Scalpel, Please

Scalpel, Please

“We have designed a strategy that combines economic sustainability with environmental sustainability.”

— Claudio Descalzi, CEO of Eni

“If you don’t have a viable alternative set, all you’re doing is moving out from one company or one country to someplace else. It doesn’t solve the problem.”

— Darren Woods, CEO of Exxon Mobil

Eni joined other European oil majors last year in targeting sharp reductions in carbon emissions, coupled with a forecast that the group’s oil production would peak by 2025. ExxonMobil, which didn’t publicly acknowledge the risk of climate change until 2014, derides any rapid shift in focus away from fossil fuels in general and crude oil in particular as a “beauty” competition that fails to address the problem.

There are investors that have responded to climate change by booting oil and gas producers from their portfolios. Some avoid the sector because of the risk that newly developed deposits may be left “stranded” by a world transitioning to a low-carbon economy. Others view the industry as obstructing meaningful climate policy through lobby and misinformation campaigns and refuse to be complicit through their investment. 

But perhaps the time has come for using a scalpel rather than a hammer and chisel when carving out a future-ready investment portfolio. Eni and ExxonMobil are both oil and gas producers. However, an investor can distinguish Eni and ExxonMobil with respect to their risk from a transition to a low-carbon economy. They share a risk of the same kind, but an examination of strategy suggests it differs in degree.

The consensus seems to be that a massive policy response to put the environment on a path to sustainable footing is neither immediate nor distant. 

Every company’s strategy (and particularly every oil and gas company’s strategy) should be evaluated against the likely self-fulfilling global goal of medium-term action.

The UN’s Principles for Responsible Investment has defined such a scenario — the aptly named “Inevitable Policy Response.” It assumes delayed policy action until a confluence of social pressure, extreme weather, and declining costs for renewable energy force a severe shift. The outline of this scenario follows the contours of the Paris Agreement’s “ratchet mechanism,” which suggests that an acceleration of policy change could occur in the 2023-2025 timeframe ahead of the 3rd round of national climate pledges.

Eni’s forecast for peak oil production in the next five years suggests this scenario plays into their thinking. By contrast, ExxonMobil’s corporate communication is more centered around the growth in fossil-fuel demand outside the wealthiest nations and the inadequacy of renewable technologies to meet this demand growth out to 2040. 

This diversity of views is visible in their long-term capital spending plans. An analysis by the think-tank Carbon Tracker suggests that 20% to 30% of Eni’s potential spending on developing oil and gas reserves in the coming decade may be uneconomic if a policy shift occurs to hold the global average temperature increase to well below 2°C. For ExxonMobil, an estimated 60% to 70% of potential investment could fail to deliver in this scenario.  

It is impossible to know which company will ultimately prove to be the better investment. The parallel of risk and behavior consistent with the social consensus presents investors with a dilemma. A company that is proactive in changing its behavior because of a changing climate is likely to reduce the risks of getting left behind the social curve. At the same time, a laggard like ExxonMobil may benefit if its peers divest oil and gas assets prematurely and demand for fossil fuels exceed expectations. 

Nevertheless, it is evident that a uniform approach to oil and gas investments no longer makes sense. Companies that best balance the need to meet the demands of the present while investing for a lower-carbon world will be rewarded, while investment plans that stray too far from the fossil-fuel demand curve will underperform.

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