Environment vs. Big Oil: The Hedge Fund’s Tale

The oil and gas industry is rarely unremarkable, but over the past two weeks there have been several events of note, including:

  • Biden renewing Chevron’s special license. The licence exempts the oil giant from the 2019 US imposed sanctions barring imports of Venezuelan oil and US dollar transactions made with PDVSA (Venezuela’s state oil company), essentially extending the time Chevron has to wind down its operations there to 01 December 2021.
  • ExxonMobil relinquishing its entire 80% stake in its deepwater oil prospect off the coast of Ghana (Deepwater Cape Three Points), leaving the venture’s two other participants (Ghana National Petroleum Corp. and Ghana Oil Co.) to search for a new operator. Meanwhile, on the other side of the planet, ExxonMobil is developing the offshore Bacalhau oilfield in Brazil with Norway’s Equinor acting as operator (each hold a 40% participating interest, with state-owned Petrobas taking the remaining 20%). They’re set to make a US$ 8 billion investment for phase one.

Unexpected news…

ExxonMobil’s other news, however, made larger headlines when, in a surprising twist, a small group of investors won three seats on its board of twelve directors. What makes this move so unusual is not – as one would expect – the fact that the investors, named Engine No. 1, are an environmental activist hedge fund established less than a year ago, but rather their success in securing these seats when they invested so little (a mere US$ 54 million, which is an absolute miniscule 0.02% stake). But how did this happen? And what exactly does this mean for the oil giant’s future?

As for the how, blame is being placed at CEO Darren Woods’ door: ExxonMobil losing US$ 25 billion last year to covid-19 is a big reason, especially since this was the company’s first loss since 1998. Even though they weren’t the only ones to suffer these kinds of figures, their shareholders were angry, including several large pension funds, advisory services and fund managers who ended up supporting the nominations. Compounding on this is the direction the company has chosen to follow in recent years. Instead of embracing the renewables trend, as its competitors have, its focus has remained staunchly on growing its ‘core competencies’ (i.e. its oil and gas business). While it is true that investment in renewable energies cannot match the current rates of return provided by fossil fuels, in taking this stance ExxonMobil has portrayed itself as stubbornly antiquated, quickly losing value and acting out of step with other global companies. Engine No. 1 took advantage, putting forward four very credible candidates with vast experience in the industry (the three successful ones were an oil refining exec, a biofuels programme exec and an energy dept. official), who offered detailed analysis (80 pages’ worth) blaming the company’s climate approach for their losses. It’s what the shareholders wanted to hear: the nominees were presenting them with a new direction of travel, a call for ExxonMobil to recognise that energy transition is a serious and unavoidable issue which must be addressed and planned for if the company is to survive, let alone thrive.

What does this mean?

As for how this will affect ExxonMobil, stocks have recovered as the world has begun to get back on its feet, but if they want stability over the long run, they’ll need to keep up with the times and diversify their options. The new directors only take up a quarter of the board, so they will be in a minority, and how pivotal a role they’ll play will depend on what committees they’ll infiltrate and what alliances they form among the other directors. As for their overall strategy for ExxonMobil and how environmentally conscious they actually aim to be, we might not have any certainties yet, but it’s worth remembering that Engine No. 1 is a hedge fund, not an environmental charity. Its main aim is to make a profit on its investment and climate change is factored into their planning because they view it as a real and serious business risk.

If nothing else, the very reason for Engine No. 1’s successful nominations and the events which led up to them suggests that the company will take a good look at its current ethos. Already under pressure at home from a number of lawsuits filed in several US states, and by the environmental pledges its competitors were making, last year ExxonMobil had announced prior to the shareholder’s annual meeting that they would be spending US$ 3 billion over the next half decade on a new ‘low carbon business unit’, which aims to cut the intensity of its CO2 emissions from its upstream production by 20% and the intensity of its more devastating methane emissions by 50%.

A smoke and mirror promise? How does it compare to others?

Their promises, however, fall far short of what many of the European major players have committed to: prompted by the Paris Agreement 2016 and the Greenhouse Gas Protocol (GHG Protocol), in early 2020 BP announced its pledge to achieve net-zero GHG emissions by 2050, forcing the metaphorical hands of both Royal Dutch Shell and Total to do the same.

These pledges do have some issues: none of them actually pledge to cut emissions directly – the most effective way of meeting their ‘net zero’ targets. Rather the goal is often to reduce ‘intensity’ and to offset production. And almost none of the companies’ pledges include scope 3 emissions.

Plans for offsetting emissions is dubious in and of itself, in that capture technology is not yet equipped to meet the requirements of the more ambitious pledges and the scale of reforestation is… questionable at best. The other problem, of course, is that offsetting and capturing doesn’t mean that fossil fuel emissions will necessarily be reduced – it is entirely possible for them to increase so long as they outsell them with renewable fuels.

As for scope 3 emissions, these are the most difficult to measure since they originate from assets not owned or controlled by the oil companies but that the organisation indirectly impacts in its value chain (e.g. transportation and distribution). BP did include such emissions in its pledge but deliberately excluded the scope 3 emissions coming from its stake in the Russian Rosneft, which accounts for nearly half of its total oil production. It’s still better than ExxonMobil’s pledge, which doesn’t include scope 3 emissions at all.

Even with their many loopholes, European big oil’s promises are far and above those offered by their American equivalents. Engine No. 1’s directors are in a prime position to move ExxonMobil forward in a way that will help them avoid what’s happened to Shell – more on that on the next blog post – but it’s a difficult path to navigate, involving steep changes and an about turn in direction for the mighty oil giant. One suspects, however, that the reason for the election of the new board members, combined with external pressures (international policy making and increasingly environmentally conscious state governments) and internal demands (shareholders and investors) will provide the company with sufficient motivation to make substantial change.

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