When Wall Street takes on Big Oil

Welcome to Catastrophic Global Risk Week

From Claire—Asteroid impacts. Gamma ray bursts. Nuclear war. Biological weapons. Artificial intelligence. Disinformation. Atomically-precise 3D printers. Autonomous nanobots. Physics disasters. Stratospheric geoengineering.

Inspired by the public’s dawning realization that yes, Covid19 could very well have escaped from a Wuhan lab, we’ll be looking over the coming week at global catastrophic risks. Are we sleepwalking toward extinction? How should we think about catastrophic and existential risks? Can we quantify them? Is there a rational way to assess how much we should spend or sacrifice to mitigate them?

Today, in a bridge from Energy Week to Catastrophic Risk Week, Vivek Kelkar writes about striking new developments in the law and economics of climate risk. Apart from this essay, though, we won’t be considering climate change as a catastrophic risk. We figure we’ve written enough about this recently, and so has everyone else. The public is acutely aware that climate change poses a risk to human well-being. We’re concerned, however, that our focus on one risk is giving rise to tunnel vision in policy, blinding us to a host of other risks that require our urgent attention. Indeed, as Vivek’s essay suggests, our efforts to mitigate climate risk may well raise the risk of other disasters.

If you have a scenario you’d like us to consider for or an essay you’d like to contribute, please let us know.


Mea culpa. We gave you the wrong address for the book club. As many of you pointed out. Here’s the right address:


Big Oil Roiled

Vivek Kelkar, Mumbai

By the standards of global capital markets, Engine No. 1 is puny. It has only 22 employees and manages a mere US$240 million in assets. But in the last few weeks it succeeded in upending the governance of ExxonMobil—a corporation worth over US$250 billion. Yesterday, capping off a month of furious politicking, Exxon’s shareholders elected a third Engine No. 1 candidate to their Board of Directors. The new members have pledged to change Exxon’s raison d’être, arguing that the Board needs “directors with experience in successful and profitable energy industry transformations who can help turn aspirations of addressing the risks of climate change into a long-term business plan, not talking points.”

Engine No. 1 describes itself as “an investment firm purpose-built to create long-term value by harnessing the power of capitalism,” but this anodyne description conceals the brilliance of the strategy it employed to get three directors whose views are sympathetic to climate change activists on the Exxon board.

This is just one of a series of events that last month sent shockwaves through the world of Big Oil. In early May, a district court in the Hague ordered Royal Dutch Shell to cut its global carbon emissions by 45 percent before 2030. These cuts are much steeper than those Shell has proposed.

Lawyers for the plaintiffs represented seven activist groups, including Friends of the Earth and Greenpeace, on behalf of 17,200 Dutch citizens. The plaintiffs argued that in failing to take more aggressive measures to mitigate climate risk, Shell was in breach of article 6:162 of the Dutch Civil Code and Articles 2 and 8 of the European Convention on Human Rights. Shell, they said, was violating human rights by not doing enough to fight global warming.

The court agreed. Shell will appeal, of course. But the decision sends a very clear message: From now on, claims of climate damage are litigable.

Weeks before, Shell had asked its shareholders to vote on a non-binding resolution treating the corporation’s energy transition strategy. Under the terms of the resolution, Shell would eliminate net carbon emissions by 2050 while expanding its renewable and low-carbon portfolios. The plan involved cutting net emissions by 20 percent before 2030, 45 percent before 2035, and completely before 2050—considerably shy of Paris Treaty targets for absolute emissions in 2030. Nearly 89 percent of the shareholders voted in favor.

But another activist group, Follow This, quickly rendered these votes redundant. Backed by Shell’s proxy advisor, Pensions & Investment Research Consultants (PIRC), Follow This put forth a competing resolution in favor of a much more aggressive policy. Shell is usually seen as the far-sighted oil major, but PIRC does not agree: Shell, they wrote, “does not seem to have a clear plan for the competitive aspects of the energy transition.” The competing resolution won more than 30 percent of the shareholders’ support. Under UK governance codes, this means Shell now has to go back and debate the issue with its shareholders all over again.

Engines of change

Typically, no one would take a fund with a name like Engine No.1 seriously, especially when  it holds less than one percent of Exxon’s stock. But no one’s laughing. Engine No.1 managed to win over three of the company’s biggest shareholders, and indeed three of the largest global investors in equity markets: BlackRock, Vanguard and State Street Corp. They also garnered the support of CalSTRs, one of the United States’ biggest pension funds. BlackRock recently joined Climate Action 100+, a group of 545 institutional investors committed to greenhouse gas emission reductions. Together, Climate Action 100+ manages US$52 trillion— nearly half of all the managed assets in the world.

Milton Friedman famously argued that a company’s only obligation is to its shareholders. “There is one and only one social responsibility of business,” he argued. “To use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.” The oil majors and their defenders have sworn by the first part of the doctrine—increase profits—for decades.

Engine No. 1 accepts Friedman’s premises. It argues that by fighting the climate regulation tides and ignoring the business risk of its carbon emissions, ExxonMobil has been failing to deliver long-term value to shareholders. The corporation has known about climate change since the late 1980s, but it concealed what it knew from the public. They should have been transparent about the risk of climate change to the business: That’s what “without deception or fraud” means.

In making this argument, Engine No. 1 is not contradicting but expanding Friedman’s case. A company, Engine No. 1 holds, is accountable to not just shareholders but to a wider swathe of stakeholders, because failing to consider the interests of these stakeholders endangers profits. As Engine No. 1’s website puts it,

We share an emerging view of value creation. One that takes into account a company’s impact and the ways that impact drives shareholder value. Over the long-term, we believe shareholder and stakeholder interests converge, and companies that invest in their stakeholders are better, stronger companies as a result.

A license to operate

Theorists have long posited a so-called social license to operate. Simply put, this means that a business requires the broad acceptance of its activities from the larger society in which it operates. Without this, risks to the business rise and costs accrue. Society at large is, therefore, a stakeholder that a business must take into account. These concepts are not new. The Hague court case proved the relevance of this concept to the oil and gas industry.

For nearly a century, economists have debated the nature of externalities, or costs imposed upon a third party whose consent was not sought in incurring that cost. When companies pollute, for example, they impose a cost on others. Carbon taxes are one way to internalize these costs. Think tanks friendly to hydrocarbons have traditionally argued that such taxes are iniquitous because they are regressive. But in recent years, some have quietly come to view carbon taxes as better than the most likely alternative—leaving hydrocarbons in the ground unexploited. In March, the American Petroleum Institute came out in favor of a carbon tax. This leaves the bigger question in economics unanswered, however: If we assume the climate is an external good—part of the commons—can economic models adequately set a price on it?

The risks of emitting carbon are real, even if we are unsure how significant these risks are. This means polluters must be forced to bear the cost of their emissions, whether or not by regressive means. Debates about the regulatory framework for this are ongoing in various global forums; little has been resolved, and solutions thus far are piecemeal. But the how is not the point. What recent events clearly show is that oil companies will not be allowed to remain impervious to public sentiment.

Suppose that by using the courts or investor pressure, advocates of the position that the earth must not warm more than 1.5ºC above pre-industrial levels succeed in advancing their agenda. By some estimates, this would render worthless as much as 80 percent of the energy majors’ assets over the coming three decades. Vast swathes of these companies’ oil reserves would be left in the ground. These reserves will become stranded assets.

The cost of stranded assets

The International Energy Agency defines stranded assets as “investments which have already been made but which, at some time prior to the end of their economic life, are no longer able to earn an economic return.” They involve both the costs, already paid, for the rights to explore for fossil fuels, and the cost of the infrastructure, already installed, for extraction and processing. The companies may have to write off these costs, never to recoup them.

Conservative estimates suggest this will amount to a loss of US$900 billion. This may be a small price compared to the cost of unmitigated warming, but it raises questions that are both real and difficult. Consider, for example, the capital markets. Share prices of most oil, gas, and coal companies listed on global stock exchanges are lower than they were five years ago. ExxonMobil share prices are still trading near 2005 levels, despite tens of billions of share buybacks.

If fossil fuel companies fail to build the risk of climate change policy into their strategy, hundreds of billions of dollars in share market value alone could be lost. Traditionally, capital market investors favor companies with access to large proven reserves. Among the largest of the listed oil and gas companies, there’s a positive relationship between enterprise value, calculated as market capitalization plus net debt, and proven reserves with a high probability of extraction.

Several days ago, the credit rating firm Moody’s noted that oil producers are now facing higher credit risks because of The Hague court’s ruling. They described the growing momentum of investor activism and investors’ diminished enthusiasm for emission-heavy industries: This, they wrote, will diminish the fossil fuel majors’ access to capital. Growing pressure to shift business away from fossil fuels will mean outsized spending on R&D. Capital will move toward assets in better odor with public opinion; companies must be seen to be playing a constructive role in preventing global warming.

For corporations, the cost of switching strategies is massive. Many, like Shell and Total, have already invested in solar power and bio-fuel energy assets, but the IEA estimates that in total, the oil and gas industry has directed less than one percent of its investments toward a low-carbon future. Shell’s estimate of the cost of its new strategy to develop and market new renewable and low-carbon products would be US$5 billion. Investor activists argued, successfully, that this wouldn’t be enough.

The geopolitical risks

The problem of stranded assets is not confined to corporate entities listed on stock markets. Whole countries will be stranded. About 70 percent of the globe’s oil and gas reserves are in the countries that make up OPEC, the Gulf Cooperation Council (GCC) and countries such as Russia, Iraq, Iran, and Venezuela. If the 1.5ºC target is to be met, most of their hydrocarbons will have to stay in the ground. These countries can’t easily transition to new sources of national income. They face not just a loss of GDP, but a significant loss of government revenue from export receipts. An IMF estimate, for example, indicated that in 2020 the GCC would lose US$150 billion, down 37 percent from 2019, owing to the impact of Covid19 and lower oil prices.

GCC countries have been trying to diversify their economies in recent years, but they have focused on a narrow set of options, like real estate, aviation, and logistics. Moody’s reports that the burden of government debt in Oman and Saudi Arabia now exceeds both countries’ sovereign wealth fund assets. Bahrain’s interest burden alone represents nearly a quarter of its revenues. Kuwait is already showing signs of a liquidity crunch.

Countries that abandon their oil and gas strategy need to invest in sectors that offer not just higher returns, but better employment opportunities. This is easier said than done. The IMF reports rising youth unemployment rates in the GCC. This spells considerable regional disquiet—even without adding Iraq and Iran to the mix.

The same applies to Venezuela and other Latin American countries that depend heavily on revenues from oil and gas. In many of the countries that make up OPEC and the GCC, these industries are state-owned. Governments thus face the task of changing their business models without unsettling their countries’ social and economic fabrics. A more dangerous political task could hardly be imagined. Arguably, some, like Saudi Arabia, have taken baby steps in that direction. But whether corporations are state-owned or market-listed, the transition away from fossil fuels means massive social and political change. It means economic change, too: we will need new paradigms to account for costs to the commons.

None of this will be easy in a world already bubbling with geopolitical tension.