EnCap: How ESG is reshaping the energy sector

Investing in the energy transition yields a wealth of opportunity, but oil and gas still have a role when executed in the cleanest, most efficient way, say EnCap Investments CFO Craig Friou and managing partner Jim Hughes.

This article is sponsored by EnCap Investments.

Craig Friou
Craig Friou

What is your ESG philosophy at EnCap?

Craig Friou: We have a 30-plus year history of investment in the energy space and of being a good steward of our investors’ capital. ESG is just one component of that stewardship. We believe that a strong focus on ESG makes good business sense and that it is essential to creating value for our investors. We have always pursued the highest standards of ESG, even before it was known by that acronym.

What role does ESG play, specifically in the context of an oil and gas strategy?

CF: The primary difference for oil and gas managers is that there is significantly more focus on the environmental aspects of ESG. And, of course, we share those concerns. It is essential for the development of oil and gas to be completed in a responsible way that minimizes environmental impact, minimizes emissions and takes care of the communities where development takes place. These must be priorities.

But I do think it is important to appreciate that oil and gas have provided the cheap and affordable energy that has helped us to sustain daily life for many years, including electricity and reliable transportation. That cheap and affordable energy has dramatically improved quality of life and brought huge numbers of people out of poverty.

Energy demands around the world are only going to continue to grow and we believe oil and gas will remain a component of overall energy supply. Private equity investment in oil and gas also has a strong history of job creation and of positive input into the communities where it operates. In short, affordable energy has done so much to enhance quality of life around the globe and it is critical that the industry continues to deliver on that, whilst doing so in the cleanest and most efficient way possible.

At EnCap, we feel we provide a good solution in this regard. Our companies are directly growing energy supply in a highly responsible way with active initiatives within our portfolio addressing environmental concerns as well as engaging in the long-term energy transition.

What specific steps are you taking at EnCap to increase ESG awareness within the firm and within your portfolio companies?

CF: The primary step we have taken is to mandate that every portfolio company presents on ESG topics at every board meeting. That has been happening now for six years and has been critical to setting the tone.

We began including ESG reporting to our investors in 2015 and published our first sustainability report in 2020, covering 2019 performance. We will be publishing our latest report imminently. That report is considerably more expansive. We will continue to challenge ourselves to come up with more and more relevant information each year.

In 2019, we also became signatories to UNPRI and last year held our first diversity, equity and inclusion training.

What questions do your investors ask about ESG?

CF: We started to see a real increase in the volume of questions in 2019, followed by an exponential rise last year. My sense is that, like us, investors are still figuring out exactly what is material to them, and what is not.

I think that, above all, they are looking for like-mindedness, rather than holding you to a strict set of targets. The nature of the conversations we have had to date have been highly collaborative.

Which brings us to the launch of your energy transition fund. Why did you decide to make that move?

Jim Hughes
Jim Hughes

Jim Hughes: EnCap began seriously studying the energy transition space around three years ago, leveraging internal investment teams and external consultants. A decision was then taken to launch a dedicated energy transition fund based on both the opportunity to deploy and the opportunity to generate returns comparable with those in our traditional oil and gas and midstream funds.

How do you actually define the energy transition?

JH: We define the energy transition as investment into any infrastructure asset or service business that is facilitating the move to lower carbon intensity, throughout the economy. It is a relatively broad definition that encompasses anything that helps us transform energy consumption into a lower carbon form.

Where do you see the most exciting opportunities within the energy transition opportunity set?

JH: With our first fund, we primarily targeted the power sector, exclusively within the US. We focused on utility-scale battery storage projects, where we saw a really exciting opportunity to be an early mover in helping create some of the larger entry-level businesses in that space.

We are also seeing real growth in distributed energy opportunities, particularly on the combined solar and storage side, and particularly with commercial and industrial customers in mind. Indeed, we sense a growing commitment on the part of corporate America, as well as the vast majority of US states, towards decarbonizing the power sector and we continue to see significant opportunity to invest behind utility-scale solar and wind projects within the North American grid as well.

We continue to be convinced that as the industrial elements of the US economy move towards a decarbonized future, there is going to be significant infrastructure investment required. For example, we see a big move, led by California, to transition to a new era of low-carbon fuels. California has its own low-carbon fuel standard, alongside the federal standard, and we are investigating the new wave of opportunities that may present. Additionally, we believe that hydrogen assets will represent a significant component of the energy mix going forward. While our current fund is primarily focused on the power sector, we are looking intently into all of these areas. And while there is clearly a wealth of opportunity globally, we feel like the energy set within the US is so large, that there is no need to venture beyond our own borders.

How do you decide when some of these more nascent technologies have become investable propositions?

JH: What we want to see is a stable technology – in other words, a technology that has been proven. That doesn’t mean it has to have widespread adoption, but we want to invest at a mature stage of the technology’s development. We also want to invest at a point in its economic lifecycle where it is either competitive without subsidies or competitive with a well-established and stable subsidy. A short-term transitional subsidy is no basis on which to build a business. After all, we are not looking to make one-off, isolated investments. We look to build platforms of scale, just as we have done with battery storage.

We are now one of the largest financial investors in the battery storage sector in the US, but we timed our entry so that we were not taking technology risk. The systems we are deploying have been around for a long time and are well understood. There are multiple vendors of the equipment we need. In short, our sweet spot is to be an early mover, but not at the bleeding edge of technological evolution.

What does the future hold for the energy transition market over the next few years?

JH: If you look at the climate targets being adopted by numerous governments and companies, the capital required to meet those targets will require trillions of dollars of investment. I, therefore, think that there is going to be a tremendous need for capable, knowledgeable and savvy investment managers to help institutional investors deploy behind the energy transition. It is a very exciting time for us, and we see a tremendous opportunity to guide our investors on this journey.