Published by Jessica Weisman-Pitts
Posted on August 26, 2021
12 min readLast updated: January 21, 2026
By Charlie Johnson, CRA Sustainability
As financial markets begin pricing ESG externalities into market value, businesses must make some difficult decisions. Charlie Johnson, Principal at CRA Sustainability, leading consultancy providing the full package of ESG services across the strategy – risk management – operations continuum, explores the actions that business leaders can take to stay ahead of the curve and continue to create value for all stakeholders.
It is only in recent years that financial markets and society more generally fully understood the broader positive and negative externalities that businesses can create as a result of their activities. Before this, a lack of general awareness resulted in the absence of a pricing mechanism enabling the “internalization” of these externalities preventing their measure from being priced into market value.
Today, specific measures and mechanisms like a carbon price are being explored as ways to enable a more accurate and quantified picture of the societal costs of specific business activities. Greenhouse gases (GHG) emissions are a particular focus. The market is already beginning to price this perspective into market value of certain assets – in particular in sectors with an increasingly clear and visible narrative connected to the creation of “externalities”, such as oil & gas – long before the specific pricing or taxation mechanism are fully in place.
Difficult decisions in a landscape of uncertainty
This sets up a difficult choice for business leaders in those sectors: ignore the market signal and deal with potential consequences including fewer potential buyers of your assets, rising cost of capital, less demand for your product – OR shift your business model to an equally uncertain future shape with exposure to markets with significantly improved externality profiles.
This choice is fundamental to most strategy work being conducted in today’s sustainability-focused macro environment.
Case example: oil & gas
Perhaps the best example of this is in the production and sale of oil, and oil-based fuels. There is broad understanding of the impact carbon emissions are having on climate change.
In order to achieve anything close to the targets set out in the Paris Agreement, the absolute level of carbon emissions being released into the atmosphere needs to decline dramatically: whether it’s through a carbon tax, policy putting limits on usage, or simply consumer choice, absolute levels of consumption must go down.
And as absolute levels of consumption go down, supply must go down with it in order to prevent downward pressure on prices. This, however, leaves producers of carbon-based fuels at an impasse: they will not be able to grow their capital (production), while also generating a good return.
The market’s concerns around the long-term value of carbon-based businesses are evident when looking at the total shareholder return of major companies in the oil and gas production and refining industries. Over the last five years, traditional producers and refiners have failed to create meaningful value for shareholders.
When compared to companies that have reduced their exposure to carbon by shifting a large portion of their energy production to sources with lower levels of emissions, the differences are stark. The market is valuing the cash flows of lower emissions businesses significantly higher than traditional oil and gas companies as concern for the long-term viability of “high carbon” cash flows continues to grow.
The solution: portfolio transitioning
As a result, management teams in these industries have begun to come around to how the broader market is thinking about value. Many have responded by choosing to move to a “harvest” model: return as much cash as possible to shareholders through dividends and buybacks, while only re-investing enough to sustain the business and continue to pay out dividends.
But, as is evident in their market performance, this is a value-neutral strategy. The only way to break out and start to create real value is to “transition” their portfolios away from carbon intensive business lines so they can start to profitably grow the capital base.
A closer look at the portfolios of the 46 largest companies (market cap>$1bn) within the global refining segment makes this evident. On average, the companies with 25% or more of revenues coming from biofuels have a 5-year total shareholder return of over 40% and an enterprise value to EBITDA multiple of over 18x. In comparison, the companies with less than 25% of revenues coming from biofuels have an average 5-year total shareholder return of 8% and an enterprise value to EBITDA multiple of 9x. A simple correlation of total shareholder return to percentage of revenue coming from biofuels confirms the strength of the relationship.
Though the outperformance of companies with higher levels of exposure to renewables are likely benefitting from the current momentum behind ESG investing, the reasons behind it are clear. As demand for carbon-based fuels declines, refiners will not only be unable to grow their capital base, but will increasingly struggle generating good returns on the current capital base, and may be at risk of large impairments due to stranded assets.
Who’s next?
While the fossil fuel industry is the first test-case due to the visibility of its link to greenhouse gas emissions, other sectors will be next. A simple analysis of percentage of total GHGs by sector suggests that the sectors including buildings, food & agriculture, transport, and iron & steel are most likely to encounter these dynamics next.
Companies in these industries looking to avoid the pressure on valuation currently being faced by oil & gas must be proactive in decarbonizing their portfolios. A recent survey of the 60 largest listed meat and fish companies found that 75% of them have not put in place reduction targets set according to scientific guidelines for emissions.
Indeed, few even disclose Scope 3 emissions that cover their supply chain, which is where the majority of their emissions comes from.
Due to the growing concern from stakeholders on the risks surrounding climate change, GHG emissions are currently the driver of stakeholder impact that is most closely linked to financial value – but it won’t always be that way. As awareness grows around other major drivers of environmental or social impact and the risks associated with them, markets will price these risks into assets or companies with exposure to it.
Immediate action is key
Portfolio shaping thus becomes the ultimate strategy lever in a sustainability-focused world, particularly when looking at strategy through the convergence of financial and societal value.
Portfolio transitions are inherently difficult journeys to embark on.
In order to survive, we at Marakon believe that business leaders must look at their business through the lens of its impact on a broader set of stakeholders. They must also adopt internal externality pricing mechanisms to send a clearer signal to the business about where “future value” resides and actively work to resolve the tensions between the way the organization has traditionally thought about value and how that is likely to change.
Finally, it is key that they begin the portfolio transition strategy sooner rather than later – such journeys take multiple planning periods to design and execute, and the odds are that the market’s ability to price in externalities is going to accelerate over the coming couple of years.
By Charlie Johnson, CRA Sustainability
As financial markets begin pricing ESG externalities into market value, businesses must make some difficult decisions. Charlie Johnson, Principal at CRA Sustainability, leading consultancy providing the full package of ESG services across the strategy – risk management – operations continuum, explores the actions that business leaders can take to stay ahead of the curve and continue to create value for all stakeholders.
It is only in recent years that financial markets and society more generally fully understood the broader positive and negative externalities that businesses can create as a result of their activities. Before this, a lack of general awareness resulted in the absence of a pricing mechanism enabling the “internalization” of these externalities preventing their measure from being priced into market value.
Today, specific measures and mechanisms like a carbon price are being explored as ways to enable a more accurate and quantified picture of the societal costs of specific business activities. Greenhouse gases (GHG) emissions are a particular focus. The market is already beginning to price this perspective into market value of certain assets – in particular in sectors with an increasingly clear and visible narrative connected to the creation of “externalities”, such as oil & gas – long before the specific pricing or taxation mechanism are fully in place.
Difficult decisions in a landscape of uncertainty
This sets up a difficult choice for business leaders in those sectors: ignore the market signal and deal with potential consequences including fewer potential buyers of your assets, rising cost of capital, less demand for your product – OR shift your business model to an equally uncertain future shape with exposure to markets with significantly improved externality profiles.
This choice is fundamental to most strategy work being conducted in today’s sustainability-focused macro environment.
Case example: oil & gas
Perhaps the best example of this is in the production and sale of oil, and oil-based fuels. There is broad understanding of the impact carbon emissions are having on climate change.
In order to achieve anything close to the targets set out in the Paris Agreement, the absolute level of carbon emissions being released into the atmosphere needs to decline dramatically: whether it’s through a carbon tax, policy putting limits on usage, or simply consumer choice, absolute levels of consumption must go down.
And as absolute levels of consumption go down, supply must go down with it in order to prevent downward pressure on prices. This, however, leaves producers of carbon-based fuels at an impasse: they will not be able to grow their capital (production), while also generating a good return.
The market’s concerns around the long-term value of carbon-based businesses are evident when looking at the total shareholder return of major companies in the oil and gas production and refining industries. Over the last five years, traditional producers and refiners have failed to create meaningful value for shareholders.
When compared to companies that have reduced their exposure to carbon by shifting a large portion of their energy production to sources with lower levels of emissions, the differences are stark. The market is valuing the cash flows of lower emissions businesses significantly higher than traditional oil and gas companies as concern for the long-term viability of “high carbon” cash flows continues to grow.
The solution: portfolio transitioning
As a result, management teams in these industries have begun to come around to how the broader market is thinking about value. Many have responded by choosing to move to a “harvest” model: return as much cash as possible to shareholders through dividends and buybacks, while only re-investing enough to sustain the business and continue to pay out dividends.
But, as is evident in their market performance, this is a value-neutral strategy. The only way to break out and start to create real value is to “transition” their portfolios away from carbon intensive business lines so they can start to profitably grow the capital base.
A closer look at the portfolios of the 46 largest companies (market cap>$1bn) within the global refining segment makes this evident. On average, the companies with 25% or more of revenues coming from biofuels have a 5-year total shareholder return of over 40% and an enterprise value to EBITDA multiple of over 18x. In comparison, the companies with less than 25% of revenues coming from biofuels have an average 5-year total shareholder return of 8% and an enterprise value to EBITDA multiple of 9x. A simple correlation of total shareholder return to percentage of revenue coming from biofuels confirms the strength of the relationship.
Though the outperformance of companies with higher levels of exposure to renewables are likely benefitting from the current momentum behind ESG investing, the reasons behind it are clear. As demand for carbon-based fuels declines, refiners will not only be unable to grow their capital base, but will increasingly struggle generating good returns on the current capital base, and may be at risk of large impairments due to stranded assets.
Who’s next?
While the fossil fuel industry is the first test-case due to the visibility of its link to greenhouse gas emissions, other sectors will be next. A simple analysis of percentage of total GHGs by sector suggests that the sectors including buildings, food & agriculture, transport, and iron & steel are most likely to encounter these dynamics next.
Companies in these industries looking to avoid the pressure on valuation currently being faced by oil & gas must be proactive in decarbonizing their portfolios. A recent survey of the 60 largest listed meat and fish companies found that 75% of them have not put in place reduction targets set according to scientific guidelines for emissions.
Indeed, few even disclose Scope 3 emissions that cover their supply chain, which is where the majority of their emissions comes from.
Due to the growing concern from stakeholders on the risks surrounding climate change, GHG emissions are currently the driver of stakeholder impact that is most closely linked to financial value – but it won’t always be that way. As awareness grows around other major drivers of environmental or social impact and the risks associated with them, markets will price these risks into assets or companies with exposure to it.
Immediate action is key
Portfolio shaping thus becomes the ultimate strategy lever in a sustainability-focused world, particularly when looking at strategy through the convergence of financial and societal value.
Portfolio transitions are inherently difficult journeys to embark on.
In order to survive, we at Marakon believe that business leaders must look at their business through the lens of its impact on a broader set of stakeholders. They must also adopt internal externality pricing mechanisms to send a clearer signal to the business about where “future value” resides and actively work to resolve the tensions between the way the organization has traditionally thought about value and how that is likely to change.
Finally, it is key that they begin the portfolio transition strategy sooner rather than later – such journeys take multiple planning periods to design and execute, and the odds are that the market’s ability to price in externalities is going to accelerate over the coming couple of years.
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