The little hedge fund taking down Big Oil
On the day the little investment firm Engine No. 1 would learn the outcome of its proxy battle at Exxon Mobil, its office in San Francisco still didn’t have furniture. Almost everyone had been working at home since the firm was started in spring 2020, so when the founder, Chris James, went into the office for a rare visit on May 26 this year to watch the results during Exxon Mobil’s annual shareholder meeting, he propped his computer up on a rented desk. As an activist investor, he had bought millions of dollars’ worth of shares in Exxon Mobil to put forward four nominees to the board. His candidates needed to finish in the top 12 of the 16 up for election, and he was nervous. Since December, James and the firm’s head of active engagement, Charlie Penner, had been making their case that America’s most iconic oil company needed new directors to help it thrive in an era of mounting climate urgency. In response, Exxon Mobil expanded its board to 12 directors from 10 and announced a $3 billion investment in a new initiative it called Low Carbon Solutions. James paced around the empty office and texted Penner: “I was doing bed karate this morning thinking about how promises made at gunpoint are rarely kept. Exxon only makes promises at gunpoint.”
At his apartment in TriBeCa, Penner, who had conceived and run the campaign since its inception, was obsessively focused on making sure that even the last moments before the annual meeting were used strategically. For weeks he had kept a tally of whom he thought big shareholders would back, but because they could change their votes until the polls closed there would be no certainty until the end. He had stayed up late the previous night writing a speech to give during the five minutes he was allotted to address shareholders, scribbling in longhand in a spiral notebook. He was hearing from major investors that the company was mounting a last-minute push, calling shareholders to swing the vote in its favor.
Penner took a quick shower and sat down at his desk for his speech. He had been sitting at the same spot since the start of the pandemic, holding virtual meetings to drum up support for Engine No. 1’s four nominees. Doubling down on fossil fuels as society tries to decarbonize was only one criticism he levied against Exxon Mobil; he also underscored the company’s declining profitability and the fact that, when the campaign started, no one on the board had experience in the energy industry. When the meeting began, Penner was the first shareholder to speak. “Rather than being open to the idea of adding qualified energy experience to its board, we believe Exxon Mobil once again closed ranks,” he said. Driving humanity off a cliff wasn’t good business practice anymore, he added, and shareholders knew it.
Forty minutes after the meeting started, Exxon Mobil called for an hourlong recess. It was an unusual move; shareholders couldn’t remember the company suspending an annual meeting right in the middle of the proceedings. It had been a bruising year for the industry, with oil prices trading negative last spring and record numbers of shareholder votes pressing major, publicly traded petroleum companies to prepare for a zero-carbon world. Just that morning, as the meeting was starting, the news broke that a Dutch court had declared that Shell must accelerate its emissions-reduction efforts. As Exxon Mobil’s meeting was underway, so was Chevron’s, and shareholders there voted in favor of a proposal to reduce the emissions generated by the company’s product, which would call for a re-evaluation of the core business. Exxon Mobil’s management had appeared confident about the activist threat, but in the last moments of the battle, it seemed that assurance was flagging.
During the break, company management and sitting board members continued making calls to some of the largest investors. Exxon Mobil said it was explaining to shareholders how to vote. The Engine No. 1 crew, huddled around laptops in their office or alone in front of their screens across the country, started speculating about what was going on — they suspected that Exxon Mobil executives saw the vote counts coming in and wanted to buy themselves time to try to make up for a shortfall. Penner texted James and told him to get an Exxon Mobil board member on the phone. “Seriously, tie them up if you can,” he wrote. Engine No. 1 sent out a statement criticizing the company for using “corporate machinery” to undercut the process. James was incredulous. Is this legal? he kept thinking. Can they really do this? An Engine No. 1 public-relations adviser started shouting on the phone at a CNBC producer who didn’t seem to be sufficiently appreciating the significance of the moment. A few minutes later, Penner went live on air. “This is classic skulduggery,” he said. “This is not the way to move this company forward.”
When the meeting reconvened, Exxon Mobil’s chief executive, Darren Woods, sounded hoarse and weary. He took questions for nearly an hour and then abruptly stopped talking so that the election results could be announced. Almost all the people at Engine No. 1 had their heads in their hands, and they went still while the list was read. One of their candidates, Greg Goff, was an oilman who had led a smaller refining company to legendary profitability and thought that mitigating environmental harm was part of corporate responsibility. Goff was elected. So was Kaisa Hietala, a former vice president for renewable energy at Neste, a Finnish petroleum company.
But Penner started shaking his head in exasperation — what about the other two candidates? Andy Karsner, an energy entrepreneur, was still in the running; the vote was too close to call. Anders Runevad, a former wind-power chief executive, was out. Penner didn’t have the final tally, but it was now clear that at least two seats had been wrested from management. Engine No. 1 had gained a foothold at the board of Exxon Mobil based largely on the strength of its argument that failing to plan for the impact of climate change could spell the demise of a business. Penner, usually subdued, raised a clenched fist.
In the corporate world, successful proxy battles are the equivalent of shareholder insurrection. Usually motivated by displeasure with management, activist investors in a company can put forward proposals, including board candidates, to be voted on at companies’ annual meetings. Investors have taken activist stances in their companies at least since a shareholder named Isaac Le Maire started complaining about money management at the Dutch East India Company in 1609. But the practice was weaponized in the United States during the 1980s, when a set of ambitious moneymakers conducted what were eventually called corporate raids, intended to pump up the value of a company’s stock even if that meant carving up the business.
Famous activist investors, like Carl Icahn or Bill Ackman, are often seen as predatory, but they are skilled at reading a company’s vulnerabilities and marshaling shareholder dissatisfaction. Because recruiting and putting forward a slate of candidates is expensive and time-consuming, though, investors often try to engage with a company behind the scenes before initiating proxy battles for board seats. “In terms of corporate America, it’s very aggressive,” said Jeff Gramm, author of the 2016 book “Dear Chairman: Boardroom Battles and the Rise of Shareholder Activism.” Companies have been known to respond with comparable aggression, holding annual meetings in remote locations or adjourning them suddenly to stifle dissent.
While activist investing typically focuses on a company’s financials, socially minded investors have used the levers available to them to press for fairer business practices. Shareholders need to hold only a small stake in a company to put forward a resolution, but disputed proposals have to be approved by the Securities and Exchange Commission, which has rules limiting shareholder influence over day-to-day business operations. Depending on the disposition of a company’s management, though, sometimes even a small amount of shareholder disquiet is enough to change a company’s behavior. In 1969, a civil rights organization of doctors and nurses filed a proposal at the Dow Chemical Company to stop selling napalm for use as a weapon; the S.E.C. backed the company’s decision to block the proposal from reaching the annual meeting. Dow stopped producing napalm for the U.S. military that year.
In the past few years, an increasing number of proposals have aimed to pressure large corporations, and especially oil-and-gas companies, to respond to climate change; more than 1,600 such proposals have been filed since 2010. Of those, less than half were put to a vote, and just a tiny sliver gained majority support; even successful resolutions are nonbinding, so companies can still dismiss them afterward. But when an activist wins board seats, companies have to choke back their dissatisfaction and accept their new directors.
Because the rules for filing a shareholder proposal are different in Europe, generally requiring a bigger stake in the company but not dependent on approval by a regulator, investors have submitted more ambitious climate proposals at the major oil companies there. In 2015, a Dutch activist named Mark van Baal started raising money to buy shares in Shell, and the next year, he went in front of shareholders with demands that the company invest its profits in renewable energy and “take the lead in creating a world without fossil fuels.”
The resolution convinced only 2.7 percent of Shell shareholders, but van Baal returned again with a proposal to put the company’s trajectory in line with the goals set out in the Paris climate accord — the 2015 global agreement committing countries to aim to keep global temperatures below a 1.5-degree-Celsius increase and not allow them to rise more than a maximum of two degrees Celsius above preindustrial levels — and this one garnered 6.3 percent shareholder support. Van Baal saw his approach as an incremental slow burn; as his proposals gained more support at each annual meeting, companies had little choice but to respond and adapt. Last year, many of the major European oil companies, including BP, Shell and Total, said they intended to cut carbon-dioxide emissions to net zero by 2050.
At Engine No. 1, Penner was sensitive to coming across as a fire-breathing activist investor during the Exxon Mobil campaign. But the core of his argument rested on mobilizing shareholders with classic activist tactics: focusing on the company’s financials, underscoring its flagging profitability and setting out an argument for how to raise the value of the company’s stock by making smarter expenditures. He didn’t aim to undercut the core business necessarily; rather than urging Exxon Mobil to give up all oil and gas, he wanted the company to practice what finance people like to call “capital discipline,” which basically just means not spending prodigiously. He also reasoned that, given mounting pressure from society and governments to decarbonize the global economy, it would be strategically smarter for Exxon Mobil to be part of an energy transition, rather than letting itself be outstripped by other companies innovating to meet demand for low-carbon power. There might still be money in oil now, but Penner and James wanted to convince shareholders that the key to profitability involved taking a longer view on the health of the business.
That argument reflected the changing nature of investment and the increasingly powerful role that large funds play in corporate decisions. Three of the largest asset managers, BlackRock, State Street and Vanguard, own nearly 20 percent of Exxon Mobil. Big pension funds, including the California and New York state funds, also own stakes in the company. The New York state comptroller, Thomas DiNapoli, said that the basis of his fund’s engagement with Exxon Mobil was about making sure that its investments would remain fiscally sound over the next 100 years. Once a portfolio is big enough, the risk exacerbated by one part can also start threatening other positions. “Diversification is meant to be one of our risk-management tools,” said Anne Simpson, managing investment director of California’s state pension fund. “But if you’re facing systemic risk, you can run, but you can’t hide. In other words, we can decide not to hold a company that’s producing emissions — that’s the divestment case. However, if the emissions continue, we’re still exposed to the risk of climate change.”
In many ways, Exxon Mobil had made itself an ideal target. Before the proxy battle started, the company’s directors were primarily former chief executives from other industries like pharmaceuticals and insurance. With plans to increase oil-and-gas production by 25 percent over the next five years, the company seemed out of step with the market. Profitability had already been slipping for a decade. Exxon Mobil earned the largest annual profit in U.S. history in 2008 and nearly eclipsed that record in 2012; last year it lost $22 billion.
In part, the loss was due to a historic $19 billion write-down on the value of its assets. That assessment may still be too rosy; a whistle-blower reportedly told the S.E.C. in January that Exxon Mobil had overvalued its assets by at least $56 billion, in part by pressuring employees to inflate expectations about the drilling timelines in the Permian Basin in Texas and New Mexico, which remains the company’s U.S. cash cow. (Exxon Mobil called the claims “demonstrably false.”) Although it managed to keep shareholders’ dividends intact — mostly by cutting costs, including announcing thousands of layoffs — the company’s stock value plunged in 2020 by 40 percent, its market valuation taking a $120 billion drop. The company has more than $60 billion in debt, borrowed to fund purchases of its own stock to buoy its price and to pay out stockholder dividends. Despite the buybacks, and a significant improvement in the stock’s value since late last year, it is still nearly 30 percent lower than it was five years ago. After almost a century on the Dow Jones industrial average, the corporation that descended from John D. Rockefeller’s Standard Oil was replaced last August by a tech company.
Chris James, the lanky and energetic 51-year-old founder of Engine No. 1, didn’t establish his firm to go after Exxon Mobil. A tech investor who speaks in the parlance of Silicon Valley start-up culture, James decided in 2019 to abandon his hedge fund and seek to reconcile what he saw as an uncomfortable tension between the consequences of his work and his volunteering at a San Francisco homelessness nonprofit. On a hunting trip near his cattle ranch near Jackson, Wyo., James decided to go into impact investing and start a new firm dedicated to reimagining the concept of value. The firm would create an E.T.F., or exchange-traded fund, and then vote actively in favor of positive measures at the companies included in it. It would also have a private offering. For James, the goal was to build something that could convey his belief that the effect a company had on society would determine its long-term success. He was influenced by a 2017 paper by the economists Oliver Hart and Luigi Zingales that rejected Milton Friedman’s canonical argument, published in 1970 in this magazine, that companies should focus exclusively on making money; they instead posited that shareholder welfare includes more than just market worth.
A few months later, in late 2019, James met Penner, now 48, at his office in New York City, having been introduced through a mutual acquaintance. Studious and analytical, Penner had just come off an activist campaign he led as a hedge-fund partner, pressuring Apple to improve parental controls on its smartphones. He also led an effort, resolved privately, to persuade McDonald’s to offer plant-based burgers. A committed campaigner with a deep sense of what he thought constituted right action, Penner had already set his sights on Exxon Mobil, and he was talking to investors who might be interested in taking on the oil company. James told Penner he should join his new firm, which hadn’t yet opened, and spearhead a proxy contest. Penner left his job at Jana Partners, a hedge fund in New York, and joined James in spring 2020. They would take until December to find nominees for the board and articulate a strategy to persuade shareholders. Penner already sensed that Exxon Mobil was an industry outlier, more reluctant than others to recognize that if the world enacted the emissions reductions that its governments had committed to, there would be no viable business for a publicly traded oil company in 30 years.
As they planned the campaign, James retreated from San Francisco to his ranch and spent the summer learning about what it would mean to rejigger the way society powers itself. What he found astounded him. As a tech investor, he was used to innovations growing on an S-curve, with a long tail of early adopters that suddenly became mainstream. Through conversations with experts, researchers and power-grid operators, he began to see potential energy-sector S-curves everywhere. Grids often rely on natural gas to help bridge over times of peak energy consumption, for example, but James talked to experts who said battery technology had advanced enough that it was poised to replace gas by storing renewably produced energy for later use. Internal-combustion engines in cars waste around 75 percent of the energy produced burning gasoline. James became convinced that, because electric vehicles use energy much more efficiently, they would simply beat out everything else in the market. He had initially thought that, optimistically, maybe half the cars on roads would be electric in the next two decades; now he revised it up to at least 80 percent. “At a price point in the energy transition,” James said, “adoption could just explode.”
One of the most difficult parts of building a system powered by something other than hydrocarbons is that it’s not clear what technology will outpace others in the market; from the perspective of oil executives, that means any particular path is fraught with potentially costly missteps. Companies like Exxon Mobil have more readily committed to reducing emissions intensity by lowering the amount of carbon released per unit of gas or oil than agreed to reduce absolute emissions. Still, in order to keep global warming under certain thresholds, there’s only so much more carbon dioxide that can be emitted into the atmosphere. According to most experts, annual carbon emissions must start declining in the next few years, be halved by 2030 and reach net zero by 2050 in order to stay within that budget. But in the largest areas of fossil-fuel consumption, which include transportation, buildings, industrial manufacturing and power generation, there are still unresolved problems about how to decarbonize.
Because the cost of wind and solar power has fallen so much over the last 10 years, to the point that they can compete with natural gas and coal, converting power grids to renewable energy and then electrifying as much as possible is one of the most popular routes to zero carbon. The approach could work in transportation with electric vehicles, but also in buildings, if gas-and-oil-consuming appliances and heating systems are systematically replaced with electrics and heat pumps. That would mean substituting the notion of energy efficiency, which still ultimately relies on fossil fuels, with the goal of emissions efficiency. “The shorthand for decarbonization is basically electrify everything and then decarbonize that electricity,” said Ed Crooks, a researcher at Wood Mackenzie, an energy consultancy. Some industrial sectors, like steel, whose production emits twice as much carbon annually as global airplane travel, are among the most difficult to decarbonize, because chemical reactions in the manufacturing process create carbon. But it’s possible that using hydrogen could lower some of the sector’s emissions, because it burns clean. Hydrogen could also play a role in long-haul trucking, but isolating it is energy-intensive, and green hydrogen, which is produced using renewable energy, currently amounts to only less than 1 percent of the roughly 100 million tons of hydrogen produced each year.
Just over a week before Penner and James’s proxy battle with Exxon Mobil culminated in the shareholder meeting, the International Energy Agency — the world’s leading energy-policy organization, with vast influence over governments’ plans — released a report that called for global investment in new gas and oil fields to stop immediately. In its assessment, the agency outlined a net-carbon-free future in which solar and wind power doubled in four years, grids were net zero by 2040, sales of internal-combustion-engine vehicles ceased by 2035 and half the world’s heating was supplied electrically by pumps by 2045. By 2050, more than 90 percent of heavy industrial manufacturing was to be converted to low-emissions processes. In addition to laying out a scenario relying primarily on clean electricity, the agency also slashed the role of fossil fuels. After years of forecasting rising demand for oil in the decade to come, the I.E.A. said the world now has 20 years to cut it in half.
Among the world’s major, publicly traded oil companies, Exxon Mobil has carved out a unique place. Before Engine No. 1 began the proxy battle, as other oil companies unveiled plans to reimagine their business models by laying out their own paths to zero carbon by 2050, Exxon Mobil entrenched itself. Last October, leaked internal Exxon Mobil documents obtained by Bloomberg showed that the company’s preliminary assessment of its investment plan included a projected 17 percent increase in its annual emissions — to 143 million metric tons of CO2 — by 2025. That represented emissions generated only by the company’s own operations; it didn’t include “scope 3” emissions, caused by consumers burning Exxon Mobil’s product. The company’s plan, based on expectations of continued growth, preceded the pandemic, but it gave an indication of how executives intended to chart the next few decades. Even as the coronavirus was causing countries around the world to shutter early last year, Woods, the chief executive and architect of the company’s growth plan, promised that Exxon Mobil would continue “leaning into this market when others have pulled back.”
One thing the company has pointed to as a sign of its commitment to addressing climate risk is its carbon-capture and storage projects, an area that oil companies advertise as making use of their expertise with subsurface mining. Most scenarios for reducing global carbon emissions to zero by 2050 include some form of removing carbon; Shell’s plan for the company’s path, for example, includes offsetting 120 million tons of carbon per year by 2030, in large part by planting millions of trees. Carbon capture as it currently exists isolates and removes the molecule at the point of production. Exxon Mobil has removed carbon dioxide as a byproduct of natural-gas extraction for decades; its most significant carbon-capture facility, near LaBarge, Wyo., separates carbon from its main end products, gas and helium, brought up from limestone at least 15,000 feet below the Earth’s surface. Most of the carbon dioxide is offered to other oil companies for use in something called enhanced oil recovery, which means that it is injected at other wells to retrieve more oil. The carbon dioxide that’s injected for oil extraction generally stays in the subsurface, but because that isn’t the end purpose, there’s little monitoring for leaks.
If the market isn’t strong enough to make selling carbon dioxide worthwhile, the company injects it back into the ground, to depths where pressure forces it to take fluid form, keeping it sealed. Researchers have also developed methods for storing carbon in saline aquifers, which are areas of porous rock filled with salty water deep underneath the Earth’s surface. Most carbon stored for environmental reasons is kept in these aquifers rather than in old oil fields. According to Steve Davis, a former Exxon Mobil employee and researcher currently affiliated with Stanford University, of the approximately 40 million tons of carbon dioxide captured annually on a global scale, only about five million is intentionally stored in saline aquifers so that it doesn’t enter the atmosphere. The rest is injected to extract more oil.
During its campaign, Engine No. 1 relied on public information about Exxon Mobil, but the company had historically obscured how much it knew about climate change. There were also signs of internal conflicts. One scientist, Enrique Rosero, publicly said he was pushed out last summer after criticizing the company’s climate strategy, and he expressed doubt about the sincerity of Exxon Mobil’s supposed environmental efforts. “My personal opinion is that most solutions are public-relations efforts and that some of the technologies and partnerships that have been prominently featured may not deliver at scale,” Rosero said, citing the company’s much-hyped algae biofuel and direct carbon capture. Much of the oil company’s long-term carbon-capture strategy depends on establishing commercial viability, either through publicly funded incentives or by establishing a price on carbon; in the absence of government support, it’s not clear how the process would make financial sense.
Other current and former employees, some of whom spoke on the condition of anonymity for fear of losing their jobs, said the rigid hierarchical corporate culture at Exxon Mobil dampened the potential for innovation. Other oil companies have announced plans to acquire renewable-energy ventures, invest in alternative fueling infrastructure and work with other industries to figure out how to remove carbon from their processes. But Exxon Mobil has resisted venturing in a significant way from its traditional bread and butter.
One global asset manager, who met with Exxon Mobil a dozen times before the proxy vote, said that while management remained steadfastly convinced that it was right, the company also approached the problem with an engineering mind-set that balked at committing to something like net zero without a detailed plan for getting there — a reasonable concern, but one that other companies have approached as a challenge with 30 years to solve. Some shareholders said the company was uniquely intransigent about responding to mounting demands; after more than 60 percent of Exxon Mobil investors voted in 2017 in favor of producing a report on the risk to the business of addressing climate change, the company published a forecast for demand that would rely on cutting emissions intensity and improving efficiency. “We found the report that they produced to be less than adequate,” said DiNapoli, the New York state comptroller. In it, the company projected a 2.4-degree global temperature increase.
In January, shortly after Engine No. 1 began its proxy battle, Penner and James had a video call with Woods and Exxon Mobil’s lead independent director, Ken Frazier. The encounter was tense, but everyone made an effort to maintain the veneer of friendly deference. At one point, Frazier flashed a peace sign at the camera, acknowledging shareholder frustration with the decreasing profitability of the last decade while also explaining that the board had criteria for vetting new candidates — selecting for chief-executive-level experience at companies with significant market value — that Engine No. 1’s nominees didn’t meet. Woods talked about how the company would play an important role in meeting the energy demands of a growing global population with improving standards of living. He said Exxon Mobil supported the idea of addressing climate change but didn’t know what kind of competitive advantage the company could have in areas like renewable energy.
“A lot of your investors think it would make sense to set longer-term goals,” Penner said midway through the call.
“Hey, Charlie, do you know how anybody is going to meet the 2050 goal today?” Woods replied. “Have you asked any C.E.O.s who have committed to that?”
“Do you know how you’re going to fulfill your business plan without burning down the planet?” Penner asked.
“If all it takes is aspiration,” Woods said and then paused. “We support that ambition.”
“Have you ever accomplished anything that, when you started, you didn’t know how you were going to finish?” Penner replied. To Penner, having a goal of getting to net zero even without an exact map was better business than planning to continue producing oil and gas in a decarbonizing world.
The call ended with the executives and activists saying they would continue to seek a resolution to avoid a standoff. They didn’t speak again.
Less than two weeks after the call, Exxon Mobil’s management announced that it was adding a director to its board — the former head of Malaysia’s national oil-and-gas company. A month later, the company said it was adding two more, an activist investor and the chief executive of an investment firm, bringing the board briefly to 13 directors, although one director’s term was due to expire. It spent more than $35 million blanketing shareholders with appeals to reject the activists and stick with management. It unveiled a $3 billion investment in its new Low Carbon Solutions venture, primarily focused on carbon-capture projects, including many that had already been announced by the company. It revised its production growth targets down. Just days before the proxy votes would be tallied, Exxon Mobil announced that it would add two more yet-unnamed directors, one with “climate experience” and one with experience in the energy industry. But the company’s efforts at placating the activists fell short, and a week after the annual meeting, it became clear by how much; the company announced that Andy Karsner, the energy entrepreneur, had also been elected to the board, giving Engine No. 1’s candidates a quarter of the seats.
Last summer, months before Engine No. 1 went public with its campaign, Penner and James went to Texas to meet Greg Goff, a candidate they were considering nominating to the Exxon Mobil board. It was the middle of the pandemic, a hurricane was forming and travel seemed imprudent. But Goff, who is 64, was revered in the oil industry for his tenure as chief executive at the petroleum-refining company Andeavor, during which its share price went to $153 from $12. He was also known to be unafraid of breaking with tradition; one analyst recalled him shunning the opulent and Central Park-adjacent St. Regis, where industry events with stockbrokers were customarily held, to host a dinner at a wood-paneled Midtown steakhouse. Penner and James had spoken with Goff a few times, and it seemed as if he was warming up to them. Having Goff on the ticket would prove that they weren’t just a bunch of Wall Street types trying to gut the company without understanding the industry. Maybe it would also show that even dedicated oil executives could see the business case for change.
They took private flights to Texas. Goff picked them up, driving a truck that had shotguns in the back of the cab. The plan had been to go out and shoot some clay birds while they discussed business. Instead, they spent the day on a porch outside a hunting lodge in the middle of Hill Country under the August sun. They dined together. They drank wine. They talked late into the night about what the future of the energy industry would look like and how to adapt to a world in which the consequences of burning fossil fuels are no longer acceptable. Goff didn’t like to talk about an energy transition, because that suggested a future free of fossil fuels, which he wasn’t sure was possible. But the oilman, who started his career at Conoco and spent 40 years in the industry, knew that something would give — and that there was potential there. “The world is changing, and many, many stakeholders have different demands and expectations,” Goff said. “The change was primarily about just business.”