In this post we will try to clarify the meaning of ESG and attempt to explain how environmental, social, and governance values are expressed in the utility industry today and how they are translated within sustainability policies in the Utility sector.
What is ESG?
The acronym ESG (Environmental, Social, and Governance) refers to the criteria that govern a company’s behavior and that socially conscious organizations use to screen potential investments. They are divided into three broad areas of application:
- Environmental criteria consider how a company safeguards the environment. They refer to interventions to keep the environmental impact of production processes under control and to risk management practices. They include actions to reduce direct and indirect greenhouse gas emissions, management’s stewardship of natural resources, and the company’s overall resilience against risks posed by climate events (such as climate change, flooding, and fire).
- Social criteria refer to how a company manages relationships with employees, suppliers, customers, and the communities where it operates. They are expressed through metrics that measure outcomes in human capital management (such as fair wages and employee engagement) and indicators of impact on the community. A hallmark of social criteria is their spillover outside the corporate perimeter onto the activities of supply chain partners (particularly in developing economies where environmental and labor standards may be less robust).
- Governance Criteria describe how a company exercises its leadership, from executive compensation, audits, internal controls, shareholder rights, and respect for the demands of end customers. Those involved in implementing ESG actions within a company are asked to answer questions such as: how are leadership incentives aligned with stakeholder expectations? Are shareholder rights recognized and honored? What types of internal controls exist to promote transparency and accountability on the part of leadership?
ESG, as we may have guessed at this point, is not an easy object to define: it is many things at once:
- A set of actions that are measured against precise environmental, social, and governance standards and given a score that describes the amount of risk associated with that particular company. This rating system is calculated not only by considering an organization’s economic performance but rather its “behavior in the world,” based on data and metrics related to its intangible resources, namely its values (such as respect for the environment and effective governance).
- A framework, one that is cultural even before technology, that directs stakeholders to understand how an organization is managing risks and opportunities related to environmental, social and governance factors.
- A term with layers of meaning that has recently (barely two decades) spread globally, but the concept that animates it, as we shall see, goes back farther, and precisely because of the meanings it conveys—related to the environment, society, internal regulation of market players—it is inextricably intertwined with the issue of sustainability in the Utility sector.
A brief history of ESG: from the industrial revolution to combating climate change
The current definition of ESG takes shape in the mid-2000s—the first mainstream mention was in 2004 in a United Nations report entitled Who Cares Wins—but its content, with its strong ideal value, has spanned centuries.
We could perhaps identify an inaugural moment in the tensions for better working conditions that characterized the Industrial Revolution, but it was certainly during the 20th century that movements, both spontaneous and organized, as well as more structured initiatives, both institutional or “from below,” took place with the aim of pushing companies toward business practices that are fair and more sustainable. Efforts to stop the exploitation of workers, denouncing the financing of wars or oppressive regimes such as apartheid, use of codes of conduct aimed at corporations—these are all examples of the growing awareness by governments, investors, and consumers of the power that corporations wield in shaping the reality around us. Control over this power has grown, and today all corporate stakeholders (managers, directors, investors, analysts, brokers) are called upon to include ESG criteria in business models and long-term action plans.
At the same time, people’s awareness and attention to issues of sustainability, respect, and diversity in the workplace have increased considerably, and, fueled by the urgency of the climate crisis, increasingly stringent environmental laws have also been passed around the world.
ESG thus refers to issues that are not traditionally part of organizations’ traditional analysis and operations, but have nonetheless assumed considerable financial significance. According to Bloomberg, global ESG assets are on track to exceed $53 trillion by 2025, accounting for more than a third of the $140.5 trillion in total assets under management projected.
ESG initiatives: why they are essential for sustainability in the Utility sector
For years, utility companies have been engaged in ESG projects aimed at advancing the energy transition (emphasis is on the letter “E” in Environmental). Few industries have changed as dramatically in recent years as the utility industry: to stabilize the climate and limit risks to the environment, organizations in the industry have implemented long-term plans to decarbonize and reduce greenhouse gas emissions into the atmosphere. This is the “net zero carbon” approach by which they seek to balance the carbon dioxide produced by absorbing or removing or actively preventing the release of the same amount into the atmosphere through sustainable production processes and the exclusive use of renewable energy sources.
The main driver of this “great transformation” that is proceeding far beyond the once unattainable horizon of the energy transition is the fight against climate change. Equally decisive in developing effective solutions are the patterns by which energy demand and consumer expectations change, the flexibility and resilience of the corporate governance system, and of course, advances in technological innovation.
Companies that have embarked on a path in the direction of greater sustainability in the Utility sector and implemented ESG initiatives will most likely improve their brand identity, gain a more authoritative reputation, and thus be able to strengthen their credit profiles and more easily gain access to capital market financing. However, their performance will not improve substantially unless their core activities, transformed to meet certain standards and lead to better profit margins and robust cash flow. To support productivity within such a complex context—where social responsibility is no longer experienced as a limitation but as a driver—players in the industry can rely on the tools made available by digital transformation.
Digital tools to increase sustainability in the Utility sector
Digitization in its most advanced forms (e.g., robotics, use of big data and artificial intelligence) has proven crucial in making companies more competitive, secure, and resilient. This statement is all the more true in a market undergoing profound and constant transformation such as the energy and utilities market, where supply and demand are changing rapidly, innovative business models are emerging, and threats to infrastructure security are multiplying.
Digital transformation has created and will continue to create new opportunities for increasing sustainability in the Utility sector in the near future: it will support both regulators and consumers and enhance business performance while providing greater transparency and control.
Digitized energy systems (e.g., smart metering, IoT, smart cars) are now able to accurately identify the needs of users, from the amount of energy required at different times of the day, to the preferred distribution mode, to details of costs incurred and payment status. All of these technologies tend to reduce energy load. The ability to have a constant flow of higher quality data and more powerful analytical tools provide utilities with a comprehensive and detailed overview of activities and enable them to be effectively supported in their decision-making processes.
Data is the real differentiator
To succeed in overcoming the energy transition, it is necessary to embrace an ESG-driven corporate culture. In order to promote actions to increase the level of sustainability in the Utility sector, it is essential for companies to use data from a variety of sources to their full potential, both to measure the extent of investment and the results achieved and to imagine and create future growth opportunities related to environmental, social, and governance factors.
In the case of marketing and customer service, data plays a strategically important role.
How can Utility companies succeed in telling their story to customers, regulators, investors, and other stakeholders while highlighting the social and environmental engagement implications? How do they strengthen reputation while at the same time providing all the assurances of full compliance with regulatory obligations? The answer is always and only one: through data. But it is a partial answer if we do not embed the descriptions provided by the data within an actual narrative targeted to the right person, at the right time, through the most appropriate channel. It is only a partial answer if we do not introduce the decisive step: that of ESG reporting processing.
Stakeholders in various capacities within the Utilities industry, including governments, regulators, customers, and shareholders, expect companies to implement concrete and sustainable ESG initiatives and to communicate them as transparently as possible. According to PwC, utilities have now largely gotten the message: 78% have already published a report on sustainability or related to ESG factors while 16% will do so in the next one to two years. Such transparency is one of the key elements for the net zero transformation described by PwC.
To be compelling, ESG reporting requires the integration of insights developed by different business functions; it involves collaboration fueled by consistent and accessible data. Many companies in the industry have yet to achieve this: less than half of the utilities contacted by PwC say they are highly capable of collecting ESG data (48%); others are still learning (40%) or have just begun to learn (13%).
Yet sustainability in the Utility sector is closely connected with the ability to communicate.
ESG reporting: sustainability in the Utility sector comes through communication
Institutional investors, rating agencies, and consumers expect companies to take full responsibility. This is why they are increasingly demanding timely and understandable reporting on corporate environmental, social, and governance (ESG) performance.
The ESG disclosure process is the first step in building an ESG strategy: ESG reporting activities, best supported by Customer Communications Management (CCM) software that allows for personalization and multichannel, help the company identify problems, frictions, and shortcomings, recognize points of discontinuity between goals and their achievement, and communicate through timely, correct, and effective documents.
Few industries in the current historical period in which we are living feel the pressure more than the utilities, whose efforts are essential to accelerate decarbonization and combat global warming risks. However, most companies in the industry still treat ESG reporting as a formality to be completed to meet required compliance standards. The most forward-looking companies are learning to use ESG reports to inform decisions on strategy, investment, and risk management, to translate environmental, social, and governance principles into concrete plans for decarbonization and improved performance, and to accelerate the energy transition to a global economy that is more respectful of territories and communities.