Larry Fink’s Letter

Every year, the CEO of the world’s largest fund manager writes an open letter to the companies which comprise a large part of BlackRock’s $5.7 billion in assets. For 2018, Larry Fink’s theme was Purpose.

“Public expectations of your company have never been greater,” wrote the BlackRock CEO in January. Governments had not done enough to prepare for an uncertain future, so people were “turning to the private sector and asking that companies respond to broader societal challenges.”

Instead of short-term focus on quarterly results, Mr Fink urged better “stewardship” of companies and more seriousness in corporate governance. For good reason. Investments which score high on environmental, social and governance criteria have outperformed market indices.

Read Mr Fink’s letter here.

At about the time when BlackRock was drafting this missive, Shell, the Anglo-Dutch oil major, announced that it is working on a plan to reduce its carbon footprint by half by 2050. The coincidence is illuminating.

BlackRock happens to be the largest shareholder in Shell, whose CEO Ben van Beurden was among the recipients of Mr Fink’s letter.

The fund manager is also concerned by a rising trend of “wasteful proxy fights” with activist investors and hedge funds. On the topic of unwanted proposals from shareholders, for example, the letter was pointed:

“When a company waits until a proxy proposal to engage or fails to express its long-term strategy in a compelling manner, we believe the opportunity for meaningful dialogue has often already been missed.”

At this juncture, the meaning of his statements becomes uncertain in relation to Shell.

Because BlackRock has voted consistently against resolutions tabled by Follow This, a shareholders’ movement, at Shell AGMs in 2016 and 2017.

A curved ball

Follow This wants Shell to lead its industry on a new course, away from carbon fuels and into clean energy — in line with the Paris climate agreement of 2015. For an oil and gas producer posting quarterly profits of around $4 billion, that’s a tough prescription for traditional investors.

But not impossible, according to Mr van Beurden. His thinking on carbon emissions continues to evolve, prompting a change of position which looks like a curved ball coming at investors.

Late last year, at Shell’s annual Management Day in London in November, Shell’s CEO announced his new plan — an aspiration, not a binding target — to shrink Shell’s carbon footprint.

Read Mr van Beurden’s rationale, here.

At a press conference which followed, he conceded (in response to a question from a Guardian journalist) that the shareholder resolutions from Follow This contained “a kernel of truth”. Spoken in idiomatic English, his phrase implies scope for a principled agreement at some level, echoing the Dutch: een kern van waarheid.

Consider, for example, Mr van Beurden’s notable interventions in 2017, when Shell’s boss:

  • Advised the United States not to abandon the Paris climate deal (a position shared by Secretary of State Rex Tillerson, over-ruled by President Trump).
  • Urged more stimulus to foster a competitive clean energy sector, emphasising a role for public policy to drive the transition to renewables.

No doubt Mr Fink, for BlackRock, would agree with these sentiments. At least in principle.

In practice, however, Black Rock – with Dutch investors Robeco and pension fund ABP/APG – has sided with Shell’s management against shareholder resolutions by Follow This. That position is becoming harder to sustain, in part due to Shell’s own stance on carbon emissions.

In November, Shell reversed its position on the vexed issue of how to measure its carbon footprint. Mr van Beurden announced that in future Shell will include emissions from its products (so-called Scope 3) when calculating its carbon footprint.

The case for Scope 3

Scope 3 is a technical term, but crucial to guide corporate actions on climate change. Until recently, Shell argued that oil producers could not be liable for emissions caused by the behaviour of customers: for example, emissions from cars.

(For context, Scope 1 refers broadly to emissions from business operations; Scope 2 covers supply chains; Scope 3 spans the activities of customers and third parties)

In most industries, it would be unreasonable to hold a producer responsible for consumer behaviour. A chef cannot really be blamed for obesity in people who eat at her restaurant, for example. A soggy meringue is not the fault of the farmer whose chicken laid the eggs.

Oil companies are an exception. The core business of Big Oil is to extract and refine carbon fuels. What else can customers do with petroleum, other than to burn it in combustion engines?

To date, institutional investors in Shell which voted against the green resolutions from Follow This typically have cited Scope 3 as justification. Taking their cue from Shell’s management, the gist of this argument was that it would be unreasonable to include emissions from cars or planes or power stations when calculating the carbon footprint of oil producers.

In future, Shell will include Scope 3 emissions when calculating its carbon footprint. By walking away from an unwinnable dispute, Mr van Beurden has disarmed his green critics while shifting the focus of their scrutiny to Shell’s institutional shareholders.

An investors’ dilemma

The hard truth is that no credible argument can be made against a faster clean energy transition. Mr van Beurden knows this. Hence Shell’s U-turn on Scope 3 emissions, and his own history of serially fascinating comments on public policy.

This “kernel of truth” has grown into an awkward challenge for institutions invested in Big Oil. As Mr Fink made clear in his annual letter, responsible stewardship requires clear signalling by company managers to society.

The same standard can be applied to investors. Many are committed publicly to policies for sustainability and environmental protection, on their own initiative or as members of industry organisations and alliances.

Asset managers who tout a strategic purpose, but depend on the carbon-intensive profits of Big Oil for quarterly dividends, risk self-inflicted wounds.

In their public statements, both Mr Fink and Mr van Beurden present a carefully choreographed display of social responsibility. To which the only honest, respectful response is: Prove It.

The next Follow This resolution, at Shell’s 2018 AGM, poses a stark test for investors – and for none more than the biggest, BlackRock.

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