Big Oil CEOs have personal reason to focus more on less fossil fuels

A Shell employee walks past the company’s new Quest Carbon Capture and Storage (CCS) facility in Fort Saskatchewan, Alberta, Canada, October 7, 2021.

Todd Korol | Reuters

With energy demand turning back and commodity market pundits talking about $100 of oil back, new factors in the energy sector are pushing producers to extract less — from greater fiscal discipline in US shale after a decade-long stagnation to stress ESG and the ways in which energy executives are paid by shareholders.

In 2018, Royal Dutch Shell became the first major oil company to tie ESG to executive pay, allocating 10% of its Long Term Incentive Plans (LTIP) to reduce carbon emissions. BP followed suit, using ESG metrics in both its annual bonus and LTIP. While the major European companies were at the top, Chevron and Marathon Oil are among the US-based oil companies that have added greenhouse gas emissions targets to their executive compensation plans.

Oil and gas companies are joining dozens of public companies in all sectors — including Apple, Clorox, PepsiCo and Starbucks — that link ESG to executive pay. Last week, industrial Caterpillar finally created the position of Chief Sustainability and Strategy and said it will now tie a portion of its executives’ compensation to ESG.

As of last year, 51% of S&P 500 companies used some form of ESG metrics in their executive compensation plans, according to a report by Willis Towers Watson. Half of companies include ESG in annual bonus or incentive plans, while only 4% use it in long-term incentive plans (LTIP). A similar report from PricewaterhouseCoopers (PwC) found that 45% of FTSE 100 companies have an ESG target in annual bonus, LTIP or both.

“We will continue to see the percentage of companies [linking ESG to pay] “And while more than 95% of ESG instances currently are annual bonuses, there is a greater shift toward long-term incentives,” said Ken Cook, senior director of talent and rewards at Willis Towers Watson.

A company survey last year of board members and senior executives revealed that nearly four in five respondents (78%) plan to change how ESG is used with their executive incentive plans over the next three years. This reflects the current debate about the purpose of profit in the corporate world, with the environment as a top priority.

Pressure on the fossil fuel industry

In 2020, petroleum made up about a third of US energy consumption, but it was the source of 45% of all energy-related carbon dioxide emissions, according to the US Energy Information Administration. Natural gas also provides about a third of the country’s energy and produces 36% of carbon dioxide emissions. Oil and gas companies have largely abandoned coal, which accounts for about 10% of energy use and accounts for nearly 19% of emissions.

Investors are increasingly focusing on environmental, social and corporate governance, and more pressure on the fossil fuel industry to reduce the global carbon footprint and risks associated with operations and bottom line profits. “The increase in the momentum that the investment community has put in place around ESG is driving the climate debate [change]”We cannot underestimate the impact that investors will have over the next two years,” said Phillippa O’Connor, a partner at London-based PwC who specializes in executive pay.

Investor input played a critical role in Shell’s fundamental decision, as well as in the decision of competitors who followed suit. And while executive compensation wasn’t high on the agenda at Exxon Mobil’s shareholder meeting last spring, the industry was amazed when the No. 1 climate activist hedge fund won three seats on its board. The reversal, as has been described at length, could eventually reduce Exxon’s reliance on carbon-based companies and move them further toward investments in solar, wind, and other renewables—and in the process lead to pay packages associated with environmental, social and corporate governance.

“We look forward to working with all of our directors to build on the progress we have made to increase long-term shareholder value and succeed in a low-carbon future,” Darren Woods, Exxon Chairman and CEO, said in a statement shortly after the proxy voting.

Meanwhile, financial regulators are also looking at climate change as a factor that investors should consider. The Securities and Exchange Commission has indicated that ESG disclosure regulation will be a major focus under new chairman Gary Gensler, from climate to other ESG factors such as business conditions.

There is nothing new about motivating corporate leaders to achieve predetermined goals, especially to increase revenue, profits, and shareholder returns in certain increments. Oil and gas companies, due to their hazardous extractions — from underground fracking wells to offshore drilling rigs — have for years had incentives to improve workplace safety.

In the wake of the Enron accounting and fraud scandal in 2001, fulfillment of new governance mandates (the Sarbanes-Oxley Act) was the basis for bonuses. Then came the added bonus of achieving the set internal goals of quality, health and wellness, recycling, energy conservation and community service – within CSR. Sustainability then became a magnet for creating executive performance metrics on environmental stewardship, diversity, equity and inclusion (DEI) in the workplace and ethical business practices – all of which are now under the ESG umbrella.

ESG is tough, and current carbon targets have critics

Although this trend is expected to continue, experts warn that the process can be deceptive, and the goals oil and gas companies have designed to combat the climate already have critics.

Including emissions reduction targets in executive pay packages could force oil and gas companies to press ahead with the PR talk about being good corporate citizens. However, the methodology can be challenging. “It’s not the what, but the how,” said Christian Malik, industry analyst at JPMorgan. For example, a company can specify how much to reduce global carbon emissions in a given year. “But that’s very limited, because they don’t disclose their emissions by region,” he said, which can vary widely from site to site. “When it comes to carbon density, it’s in [overall] a file.”

Or the company could engage in greenwashing through carbon offsets. “I have huge emissions, so I will do it [plant] A group of forests, in this way I neutralize myself,” said the owner – while the company still produces the same amount of emissions. You reveal better visually than they actually are. Disclosure must work hand in hand with compensation.”

The optics of oil and gas companies that pay well for doing good may help improve the industry’s image among the general public who are increasingly concerned about the catastrophic effects of human-caused climate change, exacerbated by the latest, relevant UN reports, and a series of deadly floods and hurricanes. heat waves and forest fires. But experts focused on the climate and energy sector note that sector goals often do not go far enough, in terms of reducing the intensity of fossil fuel operations, not primary production of fossil fuels, and dealing only with Scope 1 and Scope 2 emissions, not Scope 3 emissions that account for the largest share of the climate problem.

O’Connor said companies should be careful how they align ESG metrics with incentives. “ESG is a broad and complex set of metrics and expectations,” she said. “This is one of the reasons why we see a number of companies using multiple metrics instead of one, to get a better balance of considerations and perspectives across the ESG forum. There is no one-size-fits-all policy in this, and there is a risk in trying to move too quickly and back into a kind of of standards.”

The pandemic has put an unexpected peak on compensation incentives in 2020, and with the global economy imploding last year, the Shell Compensation Board decided to waive bonuses to CEO Ben van Beurden, CFO Jessica Uhl and other top executives, and there was no direct link between them. their LTIPs to deliver energy transition targets.

The energy sector has rebounded this year amid strong global economic growth and demand for oil and gas amid falling supply has pushed up prices. This could incentivize oil and gas companies to produce more, but at the same time, increase compensation for their energy transition goals. At Shell, the 2021 annual bonus target is 120% of the CEO and CFO’s base salary, which remains the same as set in 2020, at $1,842,530 and $1,200,900, respectively. Within this, though, progress in the energy transition is now up from 10% to 15% of the total amount that can be awarded. In addition, the energy transition is part of a LTIP that extends three years into the future, based on Shell’s 2020 annual report.

Oil prices have rebounded sharply amid limited supply and demand growth from the worst of the pandemic, but more oil and gas companies are linking CEOs’ near and long-term salaries to energy transition goals, led by Royal Dutch Shell.

According to a 2019 McKinsey study, there is mounting evidence that ESG adoption is not just a feel-good fad, but that when done right, it creates value. And that might be enough to convince more oil and gas companies to tie it up for compensation, especially since it’s one of the few industries where ESG is present, Cook said. “Sometimes we think of ESG in the context of doing good, which is fine. But I still think there must be a business reason for everything. And only when you have a business reason will ESG prevail.”

The harmful role of carbon emissions in climate change will continue to pressure oil and gas companies to adopt the IEA’s goal of achieving net zero by 2050. In addition to complying with regulatory mandates, however, linking reduction targets to CEO compensation may be a critical driver in influence change.

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