Companies must think about strategies over 30 to 40-year horizons and commit to specific financial targets about behaving responsibly, warns Karina Litvack, head of governance and sustainable investment at fund manager F&C.
Litvack’s views matter because she controls the ‘responsible engagement overlay’, which accounts for £82.7 bn ($135 bn) of F&C’s £108 bn assets under management. She has strong views about a range of sectors, including oil and gas and banking, where she believes executives should get no bonuses if credit quality falls too low.
Some investor relations executives are likely to think of responsible engagement as a low priority. But 11 workers died as a result of BP’s oil spill in the Gulf of Mexico in June 2010, and BP’s share price fell by approximately 50 per cent. That’s no small matter.
While welcoming the comprehensive actions of BP and other energy groups since the oil spill, Litvack isn’t yet ready to relax about the risk of future disasters. ‘Am I confident there will not be another major oil spill? Of course not,’ she says. ‘Remember the Texas City disaster in 2005? BP assured us – and we believed it – that safety systems had been overhauled, but disaster still struck again.’
She asks executives how they map and prepare for the risks of highly unlikely (but potentially catastrophic) events, so-called black swans. ‘Of course they know and we know that it’s not rational to manage for that one-in-a-million event,’ Litvack concedes. ‘But what if the models are wrong, what happens if there is that black swan? The stock reply is, But it won’t happen. And I say, but what if it does? What’s the fallback? Neither Fukushima nor the Gulf of Mexico was supposed to happen, and the price is devastating.’
She characterises the main risks affecting the oil and gas industry in terms of time horizon. In the short and medium term, ‘frontier oil’ presents the biggest environmental and social risks. She points to the danger of spills in the fragile Arctic ecosystems, or kidnapping in the Sudan.
But the bigger problem has a 40-year horizon, she says: in the long term it is the transition to the low-carbon economy that will ultimately determine which petroleum companies survive and which go the way of the buggy whip. ‘Sooner or later, our political leaders will be forced to change course on the climate,’ she warns. “And it will constrain the oil and gas industry in a slow-boil way.’
The question of what constitutes medium and long term makes her note wryly the difficulties of a conversation between responsible investors and corporate executives. She and her colleagues see 2020 as the medium term, 2050 as the long term. Oil and gas executives naturally think long term because of the longevity of their assets, but find most of their investors are only interested in the next few years’ performance, so their financial reporting reflects this pressure for short-term results.
‘I say don’t tell us about the next year or two – what are your big changes? If you’re in oil and gas, how does your fuel mix position you for the coming decades?’
Litvack believes chairmen must ensure the business model evolves or face possible extinction. If their business strategy does not take sufficient account of the next 40 years – for example, by diversifying out of oil and into low-carbon energy – they must change. Recently she met the chairman of BP, Carl-Henric Svanberg, a former chief executive of Ericsson. ‘I said to him, You have come from technology. Imagine if Ericsson had been in telegrams. What would you have done? He took it well.’
Turning to the detail, she warns energy companies to do what they say about climate change. BP broke new ground and won praise by facing the climate challenge and pledging a transition to lower-carbon energy – through its branding as ‘Beyond Petroleum’. But its rhetoric went beyond its actions and its business mix was indistinguishable from its competitors’. These included ExxonMobil, which denied man-made climate change and funded pressure groups to block climate-friendly policies.
Facts sometimes affect public opinion less than PR, however. When ExxonMobil took action that was partly a bet climate change policy would happen, through its $41 bn acquisition of XTO, a shale gas producer, it did not win significant praise. That partly reflected ExxonMobil’s apparent unwillingness to play up to this angle or generally court its former critics.
Meaningful action includes investing significant amounts of capital expenditure in projects that will bear fruit in the medium term. Litvack points to Shell, which has signed binding agreements for a $12 bn downstream and bio fuels joint venture in Brazil with Cosan, a sugar producer.
In banking, she wants bonuses that ensure that if the bank’s credit quality goes below a threshold, bankers get no bonuses. ‘The principle is: safety first,’ she says.
She accepts that banks say they must have the exceptional few hundred executives at the top, and that requires outstanding pay. But she says the pay structure must create the right incentives in relation to risk-taking. ‘We want banks to be profitable, but we also want the whole system to be stable,’ she explains. ‘So if banks are somewhat less profitable in order to allow all other companies in which we invest to thrive, so be it.’