The Future of the Fossil Fuel Business

This past Memorial Day weekend, as I thought about the sacrifices of those who served to protect us, I also stopped by a gas station and put gasoline in the tank of my 2014 Honda CRV. My car spends most of the time between Labor Day and Memorial Day parked in a garage, but on Memorial Day weekend, I begin my weekly drives to Long Beach, New York, and join the rest of America fighting traffic. My home, office and car are all powered by fossil fuels, and that is true for nearly everyone I know. It is important to acknowledge our dependence and not pretend it does not exist. Simultaneously, we must also understand that the transition away from fossil fuels has begun and must accelerate.

Last week we saw several dramatic developments that tell us that the fossil fuel era is coming to a gradual end. The issue is: how gradual? Last week the rate of change accelerated, and perhaps we are reaching a tipping point. I believe that fossil fuel companies will need to become energy companies or they will go out of business. As Somni Sengupta reported in the New York Times, the first event, which she termed a turning point, was a judicial action in Europe:

“The most dramatic turning point came in the Netherlands, where a court instructed Royal Dutch Shell, the largest private oil trader in the world and by far the largest company in the Netherlands itself, that it must sharply cut greenhouse gas emissions from all its global operations this decade. It was the first time a court ordered a private company to, in effect, change its business practice on climate grounds.”

Sengupta’s piece also reported on a court case in Australia where a coal mine was permitted to expand operations but was told by the court to try to avoid injuring children, thus acknowledging the long-term negative impact of fossil fuels.

In my view, the most important event was the shareholder revolt against Exxon. The more far-sighted owners of fossil fuel companies understand that their investments are jeopardized by the environmental and financial risks posed by climate change. Institutional investors and some hedge funds have started to exert pressure on oil companies to transition away from fossil fuels. I believe that the organizational capacity of these companies needs to be retained but deployed to transition to renewable energy as soon as possible. Some fossil fuel companies have begun this transition, but Exxon has resisted. According to Sengupta:

“A significant chunk of shareholders demonstrated that they were increasingly distrustful that the companies could deliver the financial performance they expected without diversifying away from oil and gas. Exxon this week lost a battle against a small new hedge fund, Engine No. 1, which rallied big investors like Blackrock and the New York state pension fund to force the company to change course. The hedge fund won at least two seats on Exxon’s 12-member board.”

The presence of these new board members will have a major effect on Exxon but will also impact other fossil fuel company boards whose members will want to avoid losing their seats to similar insurrections. I serve on the corporate board of a private company that is financed in part through shares sold in a public marketplace. Access to this source of capital is regulated in the U.S. by the Securities and Exchange Commission. Board members are required to file annual public disclosures on issues such as conflicts of interest, and most members understand that board membership obligates them to comply with a wide variety of regulations related to corporate governance.

Moreover, publicly owned companies are increasingly subject to state rules on board composition and must be sensitive to political and social trends. Boards are conscious of these trends and so is the management of well-run private companies. There are many ideologues who resent and resist public “interference” in the private marketplace. J.P. Morgan and Teddy Roosevelt fought an intense battle for control of the economy at the start of the 20th century. In the end, Roosevelt won. He “busted” trusts or monopolies and established that a key role of government was to ensure a competitive marketplace. A totally free and unregulated American economy has been a myth for over a century. Government subsidizes and regulates the private economy.

Sometimes government action promotes private interests, but often it is designed to promote the public interest. Fossil fuel companies have benefited from government policies such as the interstate highway system and the fuel depletion tax allowance. Increased mobility was promoted by public policy and both the public and oil companies benefited from those policies. But climate change has altered the political environment. The days of fossil fuel subsidies are ending, and they are being replaced by subsidies for their competitors, renewable energy. Government decarbonization targets are a direct attack on the industry that sells fuels that emit greenhouse gases. These companies may occasionally pretend otherwise, but they are far from ignorant of the meaning of climate change for their enterprises.

Fossil fuel use will continue for decades as it winds down and is replaced by renewable energy. If my parking garage installs more charging stations and the price of electric cars comes down a little, my next car will be an electric one. But for now, my trips to the gas station will continue. Some technologies that will assist decarbonization are already here, but some crucial ones must still be developed. The high temperatures required for some industrial processes and air travel still require fossil fuels. But I expect that technologies for those uses will be developed and eventually eliminate the need for fossil fuels. One of the challenges for the fossil fuel industry is to reduce fossil fuel production and capacity while replacing it with other lines of business. The volatile global market for fossil fuels is already characterized by instability and massive price fluctuations. This will make it difficult to develop and implement the business models required for successful (in other words, profitable) transitions away from fossil fuels.

Successful businesses must anticipate future demand and build their strategies to meet those demands. Exxon’s new board members will need to work to convince their new and possibly reluctant colleagues to change their direction. While a board provides broad governance to a company, it is management that really runs the show. Exxon’s management may decide to try to isolate and ignore their new members, or they could listen and take seriously the shareholder views they represent. I have no idea what they will do, but my unsolicited advice is that Exxon management takes seriously the idea that their company’s future requires that they redefine themselves as an energy company. They should apply their engineering, procurement, logistics and management talents to renewable energy. They should begin a transition to a new set of energy products. They might look to acquire some companies in the renewable energy business and develop a long-term plan for disinvesting and closing their fossil fuel extraction and refining businesses.

Fossil fuel will not disappear tomorrow, but it will be an industry in decline for decades. On the other hand, energy use will continue to grow in America and globally. A pivot away from a declining business and toward a growing one would provide shareholders with continued value. While fossil fuels are in decline, there is no reason that fossil fuel companies cannot adjust and play a part in the transition to an environmentally sustainable economy.