Money talks. That’s why one key element in the battle against climate change must be aligning the financial compensation of executives to tangible corporate efforts to decarbonize.
Better aligning incentives is particularly important in energy intensive industries, where the status quo can encourage decisions on strategy, investment, and operations that jeopardize the planet’s climate, while also generating risk to investors that can, ultimately, undercut a company’s long-term viability.
In a promising sign, Royal Dutch Shell CEO recently announced that executive bonuses at the oil and gas giant will include greenhouse gas goals. “We have linked executive remuneration in the past to energy intensity and next year we are going to make it even more specific to the CO2 footprint metrics associated with these energy efficiencies” he said. Ten percent of bonus payments to executives, including the CEO and CFO at Shell, will reportedly be linked to “greenhouse gas management”.
Indeed, a broader trend toward heightened sustainability in governance is underway. Analysts at the nonprofit organization CERES report that as of 2014, 24% of examined companies linked executive compensation to sustainability performance, up from 15% two years earlier.
Do These Pay Policies Measure Up?
As companies like Shell translate aspiration into practice, the big questions now are how will executive pay linked to de-carbonization be operationalized, and will it be enough to make the difference demanded by the dire science of climate change. There are two key issues in particular that boards, shareholders, and others can ask as GHG bonus measures are developed and assessed:
1. Are bonus payments tied to explicit, ambitious and well-chosen metrics?
The mere act of including greenhouse gas management in compensation is not sufficient. CERES found that of companies linking executive pay to sustainability, few used sustainability performance targets that go beyond goals driven by compliance with laws and regulations. In the absence of comprehensive climate policy – for example market-based signals that put a price on carbon pollution – operators like Shell must go above and beyond compliance metrics for their bonuses to be meaningful. Mere compliance should be expected as a matter of course; winning a GHG bonus must require another level of executive leadership and results.
There are a host of metrics that oil and gas operators can consider as they link compensation to GHG management. Those metrics may differ for large vertically integrated oil and gas majors like Shell, versus smaller companies that operate in just one or two segments of the oil and gas value chain. One common element is incentivizing strong methane management.
Methane emissions are a widespread issue across the oil and gas supply chain. Leaks and other intentional releases waste valuable product, speed climate change, and cast serious doubt on the ability of natural gas to play a constructive role in the transition to a cleaner energy economy. However, as Environmental Defense Fund found in Rising Risk: Improving Methane Disclosure in the Oil and Gas Industry, as of early 2016, none of the leading 65 oil and gas operators disclosed a quantitative target to reduce methane emissions.
As Principles for Responsible Investment noted in its recent Investor’s Guide to Methane developed with EDF, investors should expect operators to put governance to work to get the incentives right for enhanced methane management. After all, what gets measured, gets managed, and creating incentives to address invisible gas leaks can make a visible difference.
The ultimate methane metric would operationalize the same kind of “zero tolerance” approach to methane leaks that companies take to preventing fatalities. In the near term, we look for incentives tied to comprehensive, direct methane measurement; leading practices including minimizing venting and conducting regular leak detection and repair; and achievement of verifiable emission reductions.
Beyond methane, GHG metrics may encompass reducing CO2 intensity from fossil fuel operations, but also expanding into renewable energy, as Total, Statoil, and others have signaled. Taken together, an appropriate mix of GHG metrics will send an unmistakable signal to executives that a holistic approach to de-carbonization is the new order of the day.
2. Is the bonus a token or a change agent?
Even well-defined de-carbonization metrics can prove insufficient if the incentive is not strong enough, particularly compared with the full suite of executive motivators. In Shell’s case, while its commitment to tie 10% of executive pay to greenhouse gas management puts it 10% ahead of most of its peers, the question remains: is the incentive adequate enough to change decision making with the speed and seriousness required to achieve the energy transformation we need.
We expect institutional investors and others to look carefully not only at the specifics of the 10% bonus on GHG management, but the 90% on other factors. For energy operators taking the positive step to link pay to climate performance, it will be important to guard against also using contradictory factors that could send mixed messages, such as rewarding executives for expanding carbon reserves, a practice that 13 of 30 major U.S. fossil-fuel corporations practiced, according to a recent report by the Institute for Policy Studies.
We applaud Shell’s intent to link climate performance to pay and look forward to examining the details. In the meantime, as pressure mounts for more oil and gas operators to follow suit, varying operator reactions will tell investors a lot about which companies are poised to adapt best to a lower-carbon energy future.
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