In a Q&A with Critical Resource, Karina Litvack, a non-executive director of Eni and leading SRI expert, calls on extractive firms to plan for a 2°C world.
Karina is a leading SRI expert and has been an independent non-executive director of Italian oil & gas major Eni since May 2014. She was previously the head of Governance and Sustainable Investment at F&C Asset Management.
Please note Karina Litvack made the comments below in a strictly personal capacity.
On climate change, firms must accept the 2°C target as a basis for long-term strategy
“It is imperative that companies accept as an opening premise the need to limit the global temperature rise to no more than 2°C above pre-industrial levels. From there we need to articulate what the business will look like, and therefore how it needs to evolve over time to get there. There has been a lot of doubt about whether the 2°C cap will be realised, but that scenario doesn’t bear thinking, certainly in terms of cost to the economy and impact on financial stability, as outlined by Bank of England Governor Mark Carney – let alone of harm to humanity and the planet. If we are saying it is going to be a 4°C or a 6°C degree world, then let’s think through honestly what the operating and financing environment will look like. There needs to be a very clear position taken on that one pivotal question, 2°C yes or no?”*
Companies need to better integrate near-term plans with a 20-35 year vision
“The industry has to operate on several tracks at once. On one it has to carry on with tackling immediate challenges: responding to the crashing oil price, shoring up the business and making it resilient to the 4-10 year cycle. Yet it cannot afford to do this at the expense of the longer-term, 20-35 year horizon. Oil and mining companies like to say that they operate on a 50 or even 100-year time horizon, because their assets are so long-lived. Interestingly, however, this does not seem to be reflected in the way they articulate their strategic plans. Many companies operate on the basis of a four-year strategic plan, which most common mortals would describe as a short to medium-term horizon.
These two tracks ultimately have to converge. There needs to be an understanding of the KPIs that drive both sets of behaviours. Take remuneration incentives as an illustration; if we start from the premise that people will do what they are paid to do, we cannot pay them to act against the long-term interests of the company. We have to reconcile what is good for the company in four years with what is good for the company in 35 years. We should build into our remuneration strategies a series of indicators that capture performance against our objectives in the short to medium-term as well as the long-term. This means figuring out what the company’s long-term destination actually is – and that is a bold thing to be doing.
Another thorny example is reserves replacement. As a KPI, it makes sense as a measure of long-term productive capacity; but the focus on reserves has also driven up production costs to the point where many are uneconomic, not only in the current price environment but also potentially over the longer term, particularly if, as many are increasingly hypothesising, the relative stability brought about by the OPEC model is under threat. Seen in the context of the debate on stranded assets, which Governor Carney has just catapulted onto the agenda of two of the oil sector’s key stakeholders – insurers and investors, is this single-minded focus on reserves optimal, or should they be regarded as a means to an end, where the end is defined as generating value for shareholders? This is an opportunity to break through this cognitive dissonance, and rethink how we set objectives and measure success over both the medium and longer term.”
Tackling climate change requires significant political leadership from industry executives
“There is an enormous prisoner’s dilemma in tackling climate change; if one company gets too virtuous for its own good, it will simply put itself out of business. There is an inevitable need to work collaboratively with peers, but also with stakeholders to set new rules of the game and position one’s own company within it – which, in effect, places unprecedented responsibility on the shoulders of CEOs to step outside their familiar role and act as global citizens.
Industry leaders need to think both defensively and proactively about how to shape their business in a world where the 2°C cap will apply. There is no way around this other than building a shared understanding of what our destination point is and then getting on with it. That takes extraordinary vision and leadership. Many people have reached the top of their industry because they are brilliant engineers or businessmen; that does not mean they are brilliant political leaders, and addressing climate change certainly calls for political talent.”
ESG issues can be a powerful driver of commercial value
“My view is that anything that can get in the way of you running your business in a cost-efficient way or hanging onto your customers is a business factor. Irrespective of whether you agree or disagree with the substance of a particular challenge or the legitimacy of a given stakeholder, if they have the power to hurt you, you had better pay attention and have a strategy for getting to grips with their concerns and safeguarding your business. This can often intersect uncomfortably with morality, which is tricky terrain for business – but quite simply when moral issues threaten to morph into customer issues, they become an investment issue. This is not motivated by a sense of obligation to one’s god, or society or future generations. It is an obligation to your client next week.
A large part of the impact of environmental, social and governance (ESG) issues lies in exogenous factors, such as regulation and the evolution of customer demands – and regulators and customers are fickle. Take the example of clear-cutting in forestry; even though this practice objectively compromises the productivity of forest lands 20 years down the line, there is so much money to be saved up-front relative to more sustainable logging practices that the calculus can be compelling for companies. But in the case of one Canadian timber company in which my former company was a large investor, Greenpeace succeeded in persuading its wholesale customers to put a moratorium on their purchases until the company ceased clear-cutting. Overnight we sold the stock because what had been an ethical issue suddenly became a customer issue. The irony, of course, is that the moment an ‘ESG issue’ is perceived as a value driver rather than a soft factor to be ‘integrated’, it simply becomes ‘good management’.”
The SRI world is changing rapidly, with more engagement and integration
“The socially responsible investment (SRI) world has spread its influence over the investment market and has transformed itself in the process. This does not mean that the early tree-huggers have made tree-huggers of everybody else; rather, other mainstream actors in the investment market have appropriated a lot of the thinking that used to be confined to SRIs and made it their own. We have seen a greater focus on engagement between investors and companies. There is an acceptance that investment is not a binary question of whether to buy or sell stock, but entails working with companies to adapt to an evolving world and a diverse set of stakeholder expectations – including investors who ask unfamiliar questions. Historically there was a perception that, despite discussions about ethics or sustainability, the people who ultimately made investment decisions were completely disengaged from that debate. However these two worlds are converging as the stockpickers begin to understand how ESG factors drive value.
The most obvious example is health, safety and environment – that battle was won a long time ago, not least because the financial implications of getting this wrong can be huge. BP’s Macondo spill is an obvious example, as is Volkswagen’s deceit on emissions performance. There are many cases where getting this wrong hits share prices. But there are other, harder arguments to win that mainly boil down to a question of time horizons. Climate change is the most obvious such example. There is too much impetus to say: ‘I can make money on this now, I can make money on this for the next four, five or even ten years. It is not my job to change the world; it is my job to make money for my clients.’ This sort of thinking now needs to change.”
*For details on Critical Resource’s climate initiative ‘The Heat is On’ please click here.