stocks have a multidecade runway and stand ready to generate healthy long-term free cash flow. We see pockets of value within the oil and gas sector, particularly in the midstream space. Two stocks stand out:

Equitrans Midstream, which has a Morningstar Economic Moat Rating of narrow, offers an attractive valuation despite its ongoing legal and permitting overhang regarding the Mountain Valley Pipeline project. We think investors are unfairly discounting the stock to well below what it would be worth if the pipeline project were to fail. In our view, its existing business—which generates between $1 billion and $1.1 billion in EBITDA annually—is worth at least $10 per share in the event of an MVP cancellation. The stock trades at an appealing 50% discount to our $14 per share fair value estimate.

No-moat Energy Transfer’s current share price offers another compelling opportunity for investors. Energy Transfer is exposed to severe levels of community opposition based on its interest in, and operation of, the Dakota Access Pipeline. Despite community protests and poor sentiment surrounding the industry, Energy Transfer is well positioned to benefit from growing natural gas liquids exports. Energy Transfer screens attractively despite its community relations concerns, trading at an approximate 27% discount to our $17.50 per share fair value estimate.