It's hard to ignore Environmental, Social, and Governance (ESG) these days and much the same can be said for the energy transition. In our recent energy transition report, more than half of the respondents said they are deepening their focus on energy transition strategies despite expressing significant concerns about the economic and organisational challenges of a commitment to clean energy.

At a time when UK businesses are being required to understand and adapt to what is literally a myriad of legislation, rules, regulations, codes of conduct and statements of best practice all focussed on ESG, throw energy transition into the mix and you have a potent cocktail of headaches for UK business.

What does ESG mean for energy transition – or is it the other way around?

Let's start by considering what 'the energy transition' is. At its most basic, energy transition is the process of moving away from fossil fuels such as coal, oil and gas towards more sustainable sources of power such as wind, solar and green hydrogen. This is easy to say but in the real world considerably more complex to do and will require unprecedented levels of investment.

The legal framework for energy transition is based on two important pieces of legislation. First, the Climate Change Act 2008 (the legislation which commits the UK government to achieve a 100% reduction in greenhouse gas emissions by 2050). The second is the new Energy Act 2023. According to a Department for Energy Security and Net Zero press release on the day on which it received royal assent, the new Energy Act comprises ‘New laws passed to bolster energy security and deliver net zero’. In other words, it is intended to be a rocket booster to climate change. It certainly creates a comprehensive new regime for energy production and security and the regulation of the UK’s energy sector.

The scope of the new Energy Act is vast, covering a wide range of policy areas from the licensing of carbon dioxide transport and storage to the environmental assessment system for offshore wind. Understanding this extensive content and its legal, economic, and environmental impacts, is going to be important for every business and organisation operating in the UK.

To achieve energy transition and in particular the government's aim for net zero emissions by 2050, UK business is going to have to face up to significant investment and a strategic shift towards new systems and ways of working.

How do 'energy transition' and ESG fit together? Let's start with the obvious:

E is for environmental

Amongst the environmental legal framework there are the new mandatory climate-related financial disclosures (CRFDs) which publicly quoted companies and large private companies and LLPs must comply with for financial years starting on or after 6 April 2022. The new regulations are intended to make large UK businesses more aware of how climate change can affect them in both a positive and negative sense. Although not directly linked to energy transition, there can be no doubt that they are part of an overall plan to focus the minds of business leaders on the environment and the risks and opportunities deriving from it.

To help UK business adapt to the changes, the government has produced non-binding guidance on what disclosures businesses are required to make in their financial reports. The guidance is quite granular in detail but makes the point of saying that companies and LLPs should not rely upon it for legal guidance on how the requirements will affect them. So helpful on the one hand but not so on the other.

This is the first year that qualifying businesses must make CRFDs and it is proving to be a challenge. Even experienced accountancy firms are scratching their heads as to the nature and level of disclosures required. Over time no doubt this will become a standardised process but for now it is not.

There are additional conundrums for UK businesses who are part of an international group. Many of these businesses would have previously taken their lead on environmental governance from an overseas parent. This is no longer an option and they now need to make their own CRFDs regardless of their international group strategy. There will be some interesting conversations going on behind the scenes vis a vis UK directors' duties to comply with local legislation on the one hand and to follow overall group policies and procedures on the other.

It's not hard to see how the 'E' in ESG relates to the energy transition. However, what about the 'S' and the 'G'?

The energy transition and its social impact

Clean, breathable air, affordable and secure heating and lighting, all the attributes that the energy transition is designed to achieve would and should play well in the context of the social pillar of ESG.

The energy transition should lead to the creation of new jobs and opportunities. However, as we move away from traditional sources of heat and energy, a likely result will also be the loss of existing jobs and industries. The fact is that the energy transition will require adjustments to be made in the workplace and a balance will have to be found. Add into the mix the sober realities of several ongoing global conflicts and an era of higher interest rates and it is not difficult to see the challenges of realisation of both social and energy transition strategies.

When it comes to social factors, energy transition will have a multitude of consequences. For the energy transition to succeed, those communities and workforces most affected will need to buy into the journey. For this to happen the move away from fossil fuels must be achieved fairly and equitably with all its social implications fully factored in.

In our energy transition survey many of the respondents pointed to a lack of government support as the main threat to achieving the net zero goal. However, it was also clear that this was a worldwide and not just a UK phenomenon. The importance of international cooperation across developed and developing countries was also highlighted as was private sector support and investment for our new energy transition industries. Despite the many challenges, private investor support for renewable energy projects and infrastructure remains strong.

The energy transition and good governance

In contrast, when it comes to 'G' for governance there would appear to be a much smoother connection between a successful energy transition and sound corporate governance. The one is fundamental to the other.

With great responsibility, there should follow great governance as it is hard to see how the former may be fulfilled without the latter.

Investors are increasingly interested in whether company boards have adopted ESG frameworks and a foundation of good governance ensures companies are well-prepared to adapt to new regulations that come along.

The companies that will thrive through the energy transition will be the ones that have sound governance structures in place, enabling them to be agile, ready and willing to adapt to the latest government policy, legislation or innovation. These structures will surely be the key to unlocking the investment needed to transition to net zero.

In a nutshell…

Challenging times lie ahead which by tackling ESG and the energy transition as one, UK business will be in prime position to overcome.