BP, investors’ blind spot
Has the need for dividends compromised the green credentials of pension funds when it comes to oil companies such as BP? Nina Röhrbein reports
The Texas City refinery explosion in 2005. The Prudhoe Bay Alaskan oil spill in 2006. The Deepwater Horizon's Gulf of Mexico oil leak in 2010. Add to this a couple of fines for environmental or labour law infringements, and BP's track record looks anything but snow-white.
Based on major failings and weaknesses in the areas of plant and occupational safety, Munich-based oekom research has never rated BP B- or better, which corresponds to the ‘prime' status in oekom's sustainability assessment of the oil and gas sector.
But despite all these seemingly obvious warning signs institutional investors did not foresee the most recent accident.
Of course, given the market capitalisation of oil companies such as BP and Shell, it would be unusual for pension funds not to invest in them.
"For mainstream pension funds, BP and Shell seemed solid, blue chip investments with good cash flows and dividends that fit with their fiduciary duty to earn the best returns for their clients," says Neil Brown, SRI fund manager at Aviva Investors.
Investors initially took the best-of-sector in sustainable energy strategy by choosing the light green approach, according to Alan Kirkham, director at Investing Ethically, a UK-based specialist ethical investment advisory firm. "For a long time, BP was considered as one of the greenest oil companies because of its commitment to green energy in spite of former chief executive John Browne's safety record," he says. "In hindsight one should have taken Browne's cost-cutting into consideration - one should question whether these cost-cutting measures led to the Gulf of Mexico situation."
Kirkham continues: "Pension funds are more driven by the need for income and BP provided very good income. To an extent, pension funds invested in BP are now trapped by the low share value. They may have to sit still, regain the value in the next couple of years and then decide on the future."
But BP's accidents have caused lasting damage to the company's value and investors should know whether or not a company is able to manage these risks.
F&C's Stewardship fund has never held BP, initially because of concerns over human rights violations in Colombia. "When BP addressed those concerns the Stewardship fund still did not reinstate the company due to the company's health and safety track record," says Karina Litvack, director head of governance and sustainable investment at F&C Management. "Under Tony Hayward, BP prioritised health and safety but the Stewardship fund was waiting for the evidence to come in."
However, the rest of F&C's funds are engagement-orientated with a philosophy to drive change and have continuously held BP stocks. "Tony Hayward's articulation of such strategy gave these funds reason to believe that the company was turning a corner on these issues," says Litvack. "His new policies have apparently failed to be fully effective, which reflects the difficulty of transforming a culture across a vast organisation, especially as this was due to happen at the same time as efficiency and cost control measures were introduced."
In the past, companies that had an accident or a major incident to deal with have often turned out to be the strongest performers on safety and environmental issues over the following few years, according to Aviva's Brown, because they were the most aware of the risks and the most under pressure from shareholders and regulators. "When they come out as strongly as BP did in the past saying safety issues would be made top priority there may be grounds for allowing benefit of the doubt," he says. "This highlights the fact that investors never really know everything that is going on on the ground and many rely too heavily on information given by the company itself."
Whether the BP oil spill will have any long-term consequences on ESG research is not easy to assess. But there is increasing evidence of leading pension funds beginning to step up their ESG research, either by themselves or obliging their fund managers to undertake it on their behalf.
"But many pension funds still see themselves as traders rather than owners of those assets," believes Duncan Exley, director of campaigns at UK-based responsible investment lobbying group FairPensions. "They will delegate responsibility for ESG risks to their fund managers but a majority of fund managers say that a lack of assertiveness from asset owners is holding them back from properly tackling these issues. There is also often a focus on very short-term issues and quarterly results as a result of short-term focused research, which is cited as a barrier to extra-financial issues that may take a while to become financial."
Investors need to push for proper disclosure of the risks before any problems occur, he says, and engage with BP on whether the safeguards are in place now to make sure a similar accident will not happen again, bearing in mind that the next crisis affecting an oil company is unlikely to be exactly the same.
F&C's level of engagement with BP - which Litvack says has been relatively good in keeping an open line of communication with shareholders - has been intense since the oil leak. It is also seen as an opportunity to revisit those questions with all of F&C's other oil and gas holdings and suppliers or partners to BP, including oil service companies, insurers and banks.
Aviva Investors' SRI team is currently undertaking a review of all its oil and mining companies' ratings to find out what, if any, signals it missed. "The crux of the matter is the metrics we look at," says Brown. "SRI investors analyse plenty of health and safety data, lost time, injury rates and other factors, which are useful in their own right but also need to ensure they help anticipate and avoid such major incidents."
But the chicken and egg dilemma of energy investments is company policies versus results.
"Some companies, such as BP, are unusually transparent about what they do and the targets they set themselves," says Litvack. "Others, such as Exxon-Mobil, may have been less transparent yet at a technical level achieve better results, fewer accidents and spills. However, while flawless operational results are obviously necessary, they are not sufficient: all these companies function in an environment where they cannot fully control outcomes through their own behaviour alone so they need to engage with those who do have some degree of control or influence over their business, such as policy-makers, customers, suppliers and communities. It is very difficult to do this if they are inward-looking and simply focused on operational excellence."
The oil and gas industry in general has high ESG risks, while its business model and products do not fit very well with the idea of sustainable development and long-term energy security, according to Kristina Rüter, research director at oekom research and analyst in charge of the sector. However, she believes it is possible to identify companies that apply best practices and manage risks better than their competitors, or are not really involved in risky projects.
"In our engagement process, a very common answer from oil companies has been to say ‘just look at our share price, we are doing well'," says Litvack. "But investors need precisely to ask these questions when things are going well and the company has the resources to invest in improving its systems because good times can lead to complacency."
Litvack believes the way forward with BP remains engagement because the company, like any other that operates in a high-risk sector, faces pretty unrelenting pressure from the investor community on cost control and cash generation, and hearing a more enlightened and balanced message from investors helps management appreciate that not all of them are necessarily short-termist.
But she concedes: "As investors, we are outsiders and will always only have an approximate view at best of what is going on inside the oil and gas industry. Inevitably there will be instances where we are caught out and misread the signals just as management, and indeed the board, does. That does not mean investors should just assign a higher discount to these companies. Shareholders have a responsibility and an opportunity to make more nuanced distinctions between different operators and push for better practices."