How the degree of preference for impact informs investment decisions.
Over the course of 2018 and 2019, we engaged with large, globally integrated oil and gas companies as well as exploration and production businesses1 as part of Breckinridge’s thematic engagement efforts. Our goal is to better determine how these companies are managing carbon transition—the risks and opportunities present and emerging as the global economy evolves to a low-carbon future.
Key Takeaway: European Oil and Gas Companies Lead the Way in Risk Assessment and Management
Our key takeaway was the fact that European-domiciled companies are largely ahead of U.S.-based companies across many areas. Among them are:
- setting emission reduction targets
- investing in renewables/low carbon technologies
- broader use of carbon pricing
- more extensive use of scenario analysis
- more closely tying executive remunerations to climate change goals.
Our research shows that carbon transition risk management is generally more advanced at European oil and gas companies because in Europe there is greater acceptance of climate change, greater governmental support for climate change action and greater shareholder pressure on companies to mitigate carbon transition risks.2
Governmental support of climate change action provides substantial impetus for corporate initiatives in Europe. The U.S. lags Europe in adopting federal policies. As a result, energy policy in the U.S. is fragmented. For example, while there are no federal targets for renewable energy generation, 29 states and the District of Columbia have adopted renewable portfolio standards goals to increase electricity generation from renewable sources.3 In another example, many European countries pursue aggressive electric vehicle (EV) targets driven by tax incentives. In Norway, EVs accounted for more than 20% of new sales in 2018, while EV sales hit only 2% in the U.S.4 in 2018. U.S. tax credits for EV purchases are less generous generally than those in Europe.5
Carbon Transition Risks Have Significant Implications for Credit Quality
Carbon transition risks stem from the global economy’s shift toward low-carbon technologies to help mitigate the impacts of climate change. Carbon transition risks for corporate bond issuers can manifest in myriad ways including:
- reduced demand for oil, gas and refined products
- implementation of carbon taxes that increase corporate and consumer costs
- potential fines and legal settlements from global regulatory bodies
- reputational risks that challenge the ability of companies to attract and retain talent and customers.
Other risks include the potential for stranded assets6 for oil and gas companies if demand declines as the world moves toward cleaner energy.
Given the significant impact these risks can have on an issuer’s credit quality, we honed in on how these large oil and gas companies are managing these risks to better inform our investment analysis.
Carbon Transition Engagement Preparation and Conclusions Were Extensive
To prepare for our thematic engagement, we took part in a Massachusetts Institute of Technology working group on climate scenarios in late 2018. The sessions focused on the recommendations of the Task Force for Climate-Related Financial Disclosure related to scenario planning for oil and gas companies. The working group provided us with access to climate change scientists and representatives from large global oil and gas companies who helped us better understand industry best practices. In addition, earlier this year, we met with oil and gas analysts at CDP, which runs the global disclosure system for carbon emissions. They shared their substantial research on carbon transition risks within the oil and gas sector. Furthermore, we studied extensive materials prepared by our engagement companies, including corporate sustainability reports, climate change reports, and corporate carbon transition risk management strategy presentations.
Our engagement and analysis revealed several key observations in several areas of risk:
- Emission reduction targets: The European companies such as Royal Dutch Shell, TOTAL, BP and Equinor had comprehensive corporate-wide emission reduction programs in place while the U.S.-based companies typically had reduction targets for methane or individual business units rather than comprehensive, corporate-wide strategies.
- Investments in lower-carbon businesses: All four of the European companies we engaged invested in low-carbon businesses (such as wind and solar) and set capital spending targets for them. The U.S.-based companies had made substantially fewer investments in renewables and had not set aggressive goals to increase renewable investments over time. Several of the U.S.-based companies stated that they would not invest in low-carbon technologies unless the return profile was like the return profile of their traditional oil and gas business, which often limits their long-term low-carbon initiatives. For example, U.S.-based companies allocated capital towards shorter-cycle shale projects, expecting that they will have greater capital flexibility going forward. The European-based companies, acknowledging the lower return profile of investing in renewables relative to their traditional oil and gas business, believed these investments are prudent.
- Governance: The European companies closely tied executive remuneration to climate change goals. For example, Royal Dutch Shell announced in 2018 that it was linking part of executive compensation for senior executives to a three-year target to reduce the net carbon footprint of the energy products it sells, and it plans to roll out this target to roughly 16,000 employees in 2020. Among the U.S. companies we engaged, we did not see a clear link between executive remuneration and climate change mitigation.
- Carbon pricing and scenario analysis: While both the U.S. and European companies incorporated carbon pricing into their capital allocation policies, the European companies typically used higher prices on carbon for their process. Similarly, while both U.S. and European companies utilized scenario analysis, the European-based companies appeared to use conservative scenarios based on substantial declines in global demand for oil and gas to develop strategic plans for adapting their business models.
Our engagement was highly informative and allowed us to better understand how companies in the sector are managing carbon transition risks. The European companies we engaged with are ahead of U.S. companies in their carbon transition risk management strategies. We believe this dynamic exists for a variety of reasons, including government support in Europe, a greater acceptance that climate change is occurring in Europe and a greater shareholder focus from European investors. For example, the Eurobarometer—opinion surveys conducted by the European Commission—shows that 93% of Europeans believe that climate change is a ‘serious problem.’2 The European Union is the first major economy to put in place a legally binding framework to reach climate neutrality by 2050. Strong continent-wide support for that goal is evident in the 92% of Europeans supporting it, according to Eurobarometer.2 In contrast, the U.S. announced its intention to pull out of the Paris Agreement within the United Nations Framework Convention on Climate Change and has not set any national goals to reduce Greenhouse gas emissions or a price on carbon. As a result, U.S.-based companies face challenges in allocating capital to long-term projects facing the uncertainties of a comprehensive national acknowledgement of carbon transition risks. Based on our analysis, we believe the major European oil and gas companies are presently better prepared for the transition to a lower-carbon future.
 The companies we conducted engagement meetings with were: BP p.l.c.; Conoco-Phillips; Chevron Corp.; EOG Resources, Inc.; Equinor ASA; Occidental Petroleum Corp.; Royal Dutch Shell plc; TOTAL S.A.; and Exxon Mobil Corp. No representation is being made that these companies are holdings in any client portfolio.
 “The European Union continues to lead global fight against climate change,” https://ec.europa.eu/clima/news/european-union-continues-lead-global-fight-against-climate-change_en, August 10, 2019.
 “Updated renewable portfolio standards will lead to more renewable electricity generation,” https://www.eia.gov/todayinenergy/detail.php?id=38492, February 27, 2019.
 “Electric Cars Hit Record In Norway, Making Up Nearly 60 Percent Of Sales In March,” https://www.npr.org/2019/04/02/709131281/electric-cars-hit-record-in-norway-making-up-nearly-60-of-sales-in-march, April 2, 2019.
 “US EV Sales Surpass 2% In 2018 — 9 EV Sales Charts,” https://cleantechnica.com/2019/01/12/us-ev-sales-surpass-2-for-2018-8-more-sales-charts/, January 12, 2019.
 Stranded assets among oil and gas companies are the valuations for oil and gas reserves which may be written down due to being uneconomic or, for political reasons, have negative implications for the credit quality of these companies.
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