Fossil fuel bosses' soaring pay may spell trouble for the climate – and their firms
It may be time for oil and gas firms to take a hard look at their compensation practices, whether to save the environment or themselves
Anyone who watched the shenanigans on Wall Street in the years leading up to the 2008 financial crisis couldn’t have been left with much doubt: poorly designed compensation policies that encouraged greed and discouraged fear were partly responsible for the near-collapse of the entire financial system.
Can similar compensation policies in the oil and gas sector be held responsible for climate change? It’s a provocative question, especially as Barack Obama wraps up his three-day trip to Alaska.
While there, Obama juggled his attempts to draw attention to climate change (visiting a glacier that is melting at a faster pace than much legislation travels through Congress) with deflecting criticism by environmentalists of his decision to open up the waters off the Alaskan coast to drilling by Royal Dutch Shell.
Royal Dutch Shell isn’t among the 30 energy companies targeted in a new report on the links between executive pay in the fossil fuel industry and carbon change. It’s a British/Dutch enterprise. The Institute for Policy Studies, the Washington thinktank that studied the behavior that compensation within the industry might be likely to trigger, chose to focus on US companies, such as ExxonMobil, Chevron, Mobil Oil, and coal companies such as Peabody Energy Corp.
But the results leave any energy company, and any potential investors in these companies (and if you own an S&P 500 index fund, you’re an indirect owner of many of them, like it or not), with many questions to answer.
It shouldn’t come as a terrific shock to anyone that the CEOs and senior management of oil and gas companies – people who have been trained to think of production growth as “good”, and of oil and gas as their core business – should have compensation packages that reward them for doing business as usual: developing new fossil fuel reserves. That, after all, is the business they are in.
In contrast, banking executives were being compensated for innovating wildly, closing their eyes to the risks of those innovations (such as credit default swaps and complex mortgage-based securities) when they weren’t used as the designer intended. In 2006, the top mortgage banker at Merrill Lynch received a $350,000 salary – and a $14.5bn cash bonus and $20.2m of stock in the bank – in exchange for keeping the mortgage machine churning away at an ever-faster rate. That banker, Dow Kim, told his team to do “whatever it takes” to hang on to market share and grab the top spot in the league tables, according to later lawsuits. And we all know what happened as a result. The bankers generated phantom earnings for the institution, even as they pocketed real money for themselves.
Perhaps the most worrying element of the Institute for Policy Studies Report is the fact that the energy industry may be on the verge of doing something quite similar.
There is a certain perverse logic to the idea that the CEOs of fossil fuel companies might expand production and continue to explore and add to their reserves of oil, gas and coal, even though science has demonstrated that burning them all would result in horrific changes to the climate. What doesn’t make any sense at all, even from the viewpoint of one of those CEOs, is why they would spend billions of dollars on courting future financial problems for their companies: this is an eerie echo of what Wall Street did in the years leading up to the crisis.
This all revolves around what are known as “stranded assets”: oil- and gas- producing properties that a company has spent money to discover or acquire, and then to develop, only to find that it can’t sell the output (oil, gas or coal) because it makes no financial sense. The plunge in crude oil prices that began a year ago after the explosion in US output triggered a supply glut, exacerbated by Saudi Arabia’s refusal to cut back production, already has forced many producers to “shut in” production facilities, in effect creating stranded assets. Some of the fields that oil producers are committed to developing – including some in the Arctic – will only be profitable at prices far above today’s level.
In another take on this issue, scientists for the first time early this year published research showing that 92% of the world’s coal, nearly half of the already-discovered natural gas, and a third of already-discovered crude oil couldn’t be burned without harming the climate, and thus could end up as “stranded assets” for environmental reasons. Citigroup has estimated the value of these assets to be $100tn: that’s how much value could end up being wiped off the value of the books of the world’s energy companies, based on today’s market prices. The carnage, if the industry wrote down those assets in one fell swoop, would make 2008 look like a peaceful afternoon saunter in Central Park.
It’s hard to tell whether the oil market currently is heading for the end of a “carbon bubble”, as the authors of the Institute for Policy Studies report suggest, or whether the notoriously volatile commodity is simply in the midst of another period of turbulence. Yes, this week has seen oil record its biggest three-day percentage price gain in 25 years, and it’s now trading at about $48 a barrel, well above August’s lows of $38.24. But that’s about half the price it fetched a year or so ago.
For the report’s authors, the bottom line is clear. As long as the compensation policies are set up in the way they are today, it will be almost impossible for a rational and self-interested CEO to steer his or her company away from a future that is tied to exploiting fossil fuels, and in the direction of investing in renewable energy.
If Rex Tillerson, CEO of Exxon Mobil, had a compensation policy that linked his bonus to his success in finding ways to reduce the company’s exposure to stranded assets, to make its profits less volatile (Exxon’s quarterly earnings have tumbled to about half of what they were a year ago), then it’s safe to say he’d probably be less scathing in his dismissal of green energy initiatives in future, and more interested in figuring out whether they might become a source of profits, with some creativity and ingenuity.
The buck stops at the level of the boards of directors of these companies. It’s up to them to decide how compensation is set, and also to oversee how capital will be allocated across the company. They shouldn’t be oblivious to the fact that continuing to add reserves just for the sake of doing so, in some kind of arms race, is a bit of a fool’s game, and probably tantamount to squandering shareholders’ capital. And yet they continue to sign off on plans that call for cash flow to be reinvested – and reinvested in these traditional businesses, and not new, renewable ventures – rather than distributed to shareholders. Buybacks and dividends at least put money in the hands of shareholders, even if they also inflate the value of stock grants to CEOs, as the Institute for Policy Studies notes.
Whether you’re motivated by environmental or financial considerations, it’s impossible to avoid concluding that this isn’t a healthy state of affairs. The core problem – the fact that compensation policies routinely encourage corporate leaders to take risks that they shouldn’t, and discourage them from focusing on long-term strategies and innovations – is one that exists in all industries.
Today, however, in the case of the energy industry, those governance questions seem to have serious consequences for all of us in a way that has eerie similarities to Wall Street pre-2008. We may not know precisely who the oil and gas industry’s Dow Kim is – feverishly adding new reserves to the system, triggering the collapse of the next glacier and bringing us closer to the point beyond which climate change can no longer be managed or reined in. But the results of this report suggest that he’s out there.
- The Guardian News
- Published on:
- September 3, 2015
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