Originally published in The Impact; 2nd June 2021
Change happens gradually, and then suddenly. This week, the endgame for oil companies became a lot closer and a lot more evident, suddenly, discontinuously, a jump.
The world of energy is a vast part of the global economy: perhaps as much as $10,000 billion per year. That’s so much money that the giants that dominate it, particularly the oil behemoths, aren’t giving up easily. Their grasp on that money gusher just got rather less tight. In one week:
Two climate activists were voted on to Exxon’s board – a coup for a tiny investment advocacy firm.
60% of shareholders voted to force Chevron to lower its emissions – in its processes and in the use of its products.
A Dutch court ruled Shell has to cut its products’ greenhouse gas emissions by 45% by 2030.
A momentous week, summarized
Much has been written on this already (see HERE for example), but let’s review and put into context to see why this is momentous.
Exxon-Mobil LINK and LINK came into the week as perhaps the oil giant with the most out-of-touch expectations – many years of INCREASED oil output. But that was sharply rebuked when a small activist fund, Engine No. 1 (see below) secured enough institutional support, particularly from BlackRock, to put at least two of its candidates on the giant’s board of directors. Shareholders also approved measures calling for annual analyses of climate impact.
Chevron LINK. Shareholders voted: 61% in favor of targets to reduce Scope 3 emissions (LINK HERE for definition – basically all downstream uncontrolled uses); 48% for a report on impacts of a 2050 net-zero scenario. There’s no way to look at these numbers and not see that shareholders understand what the executive leaders may not: oil is dying and Chevron doesn’t know what to do.
Shell: LINK and LINK The Anglo-Dutch oil giant received its order from a Dutch court (a panel of judges) in the outcome of a lawsuit filed by the Netherlands’ Friends of the Earth group; the group alleged that Shell violated human rights by undermining the Paris Accords. Shell, of course, is appealing and it’s hard not to think that the gain against Shell is the most fragile of the week’s trifecta. Money beats well-meaning judges.
Engine No. 1. Who? LINK and LINK from which: “an investment firm purpose-built to create long-term value by harnessing the power of capitalism. We believe a company’s performance is greatly enhanced by the investments it makes in workers, communities, and the environment. We believe that over time the interests of Main Street and Wall Street align, and we can engage as active owners to create value by focusing on this alignment.” The six-month-old firm doesn’t have a Wikipedia entry as of this writing.
The simple lesson from the week is: changing oil firms’ future by shareholder and investor demand seems to be a winning strategy. Expect more of these. A lot more.
What banks want, they get
The battle for the climate won’t be won until banks are onside. But once that happens, victory for a healthy climate and a new economy is assured. What bankers, investors, shareholders need to see is that these firms fully embrace the inevitable future. That is the mind shift underpinning this week’s news. Oil companies must embrace the transition or become fossils themselves.
They must act soon, for the economics of disruptive technologies never favor incumbents. Newcos, the startups, are valued on the basis of the opportunity they aspire to: billions, tens of billions, more. Oldcos, the incumbent giants, aren’t valued on future prospects: they’re already at scale. Instead, they’re valued on the basis of their cash returns – dividends. Cut the dividends, cut the stock price. Or they’re valued on their assets – but oil fields face declining value as the transition accelerates.
Why the new beats the old, every time
The difference between newco and oldco valuations drives startups, equipped with promising new technologies and underpaid entrepreneurs, to rich valuations compared to incumbents. Computer companies. Hard disk drives. Software companies. Telecom. Netflix. Cars. (Tesla’s market capitalization is a singular, perhaps bizarre, example of this: the valuation of TSLA alone is similar to the combined valuation of all the world’s other car makers. LINK HERE)
Incumbents have only a brief, and early, window to make the transition to a new technology. After that, the narrative becomes one of decreasing asset values, lowering returns to investors, stagnating margins and revenues, declining belief in their ability to adapt, and a diminishing equity value and cash hoard with which to buy other firms. These feed a downward spiral that dooms slow-moving incumbents to economic extinction. Big investors will sell—and then even short—their positions to protect against deepening losses, making those losses more profound. Oil giants will, one by one, fall out of major stock indices (Fortune 100, Dow Jones index, FTSE100, etc.) and then index funds must shed their shares.
Losses beget losses.
That spiral is closer. That two of the world’s largest oil companies in one week received a significant push from institutional shareholders (and the firms that advise them) toward a future without their main product, oil, signals the beginning of the end of their business model—oil extraction—and that major investors will push to make that happen.
And, that will inevitably mean improving opportunities and valuations for new energy alternatives and their investors. Soon, and at scale. Established oil companies should seize the moment to take their diminished but not yet destroyed equity valuation to make at-scale investments in post-fossil-fuel solutions. They should, but—if history is any guide—most won’t.
They should heed the caution expressed in Ernest Hemingway’s “The Sun Also Rises”, whence originates the idea that opened this piece:
“How did you go bankrupt?” Bill asked. “Two ways,” Mike said. “Gradually, then suddenly.”