Shell and BP have recently started to tip-toe away from their climate-friendly pledges. It’s highlighted a key ESG risk at these companies that investors should be considering – governance.
Governance is the way a company is run. It’s the G in the ESG (environmental, social and governance) acronym and although it comes at the end, it’s arguably the most important.
Good governance is the linchpin that holds a successful strategy together. It also offers investors a level of trust that management are moving in the direction they’re expecting.
When times are tough, you might expect climate commitments to take a back seat. But given BP and Shell reported better-than-expected profits just last week, you’d be forgiven for questioning the need to change course. It calls into question whether their green energy strategies were really a priority, and whether we can expect further retreat if oil prices temper.
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Considering ESG issues can form a part of your investment analysis and decision-making process, but it shouldn’t be a replacement for fundamental financial research.
Is Shell looking for a way out?
When we look at the UK’s big oil companies, Shell appears more hesitant to embrace net zero. While the company has made strides to flesh out an energy transition plan, it’s taken more of a ‘wait-and-see’ approach than its peers.
It seemed when the group’s former Head of Integrated Gas and Renewables Wael Sawan took over as CEO, the strategy would evolve in a cleaner direction. This doesn’t appear to be the case. Although Shell’s committed to net zero by 2050, its existing targets focus only on its own operations and don’t account for the carbon generated by energy it sells.
On 30 January, the group announced it would be combining Renewables and Energy Solutions with its Downstream business – think things like low-carbon energy solutions and electric vehicle charging services. However, it’s also home to the group’s Chemicals and Products arm, which manages refineries that turn crude oil into a range of products.
Renewables and Energy Solutions is equally confusing, given it still deals in natural gas, a fossil fuel. So, the separation between Shell’s fossil fuel plays and its low-carbon alternatives is murky, to say the least.
This has opened the door for greenwashing allegations and a subsequent complaint to the Securities and Exchange Commission. NGO Global Witness has accused Shell of misleading investors about its commitment to renewables by rolling everything into a division with an ambiguous title.
The group’s highlighted a $2.4bn investment in the division as a part of its transition strategy. But, Global Witness suggests the real figure, once spending on oil and gas has been stripped out, is more like $288m.
The greenwashing accusations don’t stop there.
Another organisation, ClientEarth, is suing Shell’s board of directors. They claim that by not taking the transition to net zero seriously, Shell is letting down its shareholders by overlooking an important risk. The lawsuit doesn’t have a direct financial impact on Shell as a company. However, it does shine a light on an important issue – is Shell managing the energy transition risk appropriately?
Recent comments from Sawan suggest the impact of net zero on its legacy oil and gas business has dropped down the list of priorities. He’s also exploring the possibility of walking back plans to cut oil output by 1-2% each year this decade.
Where does Shell stand now?
The question now is whether Shell will back out of its transition commitments, which are already being called into question.
At the group’s 2022 AGM, a fifth of shareholders voted for a resolution calling for the board to adopt climate targets aligned with the Paris Agreement. Ultimately the group’s transition strategy was approved, but a reasonably high proportion of shareholders were unhappy.
Shell’s most recent results had no indication that the group is planning to reduce its climate commitments. But that sentiment could start to grow if the group walks back claims further.
Importantly, it brings into question how seriously the group’s taken the transition risk from the start. If Shell’s answer to questions regarding the validity of its transition strategy is to back away from it, investors might wonder whether it was ever a priority.
If climate risk isn’t on your radar, this might not feel like a big deal. But the idea that management can so quickly abandon one of its strategic focuses is a risk worth considering.
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BP chips away at its top spot
BP’s management has found itself in similar hot water after walking back its commitment to cut oil and gas output by 40% by 2030 to just 25%. CEO Bernard Looney said the revised target was thanks to increased demand due to the supply gaps created by the war in Ukraine.
He also said investment in oil and gas is a necessary step in the transition. By his rationale, cutting down the supply of the black stuff causes prices to jump which has a knock-on effect on the economy. Volatility, Looney said, would undermine support for the energy transition.
There’s some merit to his argument, but for many it’s overshadowed by BP’s apparent abandonment of its industry-leading transition strategy. When Looney took over as CEO, he pledged to reinvent the company as a green energy provider and ambitious emissions targets were a big part of that. BP has stood out among peers as one of the first to commit to managing the energy transition risk, and has probably attracted many climate-conscious investors because of it.
Given the group’s emissions target and sustainability strategy were approved by shareholders just nine months before the revision, many are understandably concerned.
Where does BP stand now?
Oil prices have started to come down from their previous highs, and that was evident in BP’s first quarter results. That’s not to say times are lean, though.
BP breaks even around $40 per barrel, well below the current price. If a global effort to cut oil demand is where the future is heading, now is a prime time to plough money into parts of the business that will thrive in a lower-carbon environment. It’s a big part of Looney’s rationale for maintaining higher-than-promised oil and gas outputs.
If Looney’s reasoning stands, the group will use its excess oil and gas income to drive its transition strategy forward. Only time will tell whether the group’s truly aiming to funnel its oil profits into cleaner alternatives. But investors can get a sense of the direction of travel from the group’s spending.
BP’s new climate strategy comes with a pledge to spend over 40% of capital expenditure (capex) on ‘transition growth engines’ by 2025. These are things like renewables, bioenergy and electric vehicle (EV) charging. They’re housed in different parts of the business, so pinpointing exactly where the cash ends up isn’t possible.
Of the $3.6bn spent the last quarter, around $400m went to low-carbon energy. A significant portion did go to Customers & Products, where EV charging and bioenergy is housed. But this segment is also home to BP’s service stations, aviation fuel, and refining and trading businesses, somewhat muddying the picture.
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