Heads up US shale: Blackrock just joined Climate 100
Frontispiece: Flaring, fuel usage, venting and other sources of GHG emissions in onshore US oil & gas operations emit over 182 million tonnes CO2e per year, more than the combined emissions of a small country like Ireland.
Last week Blackrock, one of the world’s largest institutional investors, hit the news by announcing it was joining the Climate Action 100+ group which aims to influence companies to address climate change risks and reduce their GHG emissions. This follows pressure that has been mounting during 2019 from central banks and financial organizations and activist investor groups such as Boston Trust Walden and Mercy Investment Services.
This is a big deal for the US E&P sector which is already under pressure due to several years of underperformance and disappointing returns. Balance sheets are creaking due to excessive borrowing to fund rapid production growth and Debt/Equity ratios are above 2 for an alarming number of firms. While the super-majors have been variably responded to climate change concerns by adaption and initiatives to reduce the carbon intensity of their own operations, pure play US E&P firms have been at best slow to respond other than ignoring, deflecting or denying the risks associated with climate change.
Figure 1. 30+ US E&P companies with shale in their portfolio. (Source: Data - Yahoo Finance; Graphic - Capriole Energy)
Figure 1 illustrates the group of US E&P companies that I think need to take notice of this news. An inspection of the top institutional investors in these firms in Yahoo Finance yields an interesting picture of equity ownership for this group. A top ten holding can range from a few percent of the company’s equity to more than 10%. A coalition of the top three or four of these institutions could be a very powerful influence at Proxies, Annual General Meetings and the like. A divestment by one of them would send a very powerful signal to the others. Because of its size Conoco Phillips (COP) is the only company on Figure 1 that is also on the Climate Action 100+ list of targeted companies. Within the super-major sector, who are all included in the 100+ list, Exxon Mobil, Chevron, Shell, BP, Equinor, and Repsol all have US shale in their portfolio.
Figure 2: Equity value by Institutional Investor in their top ten holdings (Source: Data - Yahoo Finance; Graphic - Capriole Energy)
As Figure 2 illustrates a number of institutions are heavily invested in the sector as a whole. For the larger cap companies, largely with more robust balance sheets, the institutional investor group is fairly similar. Certainly Vanguard, Blackrock and State Street are nearly always significant investors in each of the companies (Figure 3). Fidelity, the fifth biggest investor in US shale by this measure, is already a signatory of the Climate Action 100+ group and Vanguard and JP Morgan are under pressure to respond more to climate change risks.
Figure 3: Top ten institutional holders of the top 10 equities by market cap. (Source: Data - Yahoo France; Graphic - Capriole Energy).
In addition to demonstrating to investors that they provide competitive returns on investment, I expect firms will need to at least analyze and declare the financial risk of long-lived hydrocarbon assets becoming stranded and left un-monetized. I also expect a growing pressure on these larger firms to distinguish themselves in environment performance, particularly with respect to GHG emissions in their own operations. For the group on the right hand half of Figure 1, the returns challenge coupled with the need to deliver deleverage of their balance sheets already seems daunting. Poor environmental performance could be the last nail in the coffin for investors in these firms. Interestingly there are a number of smaller Institutional Investors particularly exposed to this part of the sector. For example Dimensional Fund Advisors LP are exposed to a number of the riskier smaller firms.
What do US shale companies need to do about this? I’ve offered a number of times measures that executive teams and company boards can enforce to cause a transformation in operational and financial performance. One of those recommendations is to undergo a cultural and systemic change to imbibe operational excellence (e.g. Lean, 6 Sigma) into the business. Such attitudes and processes are focused on the elimination of defects and waste. Unnecessary energy consumption, leaks, venting and flaring are all examples of waste in the US shale business and offer huge potential in both cost efficiency and GHG emissions reduction. In addition boards need to carefully assess the robustness of the reserves to future scenarios, including ones of drastic demand reduction and hence low prices, even though they might think that scenario unlikely.
I have always been an optimist and a believer in the art of possibility. Extraordinary outcomes, beyond expectations informed by the past, can and have been delivered when someone makes a stand. As a potential advisor or non-executive I am available to energy companies who want to embrace the energy transition as an opportunity and need help with strategy, governance, capability and so on. Energy demand and particularly lower-carbon energy supply is also a huge risk to the rest of industry and commerce. Plan C Advisors is available to help the boards of companies of many different sectors consider and act on these and other climate-related risks.