With ethical investing back on many people’s minds, Barry Coates looks at the impact of one of the biggest activist investor campaigns of recent years.

In May 2021, investment hedge fund Engine No.1 made waves in the corporate world. Their campaign, aimed at propelling oil giant Exxon toward renewable energy adoption, was a bold test of the model of activist investing. This was described as a new era where responsible investors would use their shareholding to achieve better environmental and social performance. But two years on, what changed as a result? And what does this say about the future of shareholder influence?

ExxonMobil (Exxon), a global powerhouse in the oil and gas industry, has long been synonymous with the fossil fuel sector’s resistance to climate action. Despite the internal acknowledgment of climate change impacts, the company has historically funnelled vast sums into climate denial campaigns and lobbying efforts against climate regulations.

The shareholder revolt came from an unlikely source. Despite holding only 0.2% of the shares, Engine No.1 built support amongst institutional investors (including the three largest global fund managers, BlackRock, Vanguard and State Street).

The motivation of the major fund managers was not only to support the environment. Exxon’s share price had fallen by 30% over five years and, as the costs of solar, wind and battery storage continued to decline, there was growing recognition that the future of energy will be renewable.

In a meeting of high drama, Engine No.1’s resolution was passed, and three new directors joined the Exxon board of directors under a banner of progressive policies on climate change.

A reality check on progress

However, two years on, there has been little change at Exxon. Capital expenditure has not shifted towards renewable energy. Research from Energy Monitor reveals that, in 2022, renewable energy constituted a 0% portion of Exxon’s capital expenditure, starkly highlighting the company’s reticence to pivot away from its traditional business model.

Far from a transition, Exxon has doubled down on fossil fuels. They spent US$60 billion on buying Pioneer Resources, an oil and gas producer, and they plan a massive expansion of drilling in the Permian Basin in southern US and in Guyana. Their short-term plans reveal an intention to significantly expand fossil fuel operations, with capital expenditure bringing an additional 7,161 million barrels of oil equivalent into production, more than four times their annual production. Exxon has also been exploring the deep waters off the coast of Brazil, Cyprus, Namibia, and Suriname. This proposed expansion is contrary to the International Energy Agency’s guidance that no new sources of oil and gas are needed, and that peak oil demand is only a few years away.

A recent New York Times article concluded that the resolution spearheaded by Engine No.1 “had achieved negligible results”. Key staff left Engine No.1 and it has changed its direction away from activist investing. A recent shareholder resolution calling on Exxon to reduce its scope 3 emissions from the use of its products faced strong opposition from management (and even from Engine No.1). It garnered support from only 11% of shareholders.

The euphoria over a golden age of shareholder activism has faded. So, what caused the change?

A spike in oil prices

Firstly, oil prices have spiked higher as a result of Russia’s invasion of Ukraine. This produced short term windfall profits for Exxon and other oil companies. Many of the investors that had previously shunned oil and gas producers, particularly those failing to transition to renewable energy, piled back in, seeking a sugar hit from short term returns. In the year to September 2022, New Zealand KiwiSaver and managed fund providers piled 80% more investment into those oil and gas companies that are increasing their production.

However, this is a risky game. Investment managers often think they can time the market and sell before the inevitable decline in share prices. But this has gone spectacularly wrong on numerous occasions in the past, including during the Global Financial Crisis. With trillions of dollars at risk from unusable reserves and production infrastructure, the decline of the oil and gas industry is likely to be steep – it is only a few years since oil prices went negative when demand declined during Covid. It is no wonder that the spectre of stranded assets is keeping central bankers awake at night.

As UN secretary general Antonio Guterres has commented, “Investing in new fossil fuels infrastructure is moral and economic madness. Such investments will soon be stranded assets – a blot on the landscape, and a blight on investment portfolios.”

ESG and the culture wars

Secondly, the investment approach to incorporate environmental, social and governance (ESG) risks into decision-making has become a new battleground in the US culture wars. Earlier this year, for example, 19 Republican state governors signed a statement alleging that ESG encourages the “proliferation of woke ideology”. Most investment managers globally and in New Zealand would argue that taking account of the financial risks of climate change, environmental and social harm is good financial management, but several Republican states have passed laws to limit ESG investing.

This seems to have been a key factor in persuading the major financial institutions to back off from supporting activist investing. Analysis of BlackRock’s Stewardship Report for 2023 shows it supported 7% of shareholder proposals on social and environmental issues, down from 47% in the year to June 2021. Other major institutional investors like Vanguard and State Street have also backed off from supporting shareholder resolutions that call for a climate transition.

Unwillingness to change

The third cause has been a dose of reality about how difficult it is to change companies that are unwilling to do so. The problem for those using investor engagement is not just getting companies to make pledges, but to ensure the pledges lead to action that makes a difference. Corporations have PR teams that are good at promising a lot and delivering little. The journey of Engine No.1 and Exxon serves as a reminder that company pledges on climate action are quickly overridden by short term profit and dividends for shareholders.

This has not only been the case at Exxon. In 2022, BP spent 14 times as much on shareholder payouts as investments in low carbon initiatives, and they dialled back their climate transition pledges. The Anglican Church was the leader of the Climate Action 100+ coalition that coordinated investment fund engagement with Shell, but earlier this year they announced that they would divest their shareholdings, concluding that 10 years of engagement had not been effective in aligning Shell, BP and other oil majors with the transition to net zero. Many other investors have followed, frustrated that years of engagement have failed.

Stewardship with a purpose

A survey of New Zealand fund managers reveals that engagement is now the most common approach to investing responsibly, typically in the form of voting on shareholder resolutions, writing to companies or holding meetings. However, few KiwiSaver or investment fund managers provide information on whether these actions have a result (such as successfully passing a resolution) and even fewer are able to show any social or environmental benefit as a result of their activities. During a time of growing public concern over greenwashing and warnings from the New Zealand regulator, the Australian investment regulator has warned that fund managers need to provide credible evidence of claims that their engagement is influencing companies and achieving social and environmental benefits.

It is clear that investment managers need to be responsible owners on our behalf, voting their shares and trying to influence companies. But they also need to be clear about when their engagement is not working. They should divest from those companies that are part of the problem and unlikely to be part of the solution, whether it be climate pollution, environmental damage, animal cruelty, social harm or other issues that their investors find offensive.

Investing for the future

It is over 30 years since the global agreement to transition away from fossil fuels was signed. Despite promises from the major oil and gas companies that they would invest in renewables, the transition has been driven by new entrants. Decades of engagement has not made a substantive difference to most of the major oil and gas companies – they are at risk of following most of the thermal coal sector into stranded assets, losses and bankruptcy.

Leading ethical investment managers recognise this dynamic. They are focusing their investments on those who are transitioning to renewables, engaging with those willing to change and investing in climate solutions. Informed investors can invest for a better future by managing climate risk and investing in climate solutions.

Barry Coates is the CEO of Mindful Money