The spotlight has returned to the oil and gas industry, with its important role in providing energy security to the world. Now, however, the mandate also includes reducing carbon and other greenhouse gas emissions to deal with the externalities inherent in the production of oil and gas. As a result, several oil and gas firms have publicly-announced pledges to reduce carbon emissions, including firms also announcing net-zero pledges. In a forthcoming paper, Accounting Professor Hemang Desai of SMU Cox and coauthors analyze these firms’ carbon reduction pledges to understand the drivers behind pledges and whether the market finds them credible.
According to the United Nations, net zero means cutting greenhouse gas emissions to as close to zero as possible, with any remaining emissions re-absorbed from the atmosphere, by oceans and forests, for instance. In an oil and gas context, it means that the emissions occurring in the course of business by the firm is equally remediated but can also include carbon offsets and/or credits that reduce their emissions tally. The oil and gas sector accounts for 9% of man-made greenhouse gas emissions, and directly or indirectly, accounts for 42% of the world’s carbon emissions. The upstream segment of the oil and gas (E&P) industry is particularly important as it accounts for two-thirds of the sector’s emissions.
Changing industry context
Macro-level studies of net-zero pledges exist, however, the focus of the oil and gas sector in this study brings institutional and business context to the question. “Focusing on a specific sector allows you to meaningfully comment on the path [to net zero] —what the firms are promising to do and how the market responds to these pledges,” Desai notes.
The U.S. E&P sector is a particularly interesting sector to examine as it faces some unique challenges. These firms grew production through the discovery and development of shale projects, made possible by horizontal drilling and hydraulic fracturing in areas such as the Eagle Ford, Bakken, and Permian Basin among others. From 2010 to 2019, U.S. crude oil production increased from 2 million barrels a day to 12.3 million barrels a day.
However, this growth in production was not accompanied by profitability. Thus, in the latter half of the 2010s, investor sentiment toward shale drillers soured. The investors demanded capital discipline, operating efficiency, free cash flows, and return of capital in form of dividends and share buybacks. Also the societal desire for decarbonization has arisen. However, decarbonization is going to require significant investments on part of these firms. The tension between profitability and decarbonization has begun to further emerge however. The study window occurred before the Russian invasion of Ukraine, which has shifted attention to energy security now, with various paths emerging regarding how to achieve decarbonization and how fast.
Key drivers of the pledges
The sample comprises 69 publicly-traded U.S. E&P firms. They fall into three categories based on the nature of their pledges. As of December 31, 2021, the cut-off date for the study, 18 E&P firms in the sample had publicly committed to net zero; an additional 14 had announced a significant reduction in their emissions in the future. A final 37 had not announced any formal commitments. More firms have likely made pledges since the study’s cut-off window.
The study finds that the activist firm Engine No. 1’s proxy fight with Exxon seems to be a catalyst for the greater number of pledges being made by oil and gas firms. It was a first incidence of an activist targeting an oil and gas firm, namely ExxonMobil, the global Super Major. The number of firms making carbon reduction commitments increases significantly after Engine No. 1 announced its slate of four directors for Exxon’s board in January 2021. The presence of Blackrock as an institutional owner was also positively associated with oil and gas producers’ announcement to pledge either net-zero or significant emissions reductions.
The research found that the average stock price reaction to the combined sample of net-zero and reduction announcements is not significant. However, the announcement reaction is more negative for net-zero firms relative to firms that announce reductions pledges. The negative market reaction to net-zero commitments is mainly driven by firms that pledge to achieve net zero after 2030, rather than firms that pledge to achieve net zero by 2030. One possible interpretation of this result is that plans to achieve net zero by 2030 are viewed as more credible as these firms have to lay out their plans more clearly, whereas commitments that are farther out in time are perceived as less credible—concrete plans versus goals.
The study further examines the role of credibility of the pledge by looking at two proxies to gauge the firm’s commitment to net zero or carbon reductions. These proxies are the existence of a board-level committee to oversee the path of carbon reduction and whether management compensation is tied to specific emissions or carbon reduction goals. The study finds that the market reacts more negatively to firms’ announcements of pledges if the firms’ governance structure and compensation plans lack these features. Thus, an important result is that the market responds to the credibility of the pledge’s degree of intent. “That the market reaction is related to board-level commitments and compensation plans which tie bonuses to reductions targets is a nice result,” Desai offers. “We view our result as providing a template for future results,” Desai offers.
Pledging and disclosing
The discussion with Desai shifted to policy implications and emerging disclosure regimes at the SEC. According to Desai, disclosure standards are more useful and better received if the standards are global, and provide comparable information for firms operating in a similar industry. These standards may also be in the best interests of the firms in the long-run. As an analogy Desai recalled a conversation with a chief accounting officer of a public company who mentioned how implementing SOX allowed the company to gain sensitivity and visibility to certain issues that they were not previously attentive to.
Similarly, having the framework of assessing the risk and reporting may make firms more sensitive to specific issues where they can take actions in their long-run interest but for society as well.
The study is a first run at objectively assessing the market’s pulse of company actions regarding decarbonization at a point in time. Desai and coauthors provide a path for others to follow as energy production and decarbonization evolve.
The paper “An Analysis of Carbon Reduction Pledges of the U.S. Oil and Gas Companies” is forthcoming in Management Science by authors Hemang Desai of Cox School of Business, Southern Methodist University, Pauline Lam of New York University, Bin Li of University of Houston, and Shiva Rajgopal of Columbia University.
Written by Jennifer Warren.