Can investors be confident that International Oil Companies (IOCs) are sustainable for the long term? Technological, policy and market trends intended to mitigate climate change threaten permanent displacement of oil demand. The long-term investments of oil companies may prove to be liabilities if future demand falls short of expectations. The potential implications for investors are significant, but uncertain since the likelihood and impact of these trends are difficult to forecast.
In uncertain circumstances, business strategies and practices that historically have served shareholders well may become a hindrance to adapting to new operating environments. The primary risk for oil companies is an inability to adapt to scenarios that fall outside of historical norms.
Given the difficulty of making accurate forecasts in an uncertain environment, the most useful current signal of how well a company is positioned for the long term is its corporate governance. While there is no doubt that oil companies are preparing for the future, the question for shareholders is whether the companies are envisioning a future that looks much like the present or preparing to adapt to societal change that could result in an entirely new operating environment.
As we discussed in our June 2017 piece, “Making Their Voices Heard: Shareholders Vote for Greater Transparency on Climate Change,” a majority of shareholders at two IOCs and more than 40% at a few others supported proposals asking companies to disclose an analysis of the impact on their businesses of a global shift to a “low carbon” economy – one in which greenhouse gas emissions are sharply curtailed in order to limit global warming to 2 degrees Celsius. Some companies, such as Shell, Statoil and Total, have done so. Within the past few days, Exxon Mobil has promised to produce a report as well.
While these analyses are important, we believe oil company shareholders should be primarily concerned with whether the company has adopted practices for governance, disclosure and engagement that indicate flexibility and resilience in the face of secular decline for its primary product.
We explore six key questions to guide investors as they engage with oil companies and review upcoming climate risk reports:
- Does the company’s reporting include a scenario that envisions disruption to its own production?
- How transparent is the company regarding resilience of its resource base to secular price changes, both in aggregate and by asset type?
- Does the company’s strategy provide a realistic path to meeting investor expectations in a low carbon scenario?
- Is the company’s board composition and process sufficient to execute its strategy in the case of disruption?
- Would executive compensation plans align shareholders and managers in a disruption scenario?
- What effect does the low carbon strategy have on the company’s stakeholder relationships?
Download the full report here.
John K.S. Wilson is the Head of Corporate Governance, Engagement & Research at Cornerstone Capital Group. He leads a multidisciplinary team that publishes investment research integrating Environmental, Social and Governance (ESG) issues into thematic equity research and manager due diligence. He also writes and presents widely about the relevance of corporate governance and sustainability to investment performance for academic, foundations, corporate and investor audiences. John has nearly two decades of experience in sustainable investing and corporate governance.