How should investors constructively engage with Oil & Gas companies?

Climate-related engagement: how should investors engage with oil & gas companies–insist they transition to renewable (pivot), or insist they liquidate once demand for oil & gas disappears (run down)? And what can we learn from how corporate raiders work?

“It is difficult to get a man to understand something, when his salary depends upon his not understanding it!” Upton Sinclair 1934

Sadly, there is no simple answer. Successfully engaging with Oil & Gas (O&G) companies depends much more on their individual characteristics than on what industry they sit in. I spent many years working at a large activist fund, and my argument is simple. The transition for the O&G sector is going to be really hard. To give it the best chance of success we need to think like an activist investor or a corporate raider.
When you say 'corporate raider' to people, they tend to picture Gordon Gekko from the movie Wall Street, or real world raiders such as T Boone Pickens. It's generally a derogatory term. So it might seem odd to argue that ESG investors can learn from how corporate raiders and activist investors work.

The bottom line is that we need to think about the transition company by company, rather than at an industry level. And use the language of finance wherever possible – it’s the language companies understand. This approach isn’t going to be cheap and it’s not going to be easy - but it's likely to work. Look at Engine No 1. It’s not about right or wrong, it’s what makes the best long term sense for the company and all of its stakeholders.

Our absolute number one rule -identify exactly what it was we want the company to do. And I mean exactly. Many debates start with peak oil, the risk of stranded assets, and the need to transition. This is a start, but we need to quickly move on to the company's individual circumstances. The first is probably how does their business model work, and what assets do they have? Are they lowest cost and easy to extract, or are they closer to the end of life and expensive? This requires a field by field review.

Then we have willingness. If senior management is unwilling to engage on the renewables option, it's unlikely that proposals to pivot to renewables would get traction. Conserve our resources for other battles.

What about expertise, or in other words competitive advantage? Some skills may transfer (say drilling into geothermal), but most will not. Compare running an O&G field to running a solar farm. And activities such as electricity supply, storage, grid stability, interconnectors etc are even more different. Many companies will be unable to build the resources required to successfully execute a pivot. For these companies, the best path is to run down.
So what concrete actions do we want from these companies? No new exploration is an obvious start, as is methane emission reductions. After that it gets tougher. Do we want them to be able to buy existing O&G fields? The answer to that could be 'yes', which may not sit comfortably with some stakeholders. But scale is important, and as the run-down gathers pace, we should support consolidation.

On the finance side, we should starve them of free cash to spend on new projects. So get them to distribute all of their free cash via dividends and share buybacks. This might get bad publicity. But it will make it harder for them to backtrack.

Of course some O&G companies will have the capability to pivot to renewables. They have the right culture, or they may just get the economic imperative. But take care. In lots of transitioning companies the power, and promotion prospects, can still lie within the old business. And we need a clear and very concrete plan. What technologies will be the focus? How will they build competitive advantage? How will they build a new culture? If they are just providing capital, the financial markets can do that much more efficiently.

So, what is our pitch to the O&G companies?

You need to transition, as there is a real risk of stranded assets. Our analysis leads to the view that for you the best option is rundown/pivot. If it's run down, no new fields and increased dividends; If it's pivot, we need a detailed “how to” plan. For both we need concrete metrics, so capex plans, dividend commitments - things we can track.

And to be clear, as well as supporting these companies’ strategy, we will be doing all we can to destroy their end markets. We will support the uptake of Electric Vehicles, the electrification of building heating/cooling and the replacement of fossil fuels in heavy industry. Given this, your selected decision is not just a nice to have, it's a commercial imperative. Doing nothing could be your Nokia “burning platform” moment.

Then  we build our alliances. We sell our plan to everyone who can help - politicians, NGO’s, existing & potential shareholders, and debt providers. This last group can be particularly helpful. If they believe that the company's credit position will deteriorate, they will be less willing to lend.

Our final rule was never personalise the debate. Why? By publically attacking someone, you make them defensive and they stop talking to you. And you help to persuade people in their organisation who might have become voices of reason and compromise, that they need to close ranks.

Reducing our reliance on fossil fuels is going to be tough. The simplified message of “no new oil and gas exploration” is a good start in terms of mobilising public opinion, but on its own it’s not enough. While our strategy is driven by our values, our tactics should be driven by what works. And in many cases its thinking and acting like a corporate raider. Use the tools of the financial system to create change.

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By Steven Bowen, founder of The Sustainable Investor blog and ex activist fund manager.

If you would like to read further articles in the 'Governance and Climate Change' series, click here 

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