Exxon's Dividend Policy Unlikely to Change in the Near Term After Activist Wins Board Seats

At Exxon's annual meeting Wednesday, shareholders elected at least two of the four board directors (votes are still being counted) nominated by Engine No. 1, an activist investment firm that turned up the heat on the oil major late last year.

Engine No. 1, which holds a mere 0.02% stake in Exxon, has criticized the company's poor performance over the past decade. The tiny hedge fund chided management for aggressive, debt-fueled spending that has hurt returns and alleged that Exxon has no credible plan to protect value against a widening range of energy transition scenarios.

To address these issues, Engine No. 1 wants Exxon to reduce oil production, invest only in projects with lower break-even prices, gradually diversify its business to prepare for a decline in fossil fuel demand, and better align management's compensation incentives.

While Exxon's underwhelming financial performance in recent years is a key part of Engine No. 1's focus, combatting climate change has become an equally important topic facing Big Oil as the world seeks to cut carbon emissions.

Exxon is the world's 5th largest producer of greenhouse gas emissions. Engine No. 1 argues this is an "existential risk" given that two-thirds of emissions come from countries that have pledged to reach net zero emissions by 2050.

Exxon has long argued that oil demand will experience moderate growth in the decades ahead. But the world's push for cleaner power could see oil consumption fall around 30% within a decade, according to a scenario modeled by the International Energy Agency (IEA) that accounts for net zero emissions standards by 2050.
Source: Engine No. 1 Presentation

The bottom line is that efforts to decarbonize the world are gaining steam, and the global power generation mix could be radically different in 20 years. Engine No. 1 wants to ensure that Exxon does not get left behind with its narrow focus on fossil fuels.

After all, Exxon ranks well below its peers in terms of energy transition readiness with a score of 3.2 out of 10, according to a 2021 study conducted by Bloomberg.
Source: Engine No. 1 Presentation

In large part, the rankings above reflect the ideological differences between American and European oil majors, which Bloomberg summarized:

"On one side of the Atlantic, BP, Shell and Total are trying to make themselves going concerns for a low-carbon age, diluting their fossil-fuel businesses with plans to build significant revenues from renewable energy. Exxon and Chevron -- insulated from the pressure applied by European investors and politicians -- are charting a different course: keep pumping as profitably as possible and hand the cash back to investors. Like Big Tobacco, they’re increasingly courting shareholders willing to put returns above the harm their product causes."

Shell and BP slashed their dividends last year as part of bold transformation plans to become greener. BP's plans include cutting its oil and gas production by 40% over the next decade while ramping investments in low-carbon projects and renewable power, which earn lower returns than its fossil fuels business.

Could Exxon's new directors push the firm to cut its dividend to prioritize more investments in low-carbon energy projects as well?

In at least the near to medium term, we think that's unlikely.

First, Engine No. 1 has struck a generally supportive tone for the dividend. While some of this could just be talk to win over shareholder votes, the fund in a December 2020 letter to Exxon suggested its ideas would result in more free cash flow and better dividend coverage:

"We also believe that a long-term commitment to cutting unproductive capex and tightening project return requirements for approval would likely increase free cash flow, strengthen the Company’s balance sheet, and secure its ability to cover its dividend, which are crucial considerations particularly for the Company’s smaller shareholders."

And while it's still early days, integrated peers such as Total have shown that it is possible to begin gradually diversifying – and embracing long-term emissions reduction targets – without reducing the dividend or turning away from a lucrative oil and gas business.

Even if Engine No. 1's newly appointed directors started pushing for a more dramatic shift in capital allocation priorities, it's hard to say how much influence they will have on Exxon's strategic direction.

Assuming three of its nominated directors are ultimately elected, they will account for a minority share of Exxon's 12-member board. Exxon's incumbent directors, including Chairman and CEO Darren Woods, may take a dismissive stance towards the new directors, who need to make allies if they want to push their agenda successfully.

Overall, Engine No. 1's surprising success shaking up Exxon's board shows how quickly markets and investors are moving to prepare for a future with cleaner forms of energy.

For now, we would be surprised if Exxon made any rash moves to significantly shrink its core oil and gas business, venture big into less proven and lower-margin renewables, or reduce its dividend, which is covered by cash flow in today's oil price environment.

That could change if the energy transition happens at an accelerated pace and necessitates a more rapid evolution. But long-term predictions about the world's energy mix come with plenty of uncertainty.

What's clearer is that management will be under more pressure to improve Exxon's financial performance and think more deeply about various energy transition scenarios, which seem like healthy developments.

Based on what we know today, we plan to keep holding our Exxon shares to see how the future unfolds. The stock could appeal to contrarian income investors who believe in oil's staying power, and we will continue providing updates as necessary. 

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