A Shell employee walks past the company’s new Quest Carbon Capture and Storage (CSC) facility in Fort Saskatchewan, Alberta, Canada, October 7, 2021.
Todd Korol | Reuters
As demand from the energy sector returns and commodity market experts talk about the return of $ 100 worth of oil, new factors in the energy sector are pushing producers to extract less – one more. great fiscal discipline in the American shale after a decade of crisis with ESG pressure and the way energy executives are paid by shareholders.
In 2018, Royal Dutch Shell became the first oil major to link ESG to executive pay, earmarking 10% of Long Term Incentive Plans (LTIP) to reduce carbon emissions. BP followed suit, using ESG metrics in both its annual bonus and its LTIP. While European majors were the first, Chevron and Marathon Oil were among the US-based oil companies that added greenhouse gas emissions targets to executive compensation plans.
Oil and gas companies join dozens of state-owned companies across industries – including Apple, Clorox, PepsiCo, and Starbucks – that tie ESG to executive pay. Last week, the industrial Caterpillar last created the post of chief sustainability and strategy officer and said he would now tie a portion of executive pay to ESG.
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 the 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 had an ESG target in the annual bonus, LTIP, or both.
“We will continue to see the percentage of companies [linking ESG to pay] increase, ”said Ken Kuk, senior director of talent and rewards at Willis Towers Watson. And although at present, over 95% of instances of ESG measures are annual bonuses, “there is a shift towards long-term incentives,” he mentioned.
A related survey the company conducted last year of board members and senior executives found that nearly four in five respondents (78%) are considering changing the way they use ESG with their plans. management incentive over the next three years. This reflects the current debate on purpose rather than profit in the corporate world, with the environment being the top priority.
Lobbying the fossil fuel industry
In 2020, oil accounted for about a third of U.S. energy use, but was responsible for 45% of total energy-related CO2 emissions, according to the US Energy Information Administration. Natural gas also provided about a third of the country’s energy and produced 36% of CO2 emissions. Oil and gas companies have largely moved away from coal, which accounted for about 10% of energy use and nearly 19% of emissions.
Investors are increasingly focusing on ESG and putting more pressure on the fossil fuel industry to reduce its global carbon footprint and the associated risks to operations and results. “The rise of the investment community around ESG is leading to the climate debate [change]”said Phillippa O’Connor, London-based PwC partner and executive compensation specialist.” We cannot underestimate the impact that investors will continue to have over the next two years.
The contribution of investors played a decisive role in Shell’s defining decision, as well as those of competitors who followed suit. And while executive pay was not very high at the Exxon Mobil shareholders meeting last spring, the industry was stunned when climate-activist hedge fund Engine No. 1 won three seats in the league. within its board of directors. The coup, as has been bluntly described, could ultimately reduce Exxon’s dependence on carbon-based companies and steer it more towards investments in solar, wind and energy. other renewable energy sources – and in the process lead to compensation packages linked to ESG.
“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,” said Darren Woods, President and CEO of Exxon, in a statement shortly after the proxy vote.
Meanwhile, financial regulators are also considering climate change as a factor for investors to consider. The Securities and Exchange Commission has indicated that regulating ESG disclosure will be a central focus under new chairman Gary Gensler, from the climate to other ESG factors such as working conditions.
There is nothing new about inspiring business leaders to achieve predetermined goals, especially to increase income, profits, and shareholder returns by certain increments. Oil and gas companies, because of their dangerous mining operations – from underground fracking wells to offshore drilling rigs – have for years established incentives to improve workplace safety.
Following the Enron accounting and fraud scandal in 2001, fulfilling new governance mandates (Sarbanes-Oxley Act) was the basis for the rewards. Then came additional compensation for meeting internal goals set for quality, health and wellness, recycling, energy conservation and community service, all included in corporate social responsibility. Sustainability then became the catch-all for establishing measures of executive performance around environmental stewardship, diversity, equity and inclusion (DCI) in the workplace and ethical business practices, which now fall under the ESG.
ESG is tricky and existing carbon targets have criticism
While the trend is expected to continue, experts warn that the process can be tricky and that the targets designed by oil and gas companies to tackle the climate already have criticism.
Including emission reduction targets in executive pay may force oil and gas companies to follow their public relations rhetoric about being good corporate citizens. Still, the methodology can be difficult. “It’s not the what, it’s the how,” said Christyan Malek, industry analyst at JP Morgan. For example, a company can report how much it has reduced its global carbon emissions in a given year. “But it’s very limited,” he said, “because they don’t disclose their shows by region,” which can vary widely from place to place. “In terms of carbon intensity, it is in the [overall] wallet.”
Or a business can engage in greenwashing through carbon offsets. “I have massive shows, so I’m going [plant] a bunch of forests, and that way I neutralize myself, ”Malek said – while the company still produces the same amount of emissions. “You are disclosing in a way that is optically better than it actually is. Disclosure must go hand in hand with compensation. “
The view that oil and gas companies pay well to do good could help the industry’s image with a general public increasingly concerned about the calamitous impacts of human-induced climate change exacerbated. by the latest UN report and a series of deadly floods, hurricanes, heat waves and wildfires. But climate and energy sector experts note that sector targets often don’t go far enough, related to reducing the intensity of fossil fuel operations, not the underlying fuel production. fossils, and only deal with scope 1 and scope 2 emissions, not Scope 3 emissions, which represent the largest part of the climate problem.
O’Connor said companies should be careful about how they align ESG metrics with incentives. “ESG is a large and complex set of metrics and expectations,” she said. “This is one of the reasons why we are seeing a number of companies using multiple metrics rather than a single measure, to achieve a better balance between considerations and perspectives on the ESG forum. There is no one-size-fits-all solution. policy in this area, and there is a danger in trying to go too fast and come back to some sort of standard. “
The pandemic has placed an unexpected cap on compensation incentives in 2020, and with the global economy decimated last year, Shell’s compensation board has decided to forgo bonuses for CEO Ben van Beurden, CFO Jessica Uhl and other senior executives, and there was no direct link in their LTIPs to achieving energy transition goals.
The energy sector has rebounded this year amid strong global economic growth, and demand for oil and gas amid declining supply has driven prices soaring. This could encourage oil and gas companies to produce more, but at the same time, the compensation for energy transition goals will increase. At Shell, the 2021 annual bonus is targeted at 120% of base salary for the CEO and CFO, which remains the same as set in 2020, at $ 1,842,530 and $ 1,200,900, respectively. In this context, progress in the energy transition has now gone from 10% to 15% of the total amount that can be awarded. In addition, the energy transition is part of the LTIP which is acquired in three years, on the basis of Shell’s 2020 annual report.
Oil prices have rebounded strongly amid limited growth in supply and demand after the worst of the pandemic, but more and more oil and gas companies are tying short- and long-term executive compensation to energy transition objectives, led by Royal Dutch Shell.
According to a 2019 McKinsey study, it is increasingly clear that adopting ESG is not only a wellness fad, but that when done right, it creates value. And that may be enough to convince more oil and gas companies to link it to offsetting, especially because it’s one of the few industries where ESG is existential, Kuk said. “Sometimes we think of ESG in the context of doing good, and it feels good. But I always think there has to be a business reason for everything. And that’s only when you have a reason. commercial than ESG will prevail. “
The deleterious role carbon emissions play in climate change will continue to pressure oil and gas companies to adhere to the International Energy Agency’s goal of reaching net zero by now 2050. Beyond meeting regulatory mandates, however, linking reduction targets to executive compensation can be a key driver in influencing change.