ESG Industry Report Card: Oil And Gas February 11, 2020 PRIMARY CREDIT ANALYSTS Key Takeaways Simon Redmond London - As fossil fuel producers, oil and gas companies are among the most exposed to the (44) 20-7176-3683 energy transition. Oil and gas prices and refining margins are extremely sensitive to simon.redmond @spglobal.com medium- and long-term demand expectations. Thomas A Watters - Over the next decade, we believe average oil demand will continue to grow. Industry New York projections from diverse sources typically foresee a decline in demand post-2035 (see (1) 212-438-7818 chart 1). Unlike coal, prolonged supply-demand imbalances are mitigated by the thomas.watters significant natural decline of oil fields (3%-6% per year). @spglobal.com Michael V Grande - Current long-term industry projections still show fossil-based fuels account for the New York lion's share of global primary energy demand, supported by its vital role in the global (1) 212-438-2242 economy and mobility. That said, the speed of the transition away from carbon-based michael.grande fuels is uncertain but is beginning to accelerate. Disruptive external factors such as @spglobal.com government environmental policies and regulations on greenhouse gases, and long-term SECONDARY CONTACTS product substitution risks (e.g. vehicle electrification) could weigh on credit quality. Christine Besset - Pollution is another environmental risk factor, including risks related to the use of Dallas chemicals (especially in fracking), as well as high-impact, low probability events such as + 1 (214) 765 5865 christine.besset severe oil spills and refinery accidents. Subsectors with higher exposures to such risks @spglobal.com are oil sands, shale, and offshore. Ben B Tsocanos - We also see social risks as above-average for the oil and gas industry, relating to safety New York and community impacts. A rising medium-term social concern for oil companies stems (1) 212-438-5014 from stigmatization and reputational risk. ben.tsocanos @spglobal.com - The oilfield services (OFS) and drilling subsectors have comparable exposure to ESG Danny Huang factors since they are part of oil and gas production and indirectly exposed to prices. Hong Kong OFS companies have to comply with significant international and domestic (852) 2532-8078 environmental regulations. While ultimate responsibility for control, safety, behavior, danny.huang @spglobal.com and incidents in a licensed area typically lies with the producer, operational or product shortcomings, as well as potential safety breaches, can cause OFS companies to incur See complete contact list at end of article. liabilities. www.spglobal.com/ratingsdirect February 11, 2020 1 ESG Industry Report Card: Oil And Gas Analytic Approach Environmental, social, and governance (ESG) risks and opportunities can affect an entity's capacity to meet its financial commitments in many ways. S&P Global Ratings incorporates these considerations into its ratings methodology and analytics, which enables analysts to factor in short-, medium-, and long-term impacts--both qualitative and quantitative--to multiple steps of their credit analysis. Strong ESG credentials do not necessarily indicate strong creditworthiness (see "The Role Of Environmental, Social, And Governance Credit Factors In Our Ratings Analysis," published Sept. 12, 2019). Our ESG report cards qualitatively explore the relative exposures (average, below, above average) of sectors to environmental and social credit factors over the short, medium, and long term. For environmental exposures, chart 1 shows a more granular listing of key sectors and (in some cases) subsectors reflecting the qualitative views of our analytical rating teams. This sector comparison is not an input to our credit ratings and not a component of our credit rating methodologies; it is based on our current qualitative, forward-looking opinion of credit risks across sectors. In addition to our sector views, this report card lists ESG insights for individual companies, including how and why ESG factors may have had a more positive or negative influence on an entity's credit quality compared to sector peers or the broader sector. These comparative views of environmental and social risks are qualitative and established by analysts during industry portfolio discussions, with the goal of providing more insight and transparency. Environmental risks we considered include greenhouse gas (GHG) emissions, including carbon dioxide, pollution, and waste, water and land usage, and natural conditions (physical climate, including extreme and changing weather conditions, though these tend to be more geographic/entity-specific than a sector feature). Social risks include human capital management, safety management, community impacts, and consumer-related impacts from customer service and changing behavior to the extent influenced by environmental, health, human rights, and privacy (but excluding changes resulting from broader demographic, technological, or other disruptive industry trends). Our views on governance are directly embedded in our rating methodology as part of the management and governance assessment score. www.spglobal.com/ratingsdirect February 11, 2020 2 ESG Industry Report Card: Oil And Gas Chart 1 The list of entities covered in this report is not exhaustive. We may provide additional ESG insights in individual company analyses throughout the year as they change or develop, with companies expected to increasingly focus on ESG in their communication and strategy updates. www.spglobal.com/ratingsdirect February 11, 2020 3 ESG Industry Report Card: Oil And Gas Chart 2 Exploration And Production Environmental exposure We see environmental risks for the exploration and production (E&P) industry as well above average, stemming from two types of risks. The first stems from inherent material exposure to greenhouse gas emissions. The second type concerns lower probability but potentially high-impact risks for individual companies from pollution because of well head and transport spills and leaks, and increasingly water use and contamination risks. The most significant risk is the pace of the energy transition away from carbon-based fuels; this could result in stronger deviations from the industry demand forecasts outlined below. It will likely be strongly influenced by long-term government policies for renewable energy, as well as the pace of electric vehicle penetration growth. Risk of secular change and substitution by products, services, and technologies is also a risk embedded in our key credit factors for oil and gas companies. The combustion of carbon-based fuels, specifically oil-derived products and natural gas, results in carbon dioxide. Natural gas, largely methane, is another greenhouse gas itself (when released) and has 25 or so times the impact of carbon dioxide. Production activities can also be a direct source of greenhouse gases, through methane leaks, gas flaring or extraction methods. Oil production (and prices) are more exposed over the longer term. According to many market www.spglobal.com/ratingsdirect February 11, 2020 4 ESG Industry Report Card: Oil And Gas projections, over the next two decades we will likely reach a point known as peak oil, in which aggregate demand for oil will peak and then start to decline. However, demand will likely continue to increase significantly before then. This change would also affect demand for OFS, result in stranded reserves, and likely weigh on prices, depending on the extent and timing of supply corrections, including the typical onshore conventional oilfield decline rate of 3%-6% per year. These risks could also affect the sector by limiting funding availability. Funding constraints for banks and other investors are more common for coal producers, but may well increasingly affect other fossil fuel producers and the sector as a whole. Also, the risk of pollution is material for companies producing and transporting hydrocarbons and may result in material financial and reputational damage. While infrequent and unpredictable, the occurrence of disasters with the magnitude of the Deepwater Horizon oil spill in the Macondo Prospect can severely affect issuer credit quality due to the significant liabilities incurred from environmental remediation, government fines, and lawsuits from affected industries and consumers. Such liabilities totaled over $60 billion in the case of Macondo. Oil tanker spills, even if vessels aren't operated by an oil company itself, can be a source of material litigation. Finally, the increased frequency of extreme weather events (such as hurricanes) create greater operational risk. The environmental impact of plastic waste is another topic of consumer focus. Such plastics are largely derived from petrochemicals, which altogether account for about 14% of crude oil demand. Nonetheless, depending on how plastics are used in construction, their carbon content is effectively sequestered. Water use and the risk of contamination of land and aquifers is particularly relevant for shale oil and gas producers as a result of hydraulic fracturing activities. Many countries have stringent development, operating, and decommissioning requirements and potential penalties for companies that extract hydrocarbons. These regulations vary by country and state; for example, Colorado has stricter requirements than other U.S. states. Moreover, many E&P companies, such as those operating in the Gulf of Mexico and North Sea, incur significant asset retirement (decommissioning)