Article
August 17, 2023

The Devil is in the CapEx

Investors are debating whether to continue engaging with the energy sector on climate action. We examine the capital expenditure of the sector.

Investors are questioning whether climate engagement with the energy industry ultimately impacts the long-term strategy of investee companies. These questions arise as oil majors like BP and Shell water down their climate commitments, despite years of coordinated engagement from large institutional investors pushing for climate action. As the industry deliberates on the question of whether impactful climate engagement with energy companies is possible, we have examined the capital expenditure of the industry, aligned to the SDGs. We try to understand whether investor frustration is well-founded, and highlight a potential tool to better assess engagement efforts. To find the answer, we use SDG CapEx Fundamentals to analyse how the energy sector is investing in the transition.

The Church of England has taken the bold step of divesting from both BP and Shell, among others, for not aligning with the Paris Agreement. This follows half a decade of failed engagement, the end of which has seen oil majors watering down climate commitments in the midst of record oil and gas profits. 

Beyond their own divestment, Adam Matthews, chief responsible investment officer at the Church of England Pensions Board, argues that, “Engagement with O&G should no longer be a top focus of CA100+”, the collective engagement initiative. This sentiment is shared by PGGM, which co-leads engagement with Shell on behalf of CA100+, with PGGM preparing to divest from fossil fuel companies that are misaligned with the Paris Agreement. The CA100+ is contemplating switching engagement efforts to demand-side companies in order to trigger the supply side into action. 

So, is the investment industry finally seeing the wood from the trees when it comes to whether or not oil and gas companies will align themselves with a net zero future? 

Yes, and no. 

While the Church of England Pension Fund’s decision is likely to be a moral benchmark that some others will follow, there are still those who believe that small engagement victories thus far (for example, the election of three climate conscious directors to the board of Exxon) are an indicator that engagement with O&G companies still holds promise. In addition, there are many asset owners and asset managers for whom the windfall caused by record profits means that the fossil fuel industry continues to get their full support. For example, at their recent AGM, Shell chair Andrew Mackenzie still received 93 percent support.

In the midst of all of this, oil majors are promoting an ‘andnot-or’ message, arguing that it is necessary to meet the energy needs of now (fossil fuels), whilst investing in the energy of the future (renewables). In other words, investors need to be patient and appreciate that energy companies need to balance current with future needs.

But how can investors better assess the validity of these claims? Is the energy sector merely meeting short-term demand with fossil fuels, whilst preparing for and investing in the energy transition? Or are these companies increasingly committing capital to assets that are at high risk of being stranded?  For a long time, the conversation about the traditional energy sector’s role in the energy transition has been a game of smoke and mirrors, and the big O&G companies continue to spend vast sums of money on climate communication - a recent report by InfluenceMap estimates that companies are spending around $750 million each year on climate-related communication activities.

The only way to see the truth of it, however, is to look at the data. 

Using Matter’s new data solution, SDG CapEx Fundamentals, we analysed the capital expenditure of companies in a leading global energy index, to understand whether their investments are driving us towards a green transition, or further away from it. In so doing, a clear picture emerges of whether investor frustration at the results of their engagement efforts are justified, or if indeed it is a matter of balancing the needs of now with those of the future. 

No energy transition in sight

Matter’s SDG CapEx Fundamentals analyses how the capital expenditure (CapEx) of publicly traded companies is aligned or misaligned with the SDGs. Based on a systematic analysis of +1000 categories of CapEx against the SDGs at target level, the data offers a forward-looking insight into the sustainability of the future business models of public companies. We analysed a global energy index of 373 energy companies, focussing primarily on their alignment and misalignment with SDG 7 - Affordable and Clean Energy.

Weighted by portfolio share, Figure 1 clearly shows the misalignment of the investments of companies with SDG 7. 

Figure 1 - SDG 7

The largest contributors are oil supermajors, with a large proportion of capital expenditure in ‘Fossil Fuel exploration, extraction, distribution and transportation’. This indicates that not only is the energy industry profiting off unsustainable operations in the immediate term, but are actively investing in further expansion of their fossil fuels activities. This is despite the fact oil majors need to cut current production by 35% by 2040 to hit Paris targets, according to Carbon Tracker.  

Not only is the energy industry investing heavily in more fossil fuel infrastructure, the data does not back up their claim that they are also investing in new energies, with little over 0% being invested in line with SDG 7 across the traditional energy sector. A few oil and gas companies have started to invest a minority of their capital in sustainable energy solutions, but these numbers are still negligible in the larger context.

This illustrates how the frustration currently seen by investors losing faith in their own engagement efforts with the fossil fuel industry, is grounded in the realisation that traditional energy companies are not investing in the energy transition necessary to remain within less catastrophic temperature increases.

Natural ecosystems continue to be threatened

In addition, it is increasingly accepted that climate change and natural capital are two sides of the same coin when it comes to ensuring a sustainable future. The CapEx of the energy industry is also largely misaligned with SDG 15 - Life on Land, as they are investing in extractive activities which are disruptive to the natural environments and ecosystems in which they take place.

Figure 2 - SDG 15

Despite years of engagement, the investments of the energy sector are, contrary to their messaging, driving the global economy further away from a sustainable energy future. Not only are they not part of the solution, their core future business models look set to be an ever more serious driving factor of climate change.

This should not come as a surprise 

History tells us that if we expected the energy sector to voluntarily transition away from fossil fuels against their best short-term financial interest, we would be disappointed.

As Hannah Duncan explains in Capital Monitor, the emergency of the climate crisis and the need for an energy transition is not news to the energy sector. Shell conducted research in 1988 which highlighted the wide ranging risks of global warming, acknowledging that by the time it becomes easily detectable, it may be too late to counter it. Despite this, Shell ‘doubled down on oil production’, and is still expanding its oil operations up to and beyond 2030. Exxon has a similar story.

The long-term needs of society and the planet and the long-term business priorities of the energy industry are fundamentally misaligned. This has been the case for some time, but as the climate becomes more unstable, and the impacts of the climate crisis become increasingly visible, the reality that energy companies are continuing to invest in fossil fuel expansion with insufficient transition investments becomes harder to stomach, including for the investment industry.

When engagement fails, divest? 

The last year has challenged the notion that engagement will trigger fossil fuel companies to change their core business models. So why haven’t we already seen mass divestment?

In the same way fossil fuel companies have known about the urgency of the energy transition for decades, and willfully pushed in the other direction, a large proportion of the investment industry knows that fossil fuel companies will not voluntarily drive the energy transition, yet continue to invest in them. 

This is not entirely due to a lack of climate consciousness on behalf of investors, especially pension funds. The energy sector is a historically reliable sector which can hold firm in a portfolio during a recession, and is also more liquid than other sectors. Therefore, divesting comes with serious financial risks and potential consequences for some segments of the investment industry. 

The future performance of the CofE pension fund will be closely monitored by the industry, therefore, as a potential model for a fossil fuel light portfolio, and the soft power of conscious asset managers cannot be underestimated. For those still determined to shift the needle through engagement, potentially in combination with performance related divestment deadlines, it is essential to have the correct tools at their disposal. 

While the world waits on regulation, ambitious investors continue to push

Ultimately, however, as Pilita Clark writes in the Financial Times, “we should not expect the fossil fuel industry to lead us out of a crisis caused by fossil fuels. Only governments have the power to cut the demand for these fuels, and their job has barely started.”

The influence of the fossil fuel industry, however, is holding back the creation of urgent regulation to address the climate crisis. This was clear at COP27, which was overshadowed by the influence of fossil fuel representatives, with Laurence Tubiana, CEO at the European Climate Foundation arguing that “The influence of the fossil fuel industry was found across the board… The Egyptian Presidency has produced a text that clearly protects oil and gas petrostates and the fossil fuels industries.” To illustrate this contradiction, Shell has spent $57 million in oil and gas lobbying since the Paris Agreement.

In the meantime, ambitious investors will continue to use all of the strategies at their disposal to push the energy industry towards Net Zero. While investors such as the Church of England Pension Fund divest from big oil, others continue to engage. For instance, two companies dropped by the CA100+ engagement list were then picked up by Climate Engagement Canada. Increasingly, it looks like a ‘respond or divest’ model will be increasingly trialled by investors over the coming years as they are starting to enforce deadlines for meaningful change under the threat of divestment. 

Regardless of the levers applied to pressure fossil fuel companies, one thing is constant - the need for accurate and comprehensive data. Looking at the alignment and misalignment of capital expenditure with the sustainability objectives offers a valuable perspective on the long-term intentions of public companies. This, combined with data on Net Zero targets, green revenues, emissions pathways and more can provide investors with the comprehensive arsenal of insights necessary to inform their strategies when it comes to engaging with, or divesting from, the energy industry.

Author

Investors are questioning whether climate engagement with the energy industry ultimately impacts the long-term strategy of investee companies. These questions arise as oil majors like BP and Shell water down their climate commitments, despite years of coordinated engagement from large institutional investors pushing for climate action. As the industry deliberates on the question of whether impactful climate engagement with energy companies is possible, we have examined the capital expenditure of the industry, aligned to the SDGs. We try to understand whether investor frustration is well-founded, and highlight a potential tool to better assess engagement efforts. To find the answer, we use SDG CapEx Fundamentals to analyse how the energy sector is investing in the transition.

The Church of England has taken the bold step of divesting from both BP and Shell, among others, for not aligning with the Paris Agreement. This follows half a decade of failed engagement, the end of which has seen oil majors watering down climate commitments in the midst of record oil and gas profits. 

Beyond their own divestment, Adam Matthews, chief responsible investment officer at the Church of England Pensions Board, argues that, “Engagement with O&G should no longer be a top focus of CA100+”, the collective engagement initiative. This sentiment is shared by PGGM, which co-leads engagement with Shell on behalf of CA100+, with PGGM preparing to divest from fossil fuel companies that are misaligned with the Paris Agreement. The CA100+ is contemplating switching engagement efforts to demand-side companies in order to trigger the supply side into action. 

So, is the investment industry finally seeing the wood from the trees when it comes to whether or not oil and gas companies will align themselves with a net zero future? 

Yes, and no. 

While the Church of England Pension Fund’s decision is likely to be a moral benchmark that some others will follow, there are still those who believe that small engagement victories thus far (for example, the election of three climate conscious directors to the board of Exxon) are an indicator that engagement with O&G companies still holds promise. In addition, there are many asset owners and asset managers for whom the windfall caused by record profits means that the fossil fuel industry continues to get their full support. For example, at their recent AGM, Shell chair Andrew Mackenzie still received 93 percent support.

In the midst of all of this, oil majors are promoting an ‘andnot-or’ message, arguing that it is necessary to meet the energy needs of now (fossil fuels), whilst investing in the energy of the future (renewables). In other words, investors need to be patient and appreciate that energy companies need to balance current with future needs.

But how can investors better assess the validity of these claims? Is the energy sector merely meeting short-term demand with fossil fuels, whilst preparing for and investing in the energy transition? Or are these companies increasingly committing capital to assets that are at high risk of being stranded?  For a long time, the conversation about the traditional energy sector’s role in the energy transition has been a game of smoke and mirrors, and the big O&G companies continue to spend vast sums of money on climate communication - a recent report by InfluenceMap estimates that companies are spending around $750 million each year on climate-related communication activities.

The only way to see the truth of it, however, is to look at the data. 

Using Matter’s new data solution, SDG CapEx Fundamentals, we analysed the capital expenditure of companies in a leading global energy index, to understand whether their investments are driving us towards a green transition, or further away from it. In so doing, a clear picture emerges of whether investor frustration at the results of their engagement efforts are justified, or if indeed it is a matter of balancing the needs of now with those of the future. 

No energy transition in sight

Matter’s SDG CapEx Fundamentals analyses how the capital expenditure (CapEx) of publicly traded companies is aligned or misaligned with the SDGs. Based on a systematic analysis of +1000 categories of CapEx against the SDGs at target level, the data offers a forward-looking insight into the sustainability of the future business models of public companies. We analysed a global energy index of 373 energy companies, focussing primarily on their alignment and misalignment with SDG 7 - Affordable and Clean Energy.

Weighted by portfolio share, Figure 1 clearly shows the misalignment of the investments of companies with SDG 7. 

Figure 1 - SDG 7

The largest contributors are oil supermajors, with a large proportion of capital expenditure in ‘Fossil Fuel exploration, extraction, distribution and transportation’. This indicates that not only is the energy industry profiting off unsustainable operations in the immediate term, but are actively investing in further expansion of their fossil fuels activities. This is despite the fact oil majors need to cut current production by 35% by 2040 to hit Paris targets, according to Carbon Tracker.  

Not only is the energy industry investing heavily in more fossil fuel infrastructure, the data does not back up their claim that they are also investing in new energies, with little over 0% being invested in line with SDG 7 across the traditional energy sector. A few oil and gas companies have started to invest a minority of their capital in sustainable energy solutions, but these numbers are still negligible in the larger context.

This illustrates how the frustration currently seen by investors losing faith in their own engagement efforts with the fossil fuel industry, is grounded in the realisation that traditional energy companies are not investing in the energy transition necessary to remain within less catastrophic temperature increases.

Natural ecosystems continue to be threatened

In addition, it is increasingly accepted that climate change and natural capital are two sides of the same coin when it comes to ensuring a sustainable future. The CapEx of the energy industry is also largely misaligned with SDG 15 - Life on Land, as they are investing in extractive activities which are disruptive to the natural environments and ecosystems in which they take place.

Figure 2 - SDG 15

Despite years of engagement, the investments of the energy sector are, contrary to their messaging, driving the global economy further away from a sustainable energy future. Not only are they not part of the solution, their core future business models look set to be an ever more serious driving factor of climate change.

This should not come as a surprise 

History tells us that if we expected the energy sector to voluntarily transition away from fossil fuels against their best short-term financial interest, we would be disappointed.

As Hannah Duncan explains in Capital Monitor, the emergency of the climate crisis and the need for an energy transition is not news to the energy sector. Shell conducted research in 1988 which highlighted the wide ranging risks of global warming, acknowledging that by the time it becomes easily detectable, it may be too late to counter it. Despite this, Shell ‘doubled down on oil production’, and is still expanding its oil operations up to and beyond 2030. Exxon has a similar story.

The long-term needs of society and the planet and the long-term business priorities of the energy industry are fundamentally misaligned. This has been the case for some time, but as the climate becomes more unstable, and the impacts of the climate crisis become increasingly visible, the reality that energy companies are continuing to invest in fossil fuel expansion with insufficient transition investments becomes harder to stomach, including for the investment industry.

When engagement fails, divest? 

The last year has challenged the notion that engagement will trigger fossil fuel companies to change their core business models. So why haven’t we already seen mass divestment?

In the same way fossil fuel companies have known about the urgency of the energy transition for decades, and willfully pushed in the other direction, a large proportion of the investment industry knows that fossil fuel companies will not voluntarily drive the energy transition, yet continue to invest in them. 

This is not entirely due to a lack of climate consciousness on behalf of investors, especially pension funds. The energy sector is a historically reliable sector which can hold firm in a portfolio during a recession, and is also more liquid than other sectors. Therefore, divesting comes with serious financial risks and potential consequences for some segments of the investment industry. 

The future performance of the CofE pension fund will be closely monitored by the industry, therefore, as a potential model for a fossil fuel light portfolio, and the soft power of conscious asset managers cannot be underestimated. For those still determined to shift the needle through engagement, potentially in combination with performance related divestment deadlines, it is essential to have the correct tools at their disposal. 

While the world waits on regulation, ambitious investors continue to push

Ultimately, however, as Pilita Clark writes in the Financial Times, “we should not expect the fossil fuel industry to lead us out of a crisis caused by fossil fuels. Only governments have the power to cut the demand for these fuels, and their job has barely started.”

The influence of the fossil fuel industry, however, is holding back the creation of urgent regulation to address the climate crisis. This was clear at COP27, which was overshadowed by the influence of fossil fuel representatives, with Laurence Tubiana, CEO at the European Climate Foundation arguing that “The influence of the fossil fuel industry was found across the board… The Egyptian Presidency has produced a text that clearly protects oil and gas petrostates and the fossil fuels industries.” To illustrate this contradiction, Shell has spent $57 million in oil and gas lobbying since the Paris Agreement.

In the meantime, ambitious investors will continue to use all of the strategies at their disposal to push the energy industry towards Net Zero. While investors such as the Church of England Pension Fund divest from big oil, others continue to engage. For instance, two companies dropped by the CA100+ engagement list were then picked up by Climate Engagement Canada. Increasingly, it looks like a ‘respond or divest’ model will be increasingly trialled by investors over the coming years as they are starting to enforce deadlines for meaningful change under the threat of divestment. 

Regardless of the levers applied to pressure fossil fuel companies, one thing is constant - the need for accurate and comprehensive data. Looking at the alignment and misalignment of capital expenditure with the sustainability objectives offers a valuable perspective on the long-term intentions of public companies. This, combined with data on Net Zero targets, green revenues, emissions pathways and more can provide investors with the comprehensive arsenal of insights necessary to inform their strategies when it comes to engaging with, or divesting from, the energy industry.

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