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Industry Trend

Majors’ Transition Goals to Test Investor Patience

Copyright © 2021 Energy Intelligence Group
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  • Activist and mainstream investors have shaken up strategies across the oil industry, and beyond, amid a wider awareness of environmental, social and corporate governance (ESG) issues.
  • Their focus has evolved rapidly from disclosure to targets to action and strategy, with US companies now also in investors’ crosshairs.
  • Perceived lofty promises by Western majors to set credible, transparent goals to curb emissions and grow clean energy businesses could test the limits of investor patience.

The Issue

From an investor perspective, much progress has been made in terms of the ambitious targets to curb emissions that have been set by the European majors. More recently, the momentum has switched to their US counterparts. But much work is still to be done by the majors to align themselves with the Paris climate goals. And the close investor scrutiny of their actions — in some cases, outright mistrust — is ever-present. Even the most radical climate advocates acknowledge that companies need some leeway to discern which technologies and pathways they must adopt while they continue to provide near-term upstream supplies. But investors at this year’s Energy Intelligence Forum reinforced the point that, although many energy transition pathways exist, the ultimate goal is net zero — and the majors must demonstrate that their commitment to getting there is genuine.

Balanced Transition

The Western majors are under intense pressure to set business plans and targets that comply with the Paris climate goals. They must align with investors’ expectations for bolder emissions cuts this decade, including Scope 3 (end-use emissions) targets and net-zero emissions by 2050. Investors also want to know whether companies can grow low-carbon businesses quickly enough to plug the gap left by shrinking hydrocarbons operations.

“Really, investors want to see both,” said Kim Fustier, director of oil and gas research at HSBC. Reducing emissions by putting oil and gas into “wind down mode” too quickly “is not a great investment proposition.” There’s still doubt among non-ESG investors that financial frameworks, dividends and buybacks can be resilient in that scenario, she noted. “Overall … there's a preference for a more balanced transition strategy where clean energies grow alongside a, more-or-less, stable hydrocarbons business in the short to medium term.”

No One-Size-Fits-All Strategy

Skepticism around corporate goals is growing, especially over intermediate targets. This is being driven by recent scientific climate warnings. Limiting global warming to 1.5 °C — in line with the most ambitious goals of the Paris Agreement — requires a reduction in emissions of around 40% by 2030 and getting to net zero by 2050. But none of the majors, despite their great promises, has set radical enough emissions targets to close that gap this decade, according to Mark van Baal, the founder of the Follow This investor group.

On the other hand, key investors acknowledge there must be flexibility for companies to determine the right pathway. "I don’t think there's going to be any one-size-fits-all strategy here," said Adam Matthews, head of responsible investing at the Church of England Pensions Board. “Each company will have different advantages … and some will evolve and change dramatically," he added. But low-carbon strategies must be turned into concrete action and investors also want to see capital alignment with those plans.

Transatlantic Divide

The jury is still out about the degree to which US oil companies' energy transition strategies might eventually resemble those of their European counterparts. HSBC’s Fustier believes US players will remain "quite different animals" for the next few years. For now, at least, the US majors can argue that their higher stock trading multiples validate their strategies, she said, also underlining the fundamental differences between US and European companies’ shareholder bases. Government policy also explains some of the divergence between the US and Europe, said Matthews, adding that the US may now catch up under President Joe Biden.

Moreover, investors have sent a significant signal, including through shareholder votes this year, that they want Scope 3 emissions addressed, especially at Exxon Mobil where shareholders voted to oust directors who rejected calls for more proactive climate measures. Top US companies — Occidental Petroleum excepted — have yet to set Scope 3 goals, just as oil companies in Europe once resisted curbs on product-use emissions, Van Baal said. Follow This drew majority support this year for resolutions supporting Scope 3 targets at ConocoPhillips, Phillips 66 and Chevron — with the latter this week setting a 2050 net-zero emissions goal for its upstream operations.

Reshaping Demand

Investors’ efforts to accelerate the transition must also focus on reshaping demand for fossil fuels, targeting sectors like aviation, shipping, road transport and haulage, according to Matthews. “That's where we can actually make the fundamental change and the companies then will have to be responsive to that,” he argued. Investors agree that current price spikes are indicative that society in Europe is still reliant on oil and gas. “It underlines the need to go further, faster in public policy,” Matthews added.

Rising prices have also intensified the debate over investment needs, underlining the need for a “measured approach to the transition,” in Fustier’s view. “Underinvestment creates risk of premature declines in supply and, therefore, price spikes, and these unintended consequences can be destabilizing,” she said. The current situation could potentially make it more acceptable for companies to approve new hydrocarbon projects for a few more years, particularly LNG schemes, she added. But Matthews insisted that companies cannot sit still. The Church of England will divest its holdings in companies that are not aligned with its transition pathway by 2023. This includes Royal Dutch Shell.

Shifting Assets and Emissions

Investors are also concerned about the risk of companies that, in the process of pursuing their own climate goals, offload oil and gas assets to players that may face less scrutiny. Such transactions might be "neutral at best, and counterproductive at worst," Fustier said, citing as an example BP’s sale of its fields in Alaska to a privately held company. And she suggested there could be a backlash against companies that overly rely on disposals. Van Baal said he had no issue with divestments, especially for big deals like Shell’s sale of its Permian Basin assets, if the proceeds were invested in cleaner ventures. But he said such moves would be of little benefit if the cash was simply returned to shareholders or invested in legacy businesses.

Companies are also counting on substantial nature-based solutions and carbon offsets to achieve net zero by 2050. Fustier said the priority must be on reducing emissions rather than capturing or offsetting them, and the scale of those implied negative emissions embedded within a company’s targets should be “realistic” and explicitly disclosed.

NOC Leverage

Nonetheless, listed international oil companies account for only a small percentage of the global oil and gas market and thus only a portion of the industry's emissions. State-owned entities account for most. Still, investors believe they can exert some influence here. Meanwhile, some large producing nations are already undertaking their own climate initiatives, with the United Arab Emirates announcing a net-zero emissions target last week.

Going forward, sovereign debt issues and refinancing could provide a lever to engage with national oil companies (NOCs) on climate issues, Matthews said. He cited a recent bond issue by Saudi Aramco, and asked: "Where was the climate assessment on that?" But he also noted that the decarbonization push by the Climate 100+ investor group had drawn interest from NOCs that wanted to know more. "That's an encouraging sign: That if you can move the public markets, then there is a sort of flow through to other companies," he said.

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