Investors challenge ExxonMobil on multiple fronts

ExxonMobil is facing a three pronged attack from activist investors hoping to force the US major to radically change how it spends its cash.

Investment firm Engine No 1, with the backing of the California state teachers' pension fund, wants ExxonMobil to add fresh blood to its board. The New York State pension fund is threatening to divest its stake in the company unless it moves away from fossil fuels more quickly. And the hedge fund DE Shaw wants ExxonMobil to cut costs, including capital spending, to protect its dividend.

ExxonMobil's investor challenges go to the heart of an issue faced by oil and gas industry producers as a whole: how to use its still formidable financial resources to transition toward a cleaner energy future or whether to hunker down, focus on its core business and just return cash to shareholders.

Majors have successfully fended off activist challenges before. But two factors that might help the investors this time around are the demand-slashing impact of Covid-19 and a broadening embrace of the threats of climate change in most markets. The pandemic has sapped global energy demand and significantly weakened prices, forcing producers to preserve cash flow as institutional and retail investors flee the sector. It has also laid bare the oil and gas industry's poor-to-mixed record addressing climate issues, leading many to speed up efforts to lower emissions.

Lots of capex, not enough return

While spending was cut in 2020 in response to the pandemic, ExxonMobil argues that the industry must return to higher capex spending soon in order to produce enough energy for the world's growing population.

"If the industry is to meet credible third-party estimates for energy demand, we will need to significantly increase investments," chief financial officer Andrew Swiger said during the third quarter earnings call with analysts.

But activist investors argue that even before Covid-19 the company squandered billions of dollars in capital investments over the years without sufficient returns to show for it.

In the first decade of the 21st century, ExxonMobil generated an average return of 35pc per year from its upstream capital projects. But annual returns in recent years have plummeted to less than 6pc. From 2015-2019, in the US alone, the company generated less than a 1pc return in three of those five years despite spending an average of nearly $7bn a year, according to company reports.

"We believe ExxonMobil's underperformance can be largely attributed to its pursuit of production growth at the expense of returns and a lack of adaptability to changing industry dynamics, including higher production costs and growing long-term demand uncertainty," according to a 7 December letter Engine No 1 sent to ExxonMobil's board of directors.

Engine No 1, which bought a $40mn stake in ExxonMobil, is partnering with the California State Teachers Retirement System (CalSTRS), one of the nation's largest pension funds, to pressure the company. CalSTRS owns about 8mn ExxonMobil shares.

An infusion of talent

Engine No 1 thinks ExxonMobil could very well be right about companies not investing enough to meet long term global energy demand. The problem is not necessarily amount but where ExxonMobil is spending it.

For example, ExxonMobil consistently says that it cannot justify spending lots of money on renewable energy projects because they do not offer attractive returns. But what is really lacking, Engine No 1 says, is leaders with the necessary expertise to help the company make those kind of decisions and the willingness to take such risks.

To that end, Engine No 1 said it will nominate four candidates with clean energy experience to ExxonMobil's board.

Alexander Karsner, a senior strategist at X, the innovation arm of Google, is especially noteworthy because his career spans the traditional oil and gas industry, clean energy, and Silicon Valley. Karsner was an investor in energy infrastructure firms like Enercorp and Tondu Energy Systems and served as US Assistant Secretary of Energy under the George W Bush administration, overseeing $2bn worth of federal R&D programs.

He was also a venture capitalist and advised Nest (which Google later acquired) and Tesla. ExxonMobil's board needs an infusion of such technology focused innovation talent, Engine No 1 believes.

Susceptible to pressure

ExxonMobil has successfully fought off activist challenges before. But there are signs that the major might be more vulnerable this time around.

Through the first nine months of this year, ExxonMobil has lost $2.3bn compared to a profit of $8.65bn during the same period in 2019, and said last week it expects to report in the fourth quarter an $18bn-$20bn write down related to its US shale operations. The company has tacitly acknowledged that the pandemic and rising concerns over climate change has altered its calculus.

In November, the company said it will reduce capex spending from 2022-2025 to $20bn-$25bn from its original plan of $30bn-$35bn. ExxonMobil also plans to triple cuts in methane emissions and nearly double flaring reductions at its upstream operations over the next five years, building on earlier targets.

"ExxonMobil has supported the goals of the Paris Agreement since its inception and is working to reduce emissions from our operations, while meeting the world's demand for affordable energy," the company said in a statement. "We continue to invest in and research breakthrough technologies that will play a key role in addressing the important issues related to climate change."

But ExxonMobil's actions has not appeased its critics. DE Shaw, which held 2.43mn shares of the company as of 30 September, is pushing management to cut capital spending to $13bn from a planned $16bn-$19bn this year. ExxonMobil has already committed to slash costs by $10bn by year's end but the hedge fund wants the company to further reduce expenses up to another $5bn.

A spokesperson from DE Shaw declined to comment.

New York State comptroller Thomas DiNapoli, who oversees the state's $226bn pension fund, recently announced that the fund has begun to review its portfolio of fossil fuel companies, including ExxonMobil, to determine their progress in transitioning to clean energy. The plan is to divest from firms "that do not meet standards" by 2025. The pension fund has already sold off its stakes in 22 coal companies.

CalSTRS and the New York State pension funds hold a combined 14.4mn shares in ExxonMobil.

What will BlackRock do?

Despite the backing of CalSTRS, Engine No 1 has a long way to go convincing other investors to back its campaign. Only three investors own more than 5pc of ExxonMobil stock: Vanguard (356mn shares), State Street Global Advisors (218.6mn shares), and BlackRock (210mn shares). Together, the investment firms control 18.4pc of ExxonMobil.

So even if Vanguard, State Street and BlackRock back Engine No 1, the activist firm still needs the support of a vast array of both institutional and individual investors who control the remaining 82pc.

But one factor works in Engine No 1's favor: the clout of proxy advisory firms Institutional Shareholder Services (ISS) and Glass Lewis, who advise institutional investors on how to vote on board candidates and shareholder proposals. ISS and Glass Lewis have previously backed shareholder resolutions against ExxonMobil, such as separating the chairman's role from the chief executive, but to no avail. But this time, investors might be more willing to listen, Engine No 1 thinks.

For example, BlackRock, which owns nearly 5pc of ExxonMobil shares, has said it will start to take into account climate change when managing its portfolio. In a letter to clients last year, BlackRock said it will prioritize "climate change, not only in terms of the physical risk associated with rising global temperatures, but also transition risk — namely, how the global transition to a low-carbon economy could affect a company's long-term profitability."

"We are making sustainability integral to the way BlackRock manages risk, constructs portfolios, designs products, and engages with companies," the letter continued. "We believe that sustainability should be our new standard for investing."

Veteran energy analyst Philip Verleger thinks ExxonMobil and other majors will capitulate in some way to activist investors.

"My expectation is that ExxonMobil will cut its capital expenditures and take other steps to appease the (activist) investors," Verleger said. "The Visigoths are attacking."

By Thomas Lee