Since I originally addressed stranded assets and reserve accounting last December, two carbon intensive companies have responded to shareholders with their perspective on the risk their business models face from climate change.
The actions of both Shell and ExxonMobil are notable for two reasons. First, they show the potential influence of concerted shareholder activism. Secondly, their transparency suggests sophisticated management accounting practices underlay their decisions and management processes. The question of whether fossil fuel companies can create value over the short, medium, and long term is more about how quickly a paradigm shift in energy infrastructure, and in the business models of these companies, will take place.
Shell’s response to shareholder inquires on climate change highlights what it believes are the “fundamental flaws” in the argument that not all fossil fuel reserves can be burned without warming the planet to unsafe levels.
The response clearly shows an organization operating in a world of great uncertainty. Fostering a resilient business model that can return economic and social dividends requires making strategic and operational decisions based on quality information and analysis. Shell’s 20-page analysis points to two management accounting practices that help it strive to make decisions in the interests of both its shareholders and wider society.
1. Scenarios and forecasting: For many years, Shell’s strategy and business model have been informed by, and tested against, its own scenario planning analysis. Shell’s scenarios consider the future energy landscape in the context of various societal, economic, regulatory, political, and technological developments. Scenario planning, and the process of engaging a diverse range of stakeholders and experts in discussing plausible futures, is not an exercise of predicting the future. According an article in the Harvard Business Review, scenario planning’s value “lies in how scenarios are embedded in—and provide vital links between—organizational processes such as strategy making, innovation, risk management, public affairs, and leadership development.”
A transition to a global low-carbon economy is underway, but the scenario that ultimately materializes depends on the pace and scale of this transition. This in turn depends on a range of unpredictable factors, such as the adoption of climate change-mitigation policy and regulation, the effect of efficiency gains, and the outcome of technological advances in areas such as carbon capture and storage.
2. Embedding cost and benefits into project and investment appraisal: IFAC’s Project and Investment Appraisal for Sustainable Value Creation reinforces the importance of incorporating key risks and sustainability related considerations. In evaluating price and carbon risk, Shell applies specific criteria when evaluating a potential investment decision to allow an assessment of the potential impacts of a range of potential futures. Project screening values are applied for the oil price ($70-$110 for Brent Crude) and for CO2 ($40 per tonne emitted) to evaluate the economic impact of regulatory changes. For longer life assets with higher carbon risk profiles, more extensive analysis is conducted, which involves Shell’s Greenhouse Gas and Energy Management Plan, which supports the evaluation of CO2 risk, abatement options, and the potential impact of regulatory changes.
In response to a shareholder resolution, ExxonMobil published its Energy and Carbon – Managing the Risks report and an analysis of future energy demand. Societal trends, such as world population growth, and economic trends, such as increases in global GDP, will drive demand for all economic energy sources, particularly oil and natural gas. ExxonMobil’s report analyzes the risk of managing for a “low carbon scenario”. It concludes that because oil and gas are so critical to global development and economic growth, governments are “highly unlikely” to adopt policies that align to the overall objective of a low carbon scenario, which would involve a carbon budget that limited carbon-based emission reductions in the range of 80% by 2040.
In ExxonMobil's view, demand for oil and gas will remain strong through 2035, which will require ongoing development and investment to avoid a global oil shortage. ExxonMobil discusses its approach to managing this risk through improving energy efficiency throughout their operations and products, and investing in innovative technologies to lower emissions. ExxonMobil routinely conducts life cycle assessments to understand whether a technology can result in environmental improvements across a broad range of impacts.
When Does the Tsunami Arrive?
This new level of transparency by Shell and ExxonMobil allows investors and others access to information and analysis that helps them constructively engage organizations, particularly on assumptions they have made, such as on demand and price assumptions.
But, more importantly, it shows that these companies are thinking through climate change risk by using sophisticated approaches to assessing uncertainties, and making decisions on how to respond to those risks and over what time frame.
Ultimately, the current response appears to be in the context of evolutionary and orderly transition in energy infrastructure and investment. Right now, there is no solid evidence that governments and societies will apply meaningful market signals, such as raising the price on carbon to a point that leads to significant change to energy investment through the medium term.
However, in all likelihood, a transition to a low-carbon economy is unlikely to be measured and orderly. As Paul Gilding put it at this year’s Ceres Conference 2014, financial markets do not act in a smooth and logical manner. If previous human responses to crisis are anything to go by, carbon induced financial disruption could be sudden, leading to major disruptive change in the energy market and, consequently, dramatic changes in the global economy.
The only plausible outcome is that with all paradigm shifts, there will be winners and losers. Will your organization be a winner or loser when the climate tsunami arrives?
Additional useful recent resources:
- BP’s 2013 Sustainability Report (includes a summary of its approach to optimizing its portfolio to meet the world’s energy needs and how it alters it’s investments to reflect changing policy, market, and technology conditions)
- Climate Disclosure Standards Board’s Why Are Carbon Asset Stranding Risks Invisible in Corporate Reports?
- Carbon Tracker Initiative’s Carbon Supply Cost Curves: Evaluating Financial Risk to Oil Capital Expenditures