The environmental and social challenges the world faces today are complex, alarming, and urgent. From rising global temperatures to deepening social inequalities, the stakes are getting higher. Hence, sustainability is truly everybody’s business. Companies are embracing sustainable practices in response to a growing realisation that businesses need to lead the way in ensuring sustainable performance and creating a better future for all.
The pressure to address environmental, social and governance (ESG) issues has even become an existential question, particularly for energy companies. The Paris Agreement’s goal of achieving net zero carbon emissions by 2050 has proved to be a significant wake-up call for the global energy sector, which today generates about three-quarters of the world’s greenhouse gas (GHG) emissions . With a major global push towards clean energy now underway, transitioning to sustainability is no longer optional but necessary, to remain relevant and competitive. Companies in the energy sector must reinvent themselves by integrating ESG principles throughout their business models – but doing so has potential risks of its own.
Energy Watch, together with Datuk Muhamad Umar Swift, CEO of Bursa Malaysia, explores how taking a progressive and balanced approach can help the energy sector navigate a new world of possibilities.
ESG for Energy: Opportunities and Risks
ESG principles cover a wide spectrum of factors in making important strategic decisions – such as a corporation’s approach to exploring natural resources, its response to climate change, its responsibility to stakeholders, health and safety policies, corporate culture, among others. While some of these ESG factors may be non-financial, yet their impact is relevant in financial analyses.
“Investors have long recognised that ESG issues can materially impact investment performance, and that ESG metrics can serve as a risk management tool on other important matters beyond financial performance,” explains Datuk Umar. ESG matters covers many aspects that a company is also increasingly scrutinised on, such as a company’s environmental conduct, labour practices, and corporate governance.
Empirical evidence suggests that companies with higher ESG scores consistently outperform their counterparts, exhibiting stronger stock performance and improved underlying financial metrics. In contrast, firms with poor ESG standards tend to have higher business risks and an increased likelihood of incurring financial penalties or reputational damage from issues like air pollution or excessive land use. Furthermore,
“For carbon-intensive sectors such as the energy sector, the environment or ‘E’ component of ESG is highly material,” states Datuk Umar. “Investors and financial institutions like banks are focusing on GHG emissions of companies. If a company has carbon-intensive asset(s) and the carbon price is high, then the company’s rating for the ‘E’ component will be negatively impacted”. Integration of ESG strategies can help energy companies effectively cut emissions levels, either by embracing renewable energy or capturing the emissions from fossil fuel sources.
Despite these benefits and opportunities, ESG adoption moving forward is of course not without challenges. Energy transitions can be volatile and disjointed, with potentially new risks. This includes investment mismatches, insufficient technological progress, and stranded assets. A delicate balancing act is thus needed to ensure a smooth energy transition.
Balancing Energy Sustainability with Security
Asia is expected to be the region with the fastest growth in electricity consumption over a ten-year period (2022 – 2031), and it is also the most reliant region on coal for power generation. The combination of these two factors makes it challenging for governments in the region to decarbonise their energy sectors, while meeting the increasing demand for electricity.
Ramping up the capacity of renewable energy sources can help close the supply versus demand gap. However, this effort will take careful planning and considerable time. Energy security, marked by accessibility and affordability, will depend on Asia’s ability to somewhat maintain fossil fuel production, while simultaneously investing in clean, sustainable energy sources including solar, biomass, wind, and other renewables.
Admittedly, protecting energy security in an environment of rising ESG pressures can be challenging. “Expectations will be high. For example, FTSE Russell has tightened the ESG criteria for carbon-intensive sectors over the past 24 months for the FTSE4Good Bursa Malaysia Index (F4GBM) and FTSE4Good Bursa Malaysia Index Shariah”, said Datuk Umar. He predicts this trend will accelerate in the coming years.
“Carbon-intensive assets risk becoming stranded assets when they operate in jurisdictions with compliance carbon markets, having a high number of carbon-intensive assets in one’s portfolio will be a liability, and these assets pose both transition and physical risks which will require companies to plan and implement appropriate mitigation strategies for the companies to remain relevant and investable”, cautions Datuk Umar.
Nonetheless, focusing on either energy security or sustainability at the expense of the other will potentially derail the entire energy transition. A sustainable energy system that does not ensure energy security is not realistic. Conversely, a secure energy system that is not sustainable will do little to ensure long-term energy access and affordability. Energy security and sustainability should thus go hand-in-hand.
Finding this balance is critical for achieving Malaysia’s net zero ambitions. Malaysia’s Minister of Economy, Rafizi Ramli recently announced the rollout of the National Energy Transition Roadmap (NETR) which aims to have 70% of renewables in the power mix by 2050. In the interim, carbon pricing can support decarbonisation efforts by pricing the true costs of externalities generated from conventional thermal plants.
Carbon Markets as the Next ESG Frontier
“From an economic standpoint, climate change can be seen as a consequence of insufficient incentives to mitigate GHG emissions and safeguard natural resources”, explains Datuk Umar. “Carbon pricing mechanisms provide a solution to this problem by putting a price on GHG, be it emitted or sequestered”, he added.
Placing an effective price on GHG emissions internalises the external cost of climate change in the broadest range of economic decision-making and in setting economic incentives for clean development and growth. This way, a reduction in GHG emissions can be achieved in the most flexible and affordable way for society. It can also help to mobilise financial investments to stimulate clean technology and market innovation.
Neighbouring countries have already started to introduce carbon pricing mechanisms. Singapore was the first in Southeast Asia to introduce carbon tax since 2019 , using the revenues collected to support national decarbonisation efforts. Thailand was also an early adopter of voluntary carbon pricing instruments , while the Philippines is currently studying the feasibility of implementing a carbon tax .
Here at home, Malaysia has recognised the need for an estimated RM435 billion to RM1.85 trillion investment by 2050 as indicated in the recently launched NETR Part 1 that detailed 10 flagship catalyst projects and initiatives. Aligning actions to ambitions, the government has also outlined a target to formulate a national carbon pricing policy in the 12th Malaysia Plan introduced in 2021, followed by a proposal from the government to introduce a domestic emissions trading scheme (DETS) . Meanwhile, the Ministry of Finance (MoF) is looking into the feasibility of implementing a carbon tax (CT) mechanism
In tandem with these efforts, Bursa Malaysia launched the nation’s voluntary carbon market (VCM) – Bursa Carbon Exchange (BCX) – at the end of last year. As the world’s first Shariah voluntary carbon exchange, BCX enables firms to trade carbon credits to meet their climate targets. Voluntary carbon markets are one of the enablers to facilitate Malaysia in reaching Net Zero aspirations.
Powering A Brave, Sustainable New World
With the rising focus on ESG among investors and businesses, it is clear that the clean energy transition has an impact on energy markets and demands. Added to this is the increasing need for transparent and robust ESG reporting driven by net zero commitments and regulations. Last year, Bursa Malaysia released enhanced sustainability reporting requirements in its Main Market and ACE Market Listing Requirements with the aim to elevate the sustainability practices and disclosures of listed companies. The convergence of these forces has renewed interest in carbon markets to finance emissions reduction or removal projects.
In the long term, building integrity into carbon markets is key for success.
Nonetheless, Datuk Umar emphasises that Malaysia’s VCM ecosystem is still in its infancy, and building the supply pipeline of carbon credits will take time. “It is very important to focus on intensive knowledge sharing and capacity building to accelerate growth on the supply side”, he concluded, which is why Bursa Malaysia has been organising monthly capacity development sessions including sectoral roundtables to raise VCM awareness among various stakeholders.
While the significance of a dynamic VCM ecosystem is undeniable, it’s equally critical for organisations to adopt internal strategies that pave the way for sustainable practices. When asked to elaborate on the advantages of organisations voluntarily setting an internal carbon price, Datuk Umar elaborated that companies can proactively manage the financial risks associated with carbon emissions with such measures. “Anticipating future regulatory changes and potential costs related to carbon pricing mechanisms allow companies to assess and mitigate these risks effectively, making them better prepared than organisations that are not ready”.
In the long term, building integrity into carbon markets is key for success. If held to high standards of integrity and transparency, carbon markets can help accelerate the energy transition required to power a cleaner, more sustainable future, by effectively putting a price on GHG emissions and creating an economic incentive for reducing these emissions, all while generating the vast investment sums needed to build resilient and sustainable business models.