My Oxford colleague Professor Colin Mayer and I have written before about the campaign Engine No. 1, a new and small hedge fund, is waging against the oil and gas giant ExxonMobil. The purpose of their campaign is to place four directors on the board who can help the company create a business strategy that is both financially and environmentally sustainable. It is absolutely essential that all four be elected.
By way of a little context, ExxonMobil has dramatically underperformed its peers over the last 10 years (-57.2 percent in total return pre-COVID). Since 2010 its credit rating has been downgraded twice by S&P, which has put it on negative watch. Contributing to this downgrade is that its net debt has ballooned from $7 billion in 2010 to $63 billion in 2020. This debt has been used to fund projects at a spending rate greater than any of its peers, projects that require the highest oil breakeven price of any of its peers in order for them to be profitable. It has no credible plan to protect and create value during the inevitable energy transition.
A concise summary of the reality of ExxonMobil’s corporate strategy is, “As long as there’s oil and gas out there, we’re gonna drill for it. No matter the cost and how much money we lose in doing so.” An equally concise summary of their (roll up, roll up) Magical Mystery Tour strategy is, “Hey, not to worry. Thanks to our amazing efforts in carbon capture and storage, with a little bit of help from our algae friends, all will be well!”
These are admittedly concise summaries, so let me dig into each. I’ll start with the reality of what ExxonMobil has done and plans to do, taken from a brilliant 81-page analysis by Engine No. 1, “Reenergize ExxonMobil // Investor Presentation.” I will then take you on the company’s Mystery Tour (which is hoping to take you away) in its response to Engine No. 1: “Growing Shareholder Value in a Lower-Carbon Future,” an SEC filing, no less.
Engine No. 1’s analysis addresses six issues, provides some very constructive suggestions for how ExxonMobil can play an important role in creating a low-carbon future, and provides long-term demand projections which challenge many of the company’s basic assumptions. The document is a nice combination of careful empirical analysis, expert commentary, and points out contradictions and flaws in the company’s statements.
· Issue #1—Failure to Position ExxonMobil for Long-Term Value Creation: The company’s core plan is based on overly optimistic assumptions about demand growth for oil and gas. ExxonMobil is trying to shift the conversation to emissions intensity rather than total emissions and arguing that Scope 3 emissions are society’s problem, not its problem. It is investing in a large number of projects that will achieve mediocre returns. Among listed oil and gas companies, it scores the lowest in a Bloomberg Business Model Transition Score, and between 2015-2020 its low-carbon investments as a share of capital expenditures were the lowest of any oil and gas company (significantly less than 0.1 percent).
· Issue #2—Rhetoric Does Not Address Long-Term Business Risk from Emissions: I’m just guessing, but based on the numbers from Engine No. 1, I wouldn’t be surprised if ExxonMobil is spending more on advertising its miniscule efforts in things like carbon capture and storage (CCS) and biofuels (although it did do a cute commercial in which it said “Algae are amazing little critters…”) than the projects themselves. It has projected a wildly overoptimistic trajectory for carbon emission reductions, its carbon emissions intensity will increase through 2025, and yet laughably argues that it is in conformance with the Paris Agreement. It is completely unprepared for a carbon tax which would smack its gas business hard, a business it projects to be a major source of growth.
· Issue #3—Lack of Capital Allocation Discipline: The numbers here somewhat boggle the mind; they make you wonder if executive management and the board care about numbers at all. Returns on upstream projects (75 percent of capital expenditures) have been declining for years, even in times of high oil prices. The productivity of these expenditures has decline dramatically from 39-barrel oil equivalent (BOE) per $1,000 invested to less than 8 today. Its capital expenditures have outpaced cash generation and it is spending much more dramatically than its peers. This has all added up to the company entering the Value Destruction Zone (return on capital vs. weighted average cost of capital) in 2015 and projected to remain there through 2023.
· Issue #4—Little Reason to Trust Newfound Spending Discipline: The company has flip-flopped on its spending plans. Late last year, no doubt under pressure from the Engine No. 1 campaign, it announced spending cuts. A few days later it was like, “Uh, just kidding. We’re still gonna go get that oil and gas, just delaying it a bit.”
· Issue #5—Lack of Successful and Transformative Energy Experience on the Board: The company has a history of putting together good-looking gender and racially diverse boards of big-name CEOs from big name companies. None of them have had any energy experience. In a process rife with problems, ExxonMobil appointed three new directors. Two have no energy experience, a cable guy and a hedge fund manager. The third one is from a state oil and gas company that has no shareholders and a company with which ExxonMobil has had a long-term business relationship. Yet when Engine No. 1 proposed four people with outstanding experience across the energy spectrum, rather than even meeting with them, the board packed itself with these three new directors.
· Issue #6—Misaligned Incentives: In a feat of compensation structure magic, the CEO’s stock awards (60 percent of compensation) have gone from 132,000 in 2017 to 205,000 in 2020. During that same time period, the company’s market cap has gone from around $350 billion to around $176 billion. I mean, if the stock price is going down, you have to give the CEO more shares to pay rent and buy groceries, right?
And now, here’s my invitation for you to Step Right This Way! for the Mystery Tour (no need to make a reservation). The tour begins with a little chest beating with big numbers and how the company has the “Right strategy, strong performance, world class board.” It takes a few pot shots at Engine No. 1 about not engaging, a nice wave of the Wizard’s Wand from a company famous for not engaging with its investors. In a series of beautifully designed, multicolor graphics it eloquently waxes on about the energy transition and economic growth, low carbon solutions, how much they mean to the company, and how uniquely positioned the company is to pursue them with its strong capabilities. Particular flourish is given to biofuels and CCS. The company projects that their amazing little critters will produce around 10,000 barrels in 2025, about 0.02 percent of the company’s total refining capacity. These critters need to make more babies soon, and they all have to work harder!
But the really magical fantasy part (satisfaction guaranteed) is in the company’s discussion of carbon capture and storage (CCS), beginning on p. 13. Then the rabbit pops out of the hat on p. 15 with plans for the Houston CCS Innovation zone. The company is so enamored of CCS that it has produced advertisements of how it’s going to spend $100 billion on this to mitigate around 100 million tonnes of CO2 annually. Sounds good, right? But here’s where the magic starts to fade. Much of the captured carbon is going into forcing more oil out of the ground. The project is also not viable without a tax on carbon, a tax which would basically gut the company’s entire business model.
Reflecting on this elegant legerdemain, Professor David Victor, a convening lead author for the Intergovernmental Panel on Climate Change (IPCC), observed that, “Here’s the sad truth on this PR exercise. ExxonMobil’s Houston project does not exist. Nor are there any signs that the vision, for which the firm has offered barely more detail than a college book report, is being readied for investment. The project’s $100 billion-plus price tag isn’t something ExxonMobil plans to pay for itself—instead, it wants massive government support.”
Andrew Logan, Senior Director Oil & Gas at Ceres, further explained, “Exxon is counting on carbon capture as a get-out-of-jail free card that will allow it to continue growing oil and gas production and still somehow align with a Paris-compliant trajectory. The problem is that CCS has been 15 years from commercial scale-up for the past 15 years, and this announcement doesn’t do anything concrete to speed up the process. If Exxon actually believed in the potential of CCS, it would set a net zero Scope 3 target as Oxy has done. That it hasn’t suggests that even Exxon doesn’t believe its rhetoric on carbon capture.”
So your taxpayer dollars would be going to help save ExxonMobil’s business model for a technology which is unproven at any meaningful scale. In the meantime, some of its more thoughtful competitors are investing in proven and profitable renewable energy technologies.
I realize ExxonMobil was hoping to take you away on their tour and maybe you were hoping it would give you everything you need. But now it’s time to wake up and get back to reality. What can the company do to get itself out of the deep hole it’s dug for itself over the years? It’s actually pretty straightforward. It’s not conceptually difficult but it will require a change in mindset and a big dose of humility, both no doubt hard for this company’s executive team and board to swallow.
Engine No. 1 has four sensible recommendations that will benefit investors, the environment, and the company itself that involve board composition, long-term strategy, capital allocation, and incentives.
First, and this is absolutely essential, the company needs four new board members: Greg Goff (proven value creator in the oil and gas industry), Kaisa Hietala (same and also proven value creator in oil and gas transition), Anders Runevad (deep understanding of impact of technological change and falling costs on various forms of energy), and Alexander Karsner (decades of energy experience, regulatory experience, and expertise in new energy technologies). Commenting on these nominees, Aeisha Mastagni, a Portfolio Manager within the Sustainable Investment & Stewardship Strategies Unit at CalSTRS, which is supporting the Engine No. 1 slate, commented that, ““ExxonMobil needs directors with expertise in energy and other industries under transition to effectively position the company for the long term. These candidates have the skills necessary to address ExxonMobil’s financial underperformance, align incentives with shareholder value creation, and prepare ExxonMobil for the global energy transition. We hope to see broad support for all four candidates.”
A revived board with the requisite expertise can then work with Chairman and CEO Darren Woods to craft a long-term strategy that gradually but purposefully repositions the company to succeed in a decarbonizing world. In its Mystery Tour the company complains that Engine No. 1 has not put forth a credible plan. Obviously, for it to do so would require information from inside the company.
The long-term strategy must include a long-term commitment to a coherent returns-focused strategy, something the company has consistently proven it is unable to do. With the right board, only the capital expenditures which make economic sense would be approved. Here the company would benefit from reading “Energy Transformations: Technology, Policy, Capital and the Murky Future of Oil and Gas” which Victor wrote in collaboration with Engine No. 1.
Finally, the proper incentive structure needs to be put in place which rewards management for creating shareholder value and not rewarding them for destroying it. This would include consistent metrics with disclosed preset weightings and targets, with more cost management and balance sheet-focused metrics; measuring value creation not just by reference to the oil and gas industry but to the overall market; and metrics tied to the energy transition. Examples include BP (40% weight), Shell (20%), and Total (25%).
In addition to CalSTRS, other major investors are coming out in favor of Engine No. 1’s slate of directors and plan, including CalPERS, the Church of England pension fund, and the New York State Common Retirement Fund. Anne Simpson, Managing Investment Director of Board Governance & Sustainability at CalPERS, and the investor representing Climate Action 100+ in its engagement with ExxonMobil stated that, ““Investors need climate competent boards to oversee the complex and vital task of developing credible strategies for managing the risks and opportunities of climate change. That can’t wait. As fiduciaries we need to ensure boards are equipped with the talent, skills and experience to get the job done.”
Engine No. 1’s campaign is a watershed moment in the needed energy transition. It has targeted exactly the right company to make the point. This is a moment of truth for all the asset owners and asset managers who have pledged their commitment to a net-zero world, as well as for the proxy voting firms, Glass Lewis and ISS.
Investors will vote their shares at the May 26 shareholder meeting. They have a choice to make. They can roll up, roll up with the company on its Magical Mystery tour. It will take them away to a place where they don’t want to be. More shareholder value destruction and more carbon poisoning our world.
Or they can vote for the Engine No. 1 slate. And, again, they need to vote for the entire slate in order for the board to have the critical mass it needs to put a new strategy in place. I am hoping that ExxonMobil’s shareholders will make the right decision. It’s a decision that matters to all of us.
