This article was first published in the Australia Financial Review on the 6th of October 2021 - Energy at the centre of ESG and critical asset scrutiny.

It goes without saying that ESG and decarbonisation imperatives are driving significant M&A activity in Australia.  Recent deals like BHP Petroleum and Woodside, Infigen, Tilt and Santos and Oil Search are amongst many that can be seen to have been motivated by these forces.  There’s no reason to think these pressures will reduce any time soon. 

Financial sponsors, with upstream investors with an intense ESG focus, are sitting on enormous pools of capital and looking to invest in secure assets with multi-decade horizons and infrastructure-like qualities.  Institutional equity investors are under pressure to rebalance portfolios away from carbon-intensive stocks, and everyone is looking to pick winners from the energy transition.

Energy will always be a sector of key ESG focus, and in other sectors - businesses’ own consumption of energy will be their own biggest ESG concern for the foreseeable future. This will pose complex questions for boards and asset managers in hard to abate industries where the 2021 IPCC report shows material gains are needed in decarbonisation.  Equally, the opportunity to assist those sectors is a key reason why we’re seeing deal activity around battery minerals, green-hydrogen and other technological solutions which, when viable on a mass scale, will be poised to reap huge benefits. 

APRA and ASIC really led the market on disclosure of climate-change risks while legislation lagged.  This has resulted in a growing majority of ASX 100 companies following the TCFD recommendations. But the trendline is still pointing up - the UK and NZ have recently announced new climate disclosure regimes and the Biden administration is clearly going to be active.  Capital is global, and ESG focused investors (an increasing and vocal majority) will expect best practice standards to be adopted here too.

Even though there’s much to come on disclosure, it feels like there have been impressive developments in the ASX100 beyond reporting on climate risk to actively grappling with solutions. Transitioning to net-zero while technological solutions are still being nutted out is incredibly difficult for heavy industry and is demanding plenty of courage. It’s an amazing time when an Australian iron ore champion is streaming 10% of net profits to green energy ventures and our largest listed steel company has appointed a CEO for Climate Change.   

Many prominent ESG or corporate purpose initiatives recognise that stakeholder type concerns are most important in firms with systemic social importance.  This is where the overlap between highly-sensitive ESG and national interests concerns on energy investment starts to reveal itself.  Over the last 5 years the Federal Government has been engaging in a continuous program of intensifying the regulation of critical infrastructure assets and the scrutiny of deals activities in those sectors.

The Security of Critical Infrastructure Act 2018 created a framework for managing national security risks through creation of a critical infrastructure asset register and empowering Government to exercise control over those assets in certain circumstances. Legislation currently in front of Parliament looks to substantially expand the scope of that Act, by focusing on cyber security threats to critical infrastructure. The bill widens the categories of critical infrastructure assets, including the energy sector generally, imposing enhanced cyber and reporting obligations. The obligations go well beyond those contained in equivalent laws globally, not least an ability for the Australian Signals Directorate to step in and take control of critical asset IT systems that have been hit by a cyber-attack. 

Whilst similar laws exist in other leading economies, the regime in Australia is notable for its scope.  In the case of energy, it is essentially a recognition of the integral role that technology now plays in delivering power and that the IT systems and data sitting behind the functioning of the hard infrastructure is often as critical as the infrastructure itself.  In some senses, just like ESG and stakeholder concerns, what we’re seeing with the critical asset reforms is a statement by the government that some sectors are too important to Australians to be left to traditional free market economics.

This all puts energy transactions right in the centre of complex overlapping regulatory, political and investment themes around ESG, decarbonisation and increasingly national interest-centric regulation. The deals aren’t going to slow down, so these acquisition and divestment strategies are going to have to find their way through the middle of these megatrends.