Investing socially to save money

One major area for improvement, and thus savings, is how oil and gas companies work with the local communities where they operate. Savings from developing stakeholder relations with the surrounding communities, especially in emerging and frontier markets, can be significant. Moreover, the costs due to stoppages, shutdowns, and reputational risk are almost immediate and ultimately impact the bottom line. Throughout the life-cycle of projects, relatively small investments in social alignment or corporate social responsibility (CSR) can help mitigate the effect of price variations and can have a positive effect during times of government and regulation change. When properly designed and implemented, these programs establish and maintain stakeholder relationships that act as a natural buffer against the negative impacts of social conflict.

The reduced demand for oil in Asia and struggling economies throughout Europe, coupled with global oil supplies exceeding demand, have driven prices for oil, coal, and natural gas dramatically lower. On the supply side, a major contributing factor has been the explosion in US oil production, which is up to nearly nine million barrels per day. The impacts are so dramatic that oil companies on a global scale have cut more than $100 billion in spending as breakeven analyses have become tighter.

Mining companies are also feeling the pinch. Weak coal and iron ore prices have negatively impacted the shares of Glencore, one of the world's largest mineral producers. The primary reason for the drop is reduced demand in China, where coal imports fell 26% from a year ago in April. And long-term forecasts for both sectors are not promising with oil prices forecasted to not exceed $76 a barrel until after 2025.

Compounding the fiscal problems that executives face are the social pressures from institutional investors, activists, and financiers to reduce dependency on fossil fuels and increase investment in renewable energy. Divestment from fossil fuels is becoming more prevalent as companies and investors attempt to be what they deem "morally" responsible.

For years, environmental advocates have tried to persuade investors to divest stakes in companies supporting the fossil fuel industry. They have recently found a more effective strategy-cut ting off the companies' financing. Bank of America recently announced that it would cut off funding for coal extraction projects globally. Other major financial institutions are backing away from coal and fossil fuels, as well. Citigroup, Morgan Stanley, JPMorgan Chase, Wells Fargo, Credit Suisse, and others have distanced themselves from coal companies involved in mountaintop removal.

The fossil-free campaign is also targeting educational institutions, city and state governments, and other institutions that serve the public good and attempts to influence the political system, which can lead to further regulation. Carbon Tracker has warned that regulations to limit carbon emissions could significantly impact the market value of fossil energy companies as it becomes uneconomic to extract their fossil fuel reserves.

It may seem counterintuitive to make investments within the existing complex fiscal and social environment, especially those in social alignment or CSR. However, it is a sound business decision that can save companies money, while safeguarding their investments, reputations and future profits. A major risk that extraction companies face is conflict with the communities where they operate. Protests, strikes, litigation, and sabotage cause projects to be temporarily halted or totally abandoned, which results in the loss of sales and additional expenses. With greater access to information, and platforms for stakeholders through social media, these types of events are becoming more frequent and impactful. And with oil prices around $50-60 per barrel, oil companies cannot afford the risk of delays and shutdowns to their operations.

Community conflict affects companies' profit margins in ways that are not often realized because they are sometimes hidden within local operating costs or not reflected on the balance sheet. Oftentimes, executives at headquarters do not have visibility down to the operational level to see how much of an impact such social conflicts are causing in terms profit potential. A study by Harvard University has shown that many companies do not realize the financial implications or identify the costs associated with community conflicts. According to the study, "a major, world-class mining project with capital expenditure of between US$3 billion and $5 billion will suffer costs of roughly US$20 million per week of delayed production in Net Present Value (NPV) terms, largely due to lost sales."

Even small interruptions to production have significant financial implications for companies. For example, community conflicts shut down power lines for a project and forced a company to suspend operations, at a cost of $750,000 per day. In another example, a seven-day community blockage in one Middle Eastern country interrupted operations, costing $20,000 per day. Small investments in targeted social alignment initiatives can significantly reduce the occurrence of these events and their impacts.

Executives need to recognize the fiscal consequences of community conflict where they operate now more than ever. The Canadian Centre for Social Performance and Ethics concluded that, "Even on a scale of profitability, corporations that rate highest on ethical conduct and CSR are most profitable in the long-term."

Companies looking to identify short-term savings that reduce CSR personnel, programs, or budgets may experience serious, negative long-term financial implications. Moreover, the costs associated with CSR programs often pale in comparison with site-specific operational disruptions caused by social conflict.

Successful risk mitigation through effective social alignment can also reduce the costs for physical and technical security that stem from community conflict. Multinationals operating in Colombia are required to make payments to the military for "security services" in areas where social conflict exists-paying approximately $300,000 annually. Companies that create stakeholder relations with communities, through social alignment initiatives address social conflicts early, and prevent disruptions and stoppages and increase their financial bottom line.

Whatever approach they choose, extractive companies will have to find new solutions and fiscal strategies to create sustainable projects during the downturn.

ABOUT THE AUTHOR

James R. Sisco (US Navy, retired) is the founder and president of ENODO Global Inc., a business intelligence firm that conducts population-centric analysis to solve complex social problems in dynamic cultural environments.