When a week-old hedge fund called Engine No. 1 challenged Exxon Mobil to change its ways last December, Wall Street erupted in amusement, thanks to the fund’s name, which evoked a popular children’s book, and its minuscule, then-$40 million position in what was once the world’s largest publicly listed firm.
Six months later, the fund dealt a huge blow to the oil and gas industry.
Exxon was obliged to accept new board members as a result of Engine No. 1′s campaign, which could compel the company to rethink its economic plan and confront the risk of global climate change, something many investors believe Exxon has long been unwilling to handle.
Companies with a market value of $250 billion like Exxon rarely face, much less lose, shareholder battles. But stakeholders familiar with Exxon’s thinking said Wednesday’s defeat was years in the making due to ongoing weak returns.
Institutional investors had grown frustrated with the company’s approach to the energy transition, trailing global rivals who promised big spending on power generation, solar and wind. In addition, Exxon failed to recognize how the investment community had become more attuned to climate change issues, which helped Engine No. 1 sway big pension funds in California and New York to its side.
Sources familiar with the company’s strategy say that Exxon was late to mount a defense against Engine No. 1, and even when it did, it concentrated on the threat to the company’s generous dividend. But analysts had for months cautioned that Exxon’s hefty indebtedness could put that dividend at risk, making its warnings of the fund’s intentions less threatening.
“Exxon Mobil worked very hard to lose this battle” over years of inattention to climate change, said Robert Eccles, professor of management practice at Said Business School at Oxford University. In December, Eccles said he thought the activists had a chance to win a board fight.
Exxon did not respond to requests for comment. Company executives have said its scale and investment approach had weathered boom-bust cycles. In a statement on Wednesday, CEO Darren Woods said that Exxon has “been very actively engaged with our shareholders, sharing our plans and hearing their viewpoints and the key issues of importance to them.”
A spokeswoman for Engine No. 1 declined to comment.
ENERGY EXPERIENCE WANTED
When the newly formed Engine No. 1 announced its campaign in early December, Exxon Mobil was closing out a disastrous 2020 due to the coronavirus pandemic that would end with $22 billion in losses.
With disputes about Exxon’s expenditures and lack of an energy transition plan, Engine No. 1 saw an opportunity to push for changes to the company’s board, which had no one with experience in the energy industry until this year – other than CEO Woods.
According to persons familiar with the subject, the fund’s top executives Chris James and Charlie Penner went to great lengths to find suitable directors with the qualifications to confront Exxon, eventually settling on four people with energy experience.
The fund was able to capitalize on investor dissatisfaction to turn the battle into a climate referendum, which cost both parties at least $65 million. CALSters, the California teachers’ pension fund, has been a strong supporter of the effort from the start.
Exxon attempted to mitigate the fund’s nominees by increasing its board of directors and adding director Jeff Ubben, who heads a sustainable investment fund. It also tried to assuage investor concerns about climate change by ramping up low-carbon initiatives and reducing the intensity of its oilfield greenhouse gas emissions.
The company also reversed course on a massive oil and gas expansion program, though analysts expect it to pick up the pace of spending next year.
By April, however, Engine No. 1 was lining up more allies. New York’s $255 billion Common Retirement Fund announced it would support the dissident slate of directors, following California’s $300 billion teachers retirement fund.
FOCUS ON DIVIDEND
Exxon was taking the threat more seriously by April, but focused on investor returns, warning in a shareholder letter that Engine No. 1 wanted the company “to pursue a vague and undefined plan – which we believe will jeopardize our future and your dividend.”
The company has long prized its dividend, which during pandemic-driven oil price lows grew to a yield of more than 10%. With the company’s debt load rising to more than $69 billion last year, analysts raised frequent questions about whether the dividend could be maintained as Exxon was being encouraged to cut costs.
“The biggest surprise to Exxon was how the ‘defend the returns’ strategy did not work,” said one source familiar with the company’s thinking.
The tide turned further against Exxon on May 14 after two near-simultaneous events. First was the release of a damning report from influential shareholder advisory firm ISS that criticized the company’s failure to adjust its spending plans.
“Investors have regularly highlighted concerns about preparedness for an energy transition, yet the board did not take action decisive enough to prompt recognition from the market until after launch of the dissident’s campaign,” ISS said.
That was followed by a television appearance from Woods on CNBC, where investors said he looked unprepared for host David Faber’s questions about the ISS report, Exxon’s strategy and the board’s lack of energy experience.
Exxon for years banked on the company’s size and steady dividend to blunt investor criticism, even as it made a series of risky investments such as its purchase of XTO Energy ahead of a sharp decline in natural gas prices and a 2017 purchase of Texas shale properties as oil prices were slipping.
New York State Comptroller Thomas DiNapoli, in a statement on Wednesday, said the fund for years wanted assurance that Exxon’s board took the climate crisis seriously “and was acting to put the company on a path to succeed in the low carbon economy, and for years received platitudes and gaslighting in response.”
Blackrock Inc, the world’s largest asset manager, which supported three of four dissident nominees, said in a statement on Wednesday that Exxon invested just $10.4 billion on lower-carbon energy technologies in the last 20 years, compared with more than $20 billion in overall expenditures in 2020 alone.
The corporation postponed its annual general meeting for an hour on Wednesday to continue counting votes. Woods then spent 40 minutes answering pre-selected questions from investors, significantly longer than at the previous year’s annual meeting.
One of the inquiries was concerning an International Energy Agency research warning that if the world wants to reach net zero emissions by mid-century, investors should not support new fossil fuel supply projects beyond this year. “If you look at the study, it underlines the continuous need for investment in oil and gas,” Woods said.