
Exxon Mobil's Billings Refinery in Billings, Mont. |
Many of the world's largest institutional investors that seek wider corporate adoption of environmental, social and governance metrics may not be ready to divest holdings in energy giants but are increasingly flexing their proxy muscles to prompt changes in their strategic orientation and risk planning.
Some see the initial wave of engagement between shareholders and U.S. energy companies during the 2017 proxy season as the onset of a trend where management teams and boards of publicly traded energy and power firms are forced to consider the demands of their largest shareholders in earnest, and as a matter of ensuring access to stable long-term capital.
From another perspective, the perceived shift that shareholders hold greater sway over management and boards in the energy sector is actually being driven by lower energy prices worldwide, making strategic pivots into less carbon-intensive lines of business merely a reflection that larger capital projects cannot guarantee the long-term profits they once did.
What seems indisputable, however, is that investor pressure on the energy sector from firms including BlackRock Inc., State Street Global Advisors Inc. and Vanguard Group Inc., among others, has catalyzed strategic shifts in capital expenditures for energy supermajors, as well as meaningful steps toward new risk disclosures accounting for the material impact of climate change on companies' operations. These steps are setting the stage for other oil, gas and power companies to proactively move to appease the demands of their largest shareholders, which are adopting ESG metrics into their investment mandates at a rapid clip.
Accounting for climate
Throughout the week of Dec. 4, BlackRock worked to advance its engagement agenda on corporate climate risk disclosure by circulating a letter to the various companies in which it holds long-term investments. The letter invited the companies to consider adoption of the guidelines offered by the Task Force on Climate-related Financial Disclosures, or TCFD. The TCFD framework has garnered the support of over 230 corporate members as of Dec. 12.
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In the letter, BlackRock offers a more diplomatic path for companies to opt into climate risk disclosures, despite initial pushback that such disclosures would mislead investors. If recent history is any guide, such a letter should be heeded. Nearly seven months ago, BlackRock, alongside Vanguard and State Street, collectively won a proxy contest mandating climate risk disclosures at Exxon Mobil Corp. with 62.3% shareholder approval, marking a seminal moment that some have described as the "shot heard round the world."
Exxon's board of directors on Dec. 11 announced the company would issue climate risk disclosures in the "near future," addressing the company's low-carbon strategic positioning under a number of energy demand and climate scenarios.
Joining Exxon among the ranks of energy and power companies subject to climate risk disclosures on the heels of proxy battles are Occidental Petroleum Corp. and PPL Corp., where resolutions for similar disclosures were adopted at 67% and 57% approval, respectively. For its part, Fidelity Investments maintained a low profile on the votes, despite adjusting its proxy voting guidelines to consider corporate sustainability issues.
Facing pressures from investors, Chevron Corp. headed off a similar proxy contest by proactively issuing its own internal climate risk report in March, concluding that the impact from policies to limit global emissions posed "minimal" risk to the firms operations.

Engagement party
Whether U.S. energy and power firms jump voluntarily into climate risk disclosures appears unlikely for now, with NRG Energy Inc. as the lone U.S. energy sector supporter of TCFD as of Dec. 12. The lack of support in the U.S. is consistent across the broader economy, with 67% of U.S. companies listed on the S&P 500 reporting that their board of directors maintained any oversight on climate change risk factors, compared to 90% of companies outside the U.S., according to a Dec. 7 report from research outlet CDP.
While TCFD has garnered the backing of energy supermajors such as Royal Dutch Shell plc, Statoil ASA, Total SA and Eni SpA, the path to disclosure for these companies, along with BP Plc, emerged not voluntarily but through sustained investor engagement. In 2015, shareholders voted for climate disclosures at Shell, BP and Statoil, all in excess of 98% approval. The votes coincided with strategic efforts at each company to trim their cost structures amid declining oil prices, divest noncore assets and begin positioning for a longer-term trend into low-carbon resources.
For Shell in particular, the company's management has adjusted its strategy to appease the demands of its climate-conscious shareholders moving into 2030, even declaring that it will issue climate risk disclosures consistent with TCFD recommendations starting in 2018.
"We expect the energy transition will start to gather pace, so we will have to choose our oil and gas investments with that reality in mind," Shell CEO Ben van Beurden told investors Nov. 28. "This means only proceeding with those investments that are climate-competitive, and shaping our oil and gas asset portfolio further to ensure financial resilience and compatibility with a 2-degree Celsius roadmap."
Shell also outlined how it plans to reduce the net carbon footprint of its energy product sales by 20% by 2035 and 50% by 2050, even pegging executive compensation to the mandates. The new strategy drew acclaim from analysts and investors alike.
"The most impressive part of Shell's latest strategy update was its commitment to climate initiatives, which are the most far-reaching of the big oils to date," HSBC Research analysts wrote Nov. 29. "We think this could well make Shell more investible for investors with a strong climate overlay to their investment process."
For investors contemplating the long-term risk of holding wide exposure to oil and gas stocks, the added low-carbon rationale could go along way. Norway's central bank, Norges Bank, which helps manage more than $30 billion in oil and gas equities, including a 1.8% stake in Shell, advised that oil and gas stocks should be removed from the country's benchmark index fund. Norges wrote on Nov. 14 that such a decision, "does not reflect any particular view of future movements in oil prices or the profitability or sustainability of the oil and gas sector," but rather on long-term exposure to energy price risk.

Decarbonizing
Diversification into less-carbon intensive lines of business has become a hallmark for the so-called "seven sisters" of the oil industry, with each pursuing their own strategic adaptation to what is considered the long-term energy transition. Managing the concerns of certain investors, whether around the potential for stranded upstream fuel reserves or physical climate risks to downstream assets, is one critical component to preserving channels to long-term capital. While corporate engagement may be the preferred tactic of the institutional investor playbook, the prospect that the pool of institutional capital for oil and gas businesses will shrink worldwide could manifest in weaker margins for the sector.
"From a company perspective, if you eliminate 5% of the capital pool they can access, and that grows to 15%, then their cost of capital by definition just went up," RBC Global Asset Management Head of Global Equities Habib Subjally said. "People will exit your stock because it will be uninvestable to a larger pool of investors, compared to a competitor who is engaging with investors."
While hydrocarbons will remain the undeniable focus of energy supermajors, significant CapEx allocations are being made toward low-carbon enterprises, and away from projects with a greater environmental impact, like Arctic drilling and oil sands development projects. Cooperative efforts among energy majors to reduce fugitive methane emissions from natural gas development and transportation have also come to the fore owing to institutional pressures, with all but Exxon pledging on Nov. 22 to provide increased transparency related to efforts to cut methane.
"Investors are deeply engaged and looking to keep up the pressures on companies to undertake analysis that is necessary to shift CapEx from high carbon to cleaner resources," Sue Reid, vice president for climate and energy at Ceres, said. "This is way beyond impact investing."
Notable examples of shifting CapEx include Shell's recent decision to double the capital budget for its new energy division to $2 billion annually. Statoil similarly notched the CapEx outlook for its clean energy business to comprise as much as 20% of its company budget by 2025, a figure that could exceed $1.5 billion annually after 2025. Total pledged to restructure its enterprise holdings to be comprised of 20% low-carbon operations by 2025, targeting $500 million in free cash flow from its natural gas, renewable energy and power generation segments by 2022.
While these pivots into low-carbon products and renewable energy development might satisfy investors in the short-term, the goal of delivering growth to shareholders long-term may force ESG investors and their institutional partners to one day reconcile their goodwill with the concrete need for returns. BP, for example, has dialed back its investments in new energy ventures, parsing out only $200 million annually from its near-term CapEx budget of as much as $17 billion annually through 2021.
"We still need a lot of oil, and someone is going to produce it," Chris Midgley, Global Director of Analytics at S&P Global Platts and former head of Shell's Oil Markets Analysis division said, pointing to daily global demand likely to reach 100 million barrels of oil equivalent. "The question is, can these big majors move into renewables, when the renewables model is based on very low returns, and shareholders are investing for growth."
S&P Global Market Intelligence and S&P Global Platts are part of S&P Global, which is a supporter of the TCFD recommendations.

