Why we should abandon climate engagement with oil and gas firms
Joel Moreland, principal consultant Social and Environmental Finance argues that there is little benefit in engaging with oil and gas firms on climate targets
The decision last week by the 10th largest pension fund in the world, the Dutch PZFM, that it can’t influence oil & gas companies comes off the back of the Church of England reaching the same conclusion last year. These are just the high profile names amongst a growing number of asset owners deciding engagement is not working with fossil fuel companies.
It is time to consider not whether we engage or divest but if there are sectors where engagement hasn’t and can’t work.
I’ll be using the terms engagement to cover from AGM voting to (forceful) stewardship and beyond to the most aggressive engagement practised i.e., by activists investors.
I used to work in activist investing and although we might not agree with all the practices (layoffs and loading up on debt) we can certainly agree it is the epitome of forceful stewardship, with regularly large chunks of the board and senior management sacked. Activists focus mostly on financial engineering (increasing debt, increasing dividends and tax driven actions); selling off non-core activities/geographies; M&A; replacing management/overhauling governance; cost cutting (layoffs, pressuring suppliers, increasing prices); etc. They do this by building a coalition of investors; negotiating with management; PR campaigns; reports; voting against management; replacing members of the board and ultimately management.
The important point in all of this is the activist managers never try to change or wind up the core business activity of the company. The definition of core business activity/model seems to cause some confusion. I define it as what is at the centre of everything a company does, eg, a supermarket buys products and sells them to consumers, typically in a weekly shop of multiple items but often they have non-core activities like credit cards.
Generally, the main reason an activist invests in a company is where they see real value in the core business and that everything around it is holding the core business back.
There is also no evidence from corporate history that a sector in terminal decline transforms from one core business activity to another or profitably winds up its main business activity. For instance, in the UK, the early part of the industrial revolution was powered by a large canal network but when the railways came along, the canal industry was decimated and only ONE canal company tried to operate a railway and they failed shortly afterwards. Every other example from everywhere in corporate history is the same.
We see individual companies making significant transitions but these are rare and exceedingly painful for investors, eg, Apple & IBM. NB Orsted doesn’t count as a core business transformation as they just sold their fossil assets off so there was no impact on emissions. Also Exxon and Engine No1 doesn’t count as fossil fuel capex has risen, this is because changing directors doesn’t change the core business model – investors tried this before with Exxon in the early 1990s, after the Exxon Valdez oil spill, and it didn’t stop the ramp up of their climate denial activities in the 1990s and beyond.
Oil and gas companies supply oil and gas, that is core to their business. It will not transform and it will not be wound down profitably, with or without investor engagement on climate change. If we are being picky, investor engagement can cut O&G Scope 1 & 2 emissions (not scope 3), and they have to some degree, but I don’t think any of us would count this as a win because it is so easily used as a green-smokescreen for delay.
As there is no prospect of success, engagement with oil & gas companies is a waste of money and time (and consequently potentially a breach of fiduciary duty) but the much greater risk is that it gives the impression of action when there is none. This gives governments cover for inaction and we have seen this with, for example, two UK government ministers encouraging engagement with oil & gas companies and thereby avoiding their governments own responsibility for this systemic issue.
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As I flagged at the beginning this is not a debate about divestment versus engagement because the choice can be between engaging with oil & gas companies on climate change and remaining invested but not engaging with them on climate change (the evidence is latter of these two choices is preferable, as outlined above, even if it may be counterintuitive to some).
If we care about impact then we need to base our actions on evidence. Divestment of a single sector has no material impact on long term returns so if you don’t like the thought of owning O&G, but not engaging with them on climate, then fossil fuel divestment has no downsides.
For those who ascribe to universal ownership, an alternative strategy that is higher return, lower risk and has a larger impact should be to spend the bulk of our time engaging with the governments rather than corporates, as I argue in more detail here.
Governments have a track record of winding down polluting industries (I know it is always too late but that is better than never by shareholder engagement). Lobbying has worked since the dawn of time and we have seen the likes of the Koch brothers, Exxon and others being very successful lobbying on environmental issues (albeit not in a positive direction).
Investors can do a lot of good but we can’t solve every problem, particularly systemic ones, so we need to focus our budgets on where we can have the greatest impacts.