How tiny hedge fund Engine No. 1 just reshaped Exxon’s board

The board of ExxonMobil, the biggest oil firm in the US, contains the CEO of Merck and the previous CEO of Caterpillar. They now have some new colleagues: three board members that the fossil gasoline firm didn’t need—and who plan to push for a coherent plan to handle local weather change. That’s because of Engine No. 1, a hedge fund that didn’t even exist a yr in the past.

Chris James, the investor who launched the funding agency in late November 2020, isn’t a local weather activist. In truth, within the mid-2000s, James helped open a brand new coal mine to attempt to convey jobs again to his Midwestern hometown. However his expertise as an investor—together with the failure of the coal mine round 18 months later due to the altering economics of the vitality system—helped him higher perceive the enterprise case for firms to enhance their social and environmental affect. Engine No. 1 describes itself as “purpose-built to create long-term worth by harnessing the ability of capitalism,” and says that company efficiency “is significantly enhanced by the investments it makes in staff, communities, and the setting.”

Exxon made an ideal goal. At a time when the Worldwide Power Company says that with a view to sort out local weather change no new oil and fuel fields must be developed, the corporate remains to be investing closely in new manufacturing, and has been slower than different vitality firms to plan for the vitality transition. Royal Dutch Shell, Whole, Equinor, and others are pouring more cash into renewable energy, electric charging stations, battery storage, and other alternatives to fossil fuels. (Traditionally, Exxon has labored to promote climate denial, despite the company’s own early research on climate science.) And lately, Exxon has additionally been underperforming financially in comparison with its friends.

“We’re centered on the concept that firms that suppose long run will carry out higher over the long run,” says Charlie Penner, who leads activist campaigns at Engine No. 1. “Conversely, firms which might be overly centered on the quick time period on the expense of long-term worth drivers will underperform. I feel the difficulty you’ve seen at Exxon, actually for years, is a very short-term focus and an actual disregard for the best way the trade has modified, the place the world is altering, and what that’s going to imply within the years to return.”

Engine No. 1 noticed a possibility. As a shareholder, it may nominate new Exxon board members who understood the necessity for the corporate to struggle local weather change. If it may persuade sufficient different shareholders to vote for these candidates at Exxon’s annual normal assembly, a course of that occurs each by way of proxy playing cards mailed to shareholders and thru on-line voting, these new administrators may start to assist the corporate change path. Regardless of the brand new hedge fund’s comparatively small measurement—and the truth that its $50 million stake in Exxon represents solely 0.02% of the corporate—it succeeded.

“The very first thing you do is just be sure you can really win”

Penner, beforehand a associate on the activist hedge fund Jana Companions, had labored on an earlier marketing campaign that efficiently bought Apple to spice up parental controls. For the Exxon marketing campaign, Penner began by trying on the probabilities of success. Most individuals who personal inventory just fill out their ballots utilizing the suggestions of the corporate, in the event that they vote in any respect. Engine No. 1’s path went by way of massive traders who personal vital chunks of the corporate and who could possibly be swayed. “The very first thing you do is just be sure you can really win,” he says. “Significantly provided that this firm has a really massive retail investor base, you actually sort of have to chop the numbers and be sure that when you do in addition to you suppose you are able to do with institutional traders, and also you do as poorly as you usually count on to do with retail traders, there’s nonetheless a path to victory.”

The staff began constructing the case for change, going by way of an in depth examination of what wasn’t working at Exxon and researching potential new board members who would enchantment to traders. Penner had labored intently with the California State Lecturers’ Retirement System, one of many largest pension funds on the planet, on the Apple marketing campaign, and had different relationships with massive traders in Exxon.

“They consulted broadly, deeply, broadly with large traders earlier than they bought their marketing campaign going,” says Anne Simpson, managing funding director for board governance and sustainability on the California Public Staff’ Retirement System (CalPERS), which manages round $444 billion in belongings. “That was the very first thing. Folks suppose they got here out of the blue—they didn’t. So once they had been capable of determine and announce their candidates, they knew that they’d already taken soundings with a variety of massive funds like ourselves.”

Whereas some local weather activists have pushed for CalPERS to divest from fossil gasoline firms, the pension fund believes it wouldn’t assist to promote shares to a different proprietor, particularly if the subsequent proprietor isn’t as involved about local weather change; the oil firm would nonetheless hold working. As a substitute, the fund hopes to assist fossil gasoline firms make the required transition.

The Engine No. 1 marketing campaign constructed on earlier work that CalPERS and different shareholders have carried out to realize extra energy; round a decade in the past, for instance, CalPERS began pushing to realize the suitable to vote no on proposed board members (the default provision when firms incorporate in Delaware and another states requires plurality voting, which solely offers the choice to vote sure). “What we had been doing was setting the stage for this concept that underneath capitalism, administrators of firms should be held accountable,” Simpson says. “It’s really a really critical duty.”

Shareholder discontent at Exxon has been constructing for years due to poor returns; during the last decade, it has underperformed friends by 57.2%. Massive shareholders additionally more and more say that they need to see firms reply to local weather change, together with the large asset administration agency BlackRock, which later ended up supporting three out of Engine No. 1’s 4 nominees. The marketing campaign additionally received over Vanguard and State Road; collectively, the three institutional traders maintain almost 20% of Exxon’s shares. “This was within the wind for Exxon, as a result of the standard of the board has been a subject of dialogue with shareholders for fairly a while,” Simpson says. “We see a totally underwhelming method to local weather change. However there’s no one on the board with any vitality sector background.”

Simpson says that CalPERS usually doesn’t assist hedge fund activism, as a result of hedge funds typically have a short-term focus—herald somebody new, make some adjustments, increase share costs quickly, after which get out. “The distinction with Engine No. 1 is that the entire funding thesis right here is to strengthen the board,” she says. “It’s a governance agenda.”

The hedge fund nominated 4 executives, together with Kaisa Hietala from Neste, the world’s largest producer of renewable diesel, and Alexander Karsner from X, Alphabet’s innovation arm. Gregory Goff, one other nominee voted onto the board, has many years of oil trade expertise that Engine No. 1 believes is critical for Exxon to run extra profitably; his local weather experience is much less clear. (Anders Runevad, former CEO of wind vitality firm Vestas, was nominated however not elected.) “That is going to be a yearslong technique of determining how you can reposition this firm for the long run,” Penner says. “And our core purpose right here was that it could be actually powerful to try this with out folks with profitable transformative vitality trade expertise on the board.”

Caught sleeping

Exxon didn’t appear to really feel threatened by the marketing campaign because it launched. “I feel we bought in all probability the identical name that almost all pissed off shareholders get, which is from the investor relations division,” Penner says. The fund put out its first letter to the board in December, round two months earlier than it could want to provide discover that it was going to appoint new administrators on the shareholders assembly. “We really didn’t have a dialog with anybody on the board till late January,” he says. “They might have thought that provided that we had been a brand new agency, with a reasonably small stake within the firm, that we weren’t going to see it by way of. There was by no means actually an try and substantively have interaction in regards to the those who we had been placing ahead for the board. There was a really dismissive perspective.”

DE Shaw, a bigger hedge fund, had launched the same marketing campaign on the identical time; Exxon responded with some new emissions reductions targets and appointed some new administrators. That was sufficient for DE Shaw. However the brand new administrators didn’t have vitality trade experience, and Exxon’s local weather targets are missing. (When calculating its emissions, for instance, it leaves out the largest supply—using its gasoline in clients’ autos.) Engine No. 1 stored going.

A couple of weeks earlier than Exxon’s annual normal assembly, Local weather Motion 100, a coalition of traders involved about local weather threat, held a presentation introducing the 4 nominees for the board. “We had been capable of ask all of them the powerful questions,” says CalPERS’ Simpson. “What do you do as a change agent once you’re within the minority? How do you’re employed collaboratively once you’ve come by way of the shareholder channel, and administration’s bought different folks, and a few long-standing board members could lose their seats? It’s not just have you ever every individually bought the chops and might you make the lower by way of your abilities and expertise, however do you might have the emotional intelligence and the understanding of how you can work on a board with a view to be productive with a gaggle of people that’ve bought totally different opinions to you, the place an enormous change is required.”

Exxon was invited to the assembly, however selected to not attend. (On a earlier name with Engine No. 1 in January, Exxon CEO Darren Woods reportedly informed the hedge fund that it thought the nominees had been unqualified, although Penner says every nominee has individually created billions of {dollars} of worth within the vitality trade.) On the day of the final assembly, as votes had been starting to go in opposition to Exxon’s picks, Simpson says she heard the corporate tried lobbying a minimum of some traders to vary their votes. (She says that the Securities and Alternate Fee ought to make adjustments that may stop firms from opening ballots after which asking shareholders to vary their votes.)

What can three board members do?

As a result of Goff, Hietala, and Karsner will be part of 9 different present members on the board, it’s not clear but how a lot affect they’ll have. Some local weather activists, together with campaigners from the Dawn Venture, have argued that shareholders ought to have gone additional and labored to remove Exxon’s CEO, since present administration might not be greatest capable of lead the transition to cleaner vitality.

“There’s little question that the elections had been a blow to Exxon, however I’m skeptical in regards to the capability of some new board members to reform the corporate,” says local weather activist Jamie Henn, director of the nonprofit Fossil Free Media. “Extracting oil and fuel and externalizing the prices of air pollution is hardwired into Exxon’s working system. It might be like asking Blockbuster to shutter all of its shops and turn into an internet streaming service: It has neither the enterprise mannequin nor the experience to make the transition. The best way that we’ll know the brand new board is critical isn’t with some new ‘net-zero by 2050’ dedication—that may just be cowl for enterprise as regular—but when they arrive out with a critical plan to wind down oil and fuel manufacturing. Till Exxon begins protecting fossil fuels within the floor, they’re nonetheless going to be a part of the issue.”

Nonetheless, some shareholders are optimistic. “We hope this implies we’ve now bought essential mass for a change of path,” says Simpson, who compares the corporate to an oil tanker: Altering path is one thing that she thinks will occur slowly over time. “What we’ve carried out by way of that is considerably enhance our odds of getting a transition plan which means the corporate’s fortunes could be resolved they usually can map out a path ahead.” In response to a request for an interview for this text, Exxon despatched a press release saying, partially, “We welcome the brand new administrators to the board and stay up for working with them constructively and collectively to learn all shareholders.”

As You Sow, a nonprofit that pushes for company accountability by way of shareholder motion, is cautiously optimistic. “You possibly can add new folks to the board, but when the corporate stays on enterprise as regular, then we haven’t solved something,” says CEO Andrew Behar. “That’s solely pretty much as good as the selections that they make, and the incentives they offer administration to make. So we’re hoping to see an actual shift within the firm. The corporate wants a significant transformation in the way it’s allocating its capital expenditures.”

There’s no purpose that Exxon can’t transition to extra renewable vitality or different enterprise ventures that cut back local weather threat. “The concept this firm can solely do one factor over the long run isn’t backed up by their historical past,” Penner says. Exxon scientists helped develop the lithium ion battery, for instance, and expertise utilized in photo voltaic cells. The corporate’s expertise working within the ocean can simply translate to offshore wind vitality. Different oil firms are already transferring extra rapidly. And the results of the vote at Exxon will even affect different firms.

“This result’s reverberating by way of boardrooms,” Simpson says. “I had a name from the chair of one other large oil firm just saying, ‘So, how did you do this?’ But in addition, ‘Thanks.’ As a result of there are some oil firms eager to push additional, quicker. I feel Exxon and likewise Chevron, to an extent, have been laggards. Should you take a look at the statements and commitments popping out of a few of the rivals, they want Massive Oil within the U.S. of their nook. They want to have the ability to work on this as a sector. So we all know that is being intently watched.”

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