At the same time that oil and gas majors around the world are announcing plans to tie company climate action to employee remuneration, these same companies are still rewarding executives for pursuing traditional growth that will inevitably lead to stranded assets and financial loss for investors.
These are the findings from a new report from independent financial think-tank Carbon Tracker published this week entitled Paying with fire: How oil and gas executives are rewarded for chasing growth and why shareholders could get burned. The report focuses on the metrics that are used in the remuneration schemes by 40 of the largest listed oil and gas companies in North America, Europe, and Australia, and highlights those metrics that are inconsistent with investor concern over the future strength of the oil and gas industries. Specifically, as investors continue to increase pressure on oil and gas majors to conform to climate targets enshrined in the Paris Climate Agreement, and as renewable energy costs continue to fall and, therefore, eat into the market traditionally owned by the fossil fuel industry, business-as-usual methods must fall by the wayside as oil and gas lose their market dominance.
Carbon Tracker warns of oil and gas companies that continue to maximize production risk by overinvesting and wasting money on projects that deliver poor returns and destroy value alike. Specifically, the report deems that “For fossil fuel companies to navigate the energy transition will require them to focus exclusively on extracting value from a smaller opportunity set rather than expansion for its own sake. “
“The vast majority of oil and gas companies incentivise their executives to chase growth — behaviour that risks destroying value given uncertainty over future demand,” explained Andrew Grant, Senior Analyst at Carbon Tracker and author of the report. “This report provides shareholders with the ammunition they need to challenge this approach and press for remuneration policies which reward executives for delivering solid financial returns.”
Paying with Fire shows that 92% of oil and gas companies include remuneration measures that directly incentivise and ward growth in fossil fuel development — relating to either production, reserves, or both — with companies such as Anadarko, Cabot Oil & Gas, CNRL, and Oil Search boasting the highest weightings on growth.
Conversely, only three companies — Galp Energia, Diamondback Energy, and Origin Energy — did not include production or reserves growth in their incentive structures in 2017, while BP and Equinor joined this list in 2018. Unfortunately, 4 of these 5 companies have other metrics that indirectly reward such growth, “but in a less obvious manner.” Carbon Tracker highlights US-based company Diamondback Energy as the only company to have no growth metrics in its incentive structure for 2018, with its executives incentivized solely on returns and cost metrics. Norwegian energy company Equinor was the next closest with only a minor inclusion of cash flow from operations.
On the other side of the equation, only 9 companies have performance metrics that relate in some way to mitigating climate change — including half the European companies reviewed such as Equinor and Shell, but only one US company out of 20, ExxonMobil, and this, relating only to its algae, CCS, and methane reduction initiatives. Unfortunately, even for those companies who include such climate-related remuneration incentives, these metrics tend to only impact a small minority of compensation, and most of these companies also encourage fossil fuel growth.
“We believe that oil and gas companies should focus on extracting maximum value whether demand is growing or not — but particularly so in a low-carbon transition,” said Andrew Grant. “Focusing on generating the highest returns may mean getting smaller in terms of absolute production, as capital is returned to shareholders or redeployed in other sectors where sufficiently low cost oil and gas project options aren’t available. Executives should not have pay packets that reward them for chasing ever greater volumes of reserves and output.”
I asked Andrew Grant what he felt was necessary on the part of the oil and gas companies to fall in line with what is necessary and put aside business-as-usual practices. “Abandoning the pursuit of growth will probably require a fundamental shift of mindset, which may well be protracted process,” Grant explained, “although investor pressure will help, and attention has already been sharpened on prioritising returns following the recent oil price crash. However, we believe that companies need to go further.”
From the investor side of things, Grant believes that “Investors can put pressure on companies through a number of routes – engagement with management, submitting shareholder resolutions, and voting at AGMs. Investor pressure to focus on value rather than growth for the sake of growth has already had an effect – there has been something of a shift towards financial returns performance conditions, although the large majority of companies still retain growth incentives. A shareholder resolution at BP resulted in them dropping their reserves replacement metric – BP’s remuneration committee agreed that it “does not fit with the group’s strategic focus on ‘value over volume’.”
Carbon Tracker’s report also comes after several high-profile oil and gas majors made announcements that heralded further cooperation with investors on climate issues. In just the last three months Shell, BP, and Chevron have all made announcements which, although not in any way comprehensive, nevertheless signal the growing strength of investors and the strain being felt by fossil fuel companies.
“The recent announcements from Shell and Chevron about linking emissions performance to executive pay will relate to future years, and full details have not been disclosed,” said Grant, in response to whether any of these recent announcements impacted the findings of the report. “Chevron’s targets relate to methane emissions and flaring reductions only, whereas Shell’s will include other sources and in particular scope 3 emissions – those produced when using the oil/gas, and by far the bulk of life cycle emissions relating to fossil fuels.
“Measures to reduce pollution are of course a worthy objective, but there remains the more central issue. The ‘carbon budget’ of emissions that can be released while meeting our climate commitments is finite, yet both of these companies currently incentivise their management to continue increasing production of oil and gas. Shell and Chevron have the option of rebalancing their pay policies away from such production incentives in future, but so far they have not indicated this intention.”