Disclaimer: Views in this blog do not promote, and are not directly connected to any Legal & General Investment Management (LGIM) product or service. Views are from a range of LGIM investment professionals and do not necessarily reflect the views of LGIM. For investment professionals only.

Oil turmoil: reflections on a remarkable AGM season

Amid unprecedented shareholder support for corporate action on climate change, particularly in the oil industry, we present some of our key takeaways for forward-looking companies.

 

‘Show me the numbers!’

The scrutiny of sustainability strategies is strengthening. Notably, a majority of investors at US oil majors including Chevron* and ConocoPhillips* supported proposals for the companies to set emissions targets which include emissions from their products (known as ‘Scope 3 emissions’, which represent the overwhelming majority of emissions associated with fossil-fuel companies).

Historically, many companies in the sector have argued that the demand for their products (and thus associated emissions) is ultimately driven by the strength of consumer appetite and government policies, and that these associated emissions are therefore outside their direct control. Whilst true, we do not believe this argument exonerates companies from the need either to disclose their emissions, or to work to reduce their total footprint.

Consider a scenario where demand for oil drops. The producer will lose 100% of the associated revenues, even if the causal chain involves not just the producer, but the pipeline operator, the refiner, the automaker and the motorist filling up. We therefore believe companies disclosing their total carbon footprint provides information of first-order investment importance – and LGIM has been voting against companies in relevant sectors which do not meet this minimum standard.

Disclosure is not an end in itself: it should support the alignment of oil and gas production to the goals of the Paris Agreement. Whilst this gives companies some leeway to use their own models of supply and demand, benchmarking against widely used scenarios – e.g. from the IPCC or the International Energy Agency – is growing in importance. Indeed, 48% of shareholders also voted for Chevron to report on the business impacts of the IEA net zero scenario

Takeaway #1: investor expectations are shifting from qualitative climate reporting to quantitative modelling and targets.

An oil spill on Lake Wobegon

We recognise that there are multiple paths for Paris alignment. Reinvention into renewables is one possible option, but carries risks and we do not endorse it for the sector as a whole. ‘Managed decline’ through reduced production and increased dividends or share buybacks may be financially appealing to investors, but not to executives wishing to leave a legacy of growth. Growth itself may still be an option, but only for the very few companies that manage to consolidate amid an overall shrinking market.

With a few notable European exceptions, however, the growing acknowledgment of climate change as a business risk has not translated into significant changes to oil and gas production plans. Like in Garrison Keillor’s fictional Lake Wobegon where ‘all children are above average’, many companies take great pains to emphasise whatever unique factors (breakeven costs, carbon and methane intensity, human rights record, etc.) make the risks of the energy transition appear to be every other company’s problem. Similar arguments – companies each claiming to have the best acreage or efficiency or other differentiators – have led to the collective overinvestment and underperformance in the US shale sector in the past, for example.

As the uncertainty around the long-term role of fossil fuels grows, we remain concerned that companies overinvesting in oil and gas production may be putting the capital we manage on behalf of our clients at risk – whilst also delaying, and potentially derailing, the achievement of the world’s shared climate goals.

Investors are therefore increasingly challenging companies that are insufficiently transparent (or overly optimistic) in their assumptions for fossil-fuel demand growth. At ExxonMobil*, a majority of shareholders have voted to add three new directors to the company board, amid dissatisfaction with the company’s climate and capital-allocation strategy. Supporting the activist investors pushing for this change formed an important part of the escalation of LGIM’s engagement, which included making our stance publicly known ahead of the AGM.

Activist investors and investor activists

One of the many remarkable aspects of the Exxon campaign was that a hedge fund less than a year old has managed to shake up the board at the once-largest company in the world by rallying support from major fund houses. There have been similar developments in other sectors – for example, Tesco* has set targets for increased sales of healthier products, some of the UK’s largest banks have pledged to reduce their financed emissions and coal exposure following shareholder campaigns led by investor-backed NGO ShareAction, and a record 81% of shareholders have called on DuPont* to report on how much of the company’s plastic ends up in the environment.

In each of these cases, the companies involved could – up to a point – object that it is customers and governments who ultimately decide how much ‘junk food’ is consumed, coal is burnt or plastic purchased. And yet in all cases, investors asked the companies to face up to the potential risks from simply waiting for government intervention (which may eventually be more drastic the more it is delayed).

Takeaway #2: the management of environmental, social and governance (ESG) risks is becoming the focal point for new modes of both collaboration and confrontation between companies, their investors and broader stakeholders.

The examples above – financials, chemicals, food retailers – also point to the broader scrutiny of climate and ESG risks outside the ‘usual suspects’ in the fossil-fuel industry. Indeed, the recognition of the need to address the market-wide risks and opportunities from climate change was a key part of LGIM’s decision to broaden the number of companies and sectors under our Climate Impact Pledge engagement programme.

Later this month, we will be announcing our annual ranking of corporate leaders and laggards on climate, alongside the latest results of our engagements – stay tuned!

 

*For illustrative purposes only. Reference to a particular security is on a historical basis and does not mean that the security is currently held or will be held within an LGIM portfolio. The above information does not constitute a recommendation to buy or sell any security.

 

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