Research from The University of Texas at Austin highlights the powerful — and sometimes counterproductive — role that very strict regulatory standards and stakeholder pressure can play in driving environmental improvements within the oil and gas industry. The certified market, a place where only firms who meet environmental criteria can sell gas (at a premium price), had the biggest single impact on environmental outcomes in the oil and gas industry.
The energy industry, particularly oil and gas companies, is under increasing pressure to decarbonize due to the increase in extreme weather events associated with climate change. Some of these companies have begun to voluntarily reduce their greenhouse gas footprint, motivated by social responsibility, pressure from activists, market opportunities or simply copying efforts of peer firms.
The study, produced by researchers from both the LBJ School and Cockrell School, reveals that while firms can respond to external pressure by making changes that enhance environmental performance, the nature and type of pressure significantly impact the outcomes. Not all activist efforts yield the same results, even when operating under similar financial constraints, and markets with very high barriers to entry may unintentionally hinder progress. These findings emphasize the need for strategic, well-targeted actions to ensure lasting environmental benefits at both the firm and industry levels.
“Some firms have begun to address the issue of natural gas flaring– whether out of a sense of social responsibility, fear of environmental activists, search for new market opportunities, or an impulse to mimic peer firms,” said LBJ School professor and a study co-author Varun Rai. “However, studying such complex drivers in real-world settings and with highly detailed market and resource data is challenging. To address that, in this paper we formulate a general framework that captures each of these factors, apply it to build an empirically-grounded model, and provide insights into the distribution of outcomes in the oil and gas industry’s flaring performance in the US.”
Researchers developed an agent-based model—an increasingly important computational modeling technique in the AI era that relies on resolving the components of a system rather than specifying its aggregate dynamics—to simulate the decision-making processes of energy firms and identifying key influences on firm behavior. The researchers investigated how different pressures—social, regulatory, shareholder and peer effects—influence firms' decisions to reduce flaring and participate in emerging markets for certified low-emission natural gas.
Social Activism: The research highlights the role of social activism in influencing corporate behavior. Activists can impose significant costs on firms through boycotts, protests and shareholder actions, which in turn can affect a firm's market value. The study investigates different activist strategies, such as targeting the largest firms or the worst environmental performers, and finds that focused activism is more effective in reducing flaring intensity compared to a broad industry-wide approach.
Shareholder and Consumer Pressure: The research also examines the impact of shareholder expectations and consumer willingness to pay premiums for certified low-emission gas. These factors can drive firms to engage in corporate social responsibility (CSR) activities, such as reducing flaring to qualify for certified markets or benefit from more positive stock valuation by shareholders. The study finds that even a relatively small certified gas market (around 0.75% of the total market) that only admits supply from firms below a certain threshold of flaring intensity can significantly improve market-level environmental performance, but only if the market threshold is set at a realistic level that firms can meet without prohibitive costs.
Peer Effects: Peer effects, where typically smaller firms imitate the behavior of their larger, more successful competitors, also play a role in shaping industry practices. The research shows that peer effects are especially important in the event of a well-publicized environmental disaster.
The research provides insights into how these different strategies can be used to influence behaviors in the energy sector. Policymakers can leverage these findings to carefully craft regulations to drive decarbonization in the industry, while activists can maximize their impact by focusing their efforts on the worst performers or the largest firms in the industry.
"This research illustrates how the actions of stakeholders - including activists, shareholders and consumers - can influence the behavior of firms when regulators are slow or unwilling to regulate,” said Nick Willems, a Ph.D. graduate of the Cockrell School of Engineering's Walker Department of Mechanical Engineering, who is the first author of the paper. “In the case of natural gas flaring, we also demonstrate the critical role of selecting a threshold for environmental performance. Stricter environmental benchmarks can actually lead to worse environmental outcomes if not accompanied by commensurate levels of activism, shareholder valuation of corporate social responsibility and market premiums."
The study underscores the complex interactions between social, regulatory and economic factors in shaping firm behavior in the oil and gas industry. By integrating these influences into an agent-based model, the research provides a nuanced understanding of how firms respond to various drivers and how these responses affect energy market outcomes, particularly in the context of reducing natural gas flaring. The findings highlight the importance of realistic market thresholds, targeted activism and the potential for certified markets to drive significant environmental improvements in the industry.
The research is peer-reviewed and published in Joule.
