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Paying with Fire – How oil and gas executives are rewarded for chasing growth and why shareholders could get burned 1
Paying with Fire
How oil and gas executives are rewarded for chasing growth and why shareholders could get burned
February 2019
About Carbon Tracker
The Carbon Tracker Initiative is a team of financial specialists making climate risk real in today’s capital markets. Our research to date on unburnable carbon and stranded assets has started a new debate on how to align the financial system in the transition to a low carbon economy.
www.carbontracker.org | [email protected]
About the Author
Andrew Grant – Senior AnalystAndrew joined Carbon Tracker in 2014 as a Senior Analyst, leading research on oil & gas and coal mining. He has authored a number of Carbon Tracker’s major reports on these sectors, including the Carbon Supply Cost Curves series, scenario analysis of the oil refining industry in Margin Call, and exploring transition risk at the company level in 2 Degrees of Separation. Prior to joining Carbon Tracker, Andrew formerly worked at Barclays Natural Resources Investments, a private equity department of Barclays that committed capital across a range of commodities and related industries. Andrew has previous experience in remuneration and corporate governance at Barclays Capital and New Bridge Street LLP. He is also a Senior Advisor to Critical Resource, a management consultancy specialising in political, stakeholder and sustainability challenges in the energy and mining sectors. Andrew has a degree in Chemistry & Law from Bristol University.
AcknowledgementsThe authors would like to formally thank Jeanne Martin from ShareAction for her valuable comments. Report design and typeset: Margherita Gagliardi.
Readers are encouraged to reproduce material from Carbon Tracker reports for their own publications, as long as they are not being sold commercially. As copyright holder, Carbon Tracker requests due acknowledgement and a copy of the publication. For online use, we ask readers to link to the original resource on the Carbon Tracker website.© Carbon Tracker 2019.
Front cover photo credits: Flickr, Pete from Liverpool, UK, CC BY 2.0
Key Findings
Executive Summary
Introduction
Overview of Executive Remuneration
The Climate Change Context
Identifying Growth Metrics
Scope of Research
Research Findings
Appendix I: Summary of growth metrics used at company level
Appendix II: Company incentive plan performance conditions
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• Most oil and gas companies incentivise their management to pursue growth, rather than focus solely on shareholder returns. Climate is rarely taken into account.
• In 2017, 92% of oil and gas companies in our universe included measures that directly incentivise growth in fossil fuel development, relating to either production, reserves, or both.
• Companies with the highest weightings on production and reserves/resources growth include Anadarko, Cabot Oil & Gas, CNRL and Oil Search.
• Only three companies (Galp Energia, Diamondback Energy and Origin Energy) did not include production/reserves in their incentive structures in 2017; BP and Equinor joined them in 2018. However, 4 of these 5 companies have other metrics that indirectly reward growth, but in a less obvious manner.
• We highlight Diamondback Energy as the only company to have no growth metrics in its incentive structure for 2018, with its executives incentivised entirely on returns and cost metrics. Equinor is next closest, with only a minor inclusion of cash flow from operations.
• Shareholder pressure to focus on value has had an effect – 10 companies (26% of those giving full disclosure) introduced or increased emphasis on returns measures in 2018 over 2017. For example, BP removed a reserves
replacement metric from its long term incentive plan and introduced return on capital employed.
• In the 2 years following the 2014 oil market crash, US E&P companies with a lower proportion of reserves or production incentive in their annual bonuses outperformed more growth-oriented companies by 7% CAGR (although the gap has subsequently closed). Shareholder returns exhibited a negative correlation with production and reserves-related annual bonus metrics, but a positive correlation with financial returns metrics.
• 9 companies have performance metrics that relate in some way to mitigating climate change. This includes half of the European companies reviewed, such as Equinor and Shell, but only one US company out of 20 (ExxonMobil, relating to its algae, CCS and methane reduction initiatives). However, where they are included, these metrics tend to affect a small minority of compensation, and most of these companies simultaneously encourage fossil fuel growth.
We believe that oil and gas companies should focus on extracting maximum value, whether demand is growing or not – but particularly so in a low carbon transition. Focusing on generating the highest returns may mean getting smaller in terms of absolute production, as capital is returned to shareholders or redeployed in other sectors where sufficiently low cost oil and gas project options aren’t available. Accordingly, executives should not have pay packets that reward them for chasing ever greater volumes of reserves and output.
Key Findings
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Paying with Fire – How oil and gas executives are rewarded for chasing growth and why shareholders could get burned
The energy transition requires reduced use of oil, gas and coal…If the world is going to be successful in its aim of avoiding the worst effects of climate change, demand and supply of all three of the fossil fuels – each of oil, gas and coal – will need to slow, plateau and then fall in absolute terms as soon as possible. For fossil fuel companies to navigate the energy transition will require them to focus exclusively on extracting value from a smaller opportunity set rather than expansion for its own sake. Recent commodity price volatility has already pointed investor demands in this direction.
… yet fossil fuel executives are rewarded for increasing outputDespite this, the vast majority of oil and gas companies incentivise their executives to pursue continued growth. Some incentive metrics are obvious, for example targets relating to production or reserve replacement, which have been shown to have a poor or negative historic correlation with shareholder returns. We believe these metrics incentivise potentially value-destroying behaviour given uncertainty over future demand.
Most companies also include other growth metrics which are more subtle, and incorporate other factors, for example metrics relating to earnings or cash flow. While these do include an element of value, they still incentivise production growth – for example, the easiest way to boost earnings might be to increase leverage and acquire more assets. These metrics should be considered in light of the rest of the company’s remuneration structure, and alternatives considered.
In this note, we look at a universe of 40 of the largest listed oil and gas companies with upstream operations headquartered in North America, Europe and Australia (drawn from the S&P Global Oil Index), and highlight such growth incentives.
Incentives should reward good management without requiring continued growthFrom a value perspective, metrics that are growth neutral are preferable in our view – particularly in the context of uncertain future demand. Financial metrics should promote a focus on returns or value, for example return on capital employed. Returns metrics have a positive correlation with shareholder value (see later). Non-financial metrics such as safety are also clearly relevant.
We commend the handful of companies that have included metrics relating directly to climate change, but note the somewhat perverse situation that they are often still accompanied by incentives to increase fossil fuel production and/or reserves/resources.
Shareholders have the ability to influence corporate pay structures and have done so successfully in recent years, with a notable shift in the direction from growth to value. However, there is a lot more improvement to be made.
Executive Summary
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Human behaviour generally responds to incentives. Certainly company boards believe this, given the amount of time, effort and consultants’ fees expended designing pay packages that will motivate executives to direct their companies in line with strategic goals and maximise shareholder value.
Remuneration for executive management is formulated to achieve a variety of goals, but principally to attract and retain talented management, and motivate them to act in a way that furthers the company’s aims. In this study we will look at the last of these aspects.
As different companies choose different ways to pursue their varying strategic goals, so they choose a variety of different metrics to deliver this incentivisation and measure success. The incentive structures common in the fossil fuel industry have particular relevance when viewed through the lens of the low carbon energy transition.
In particular, the supply of and demand for oil, gas and coal will need to start falling soon if the world is to have a reasonable chance of achieving the Paris Agreement goal to limit global warming to “well below 2ºC” and “pursue efforts” for 1.5ºC. As well as the need for this outcome, increasingly there is the means to achieve it, with technological advances making alternatives ever more competitive1.
1 See for example Carbon Tracker, “2020 Vision: Why You Should See Peak Fossil Fuels Coming”, September 2018. Available at https://www.carbontracker.org/reports/2020-vision-why-you-should-see-the-fossil-fuel-peak-coming/2 Carbon Tracker, “The Fossil Fuel Transition Blueprint”, April 2015. Available at https://www.carbontracker.org/reports/companyblueprint/
Fossil fuel companies must therefore be prepared for resilience and lower output, and have strategies that focus on value instead of continually increasing production and reserves. Are executives incentivised to direct their companies in accordance with this trend, and act for or against shareholders’ interests?
In this study we will review the remuneration practice used in the oil and gas industry and look at alignment with either growth or value factors. We will focus on the metrics that are used by different companies in their incentive plans, what the effect on management behaviour might be, and highlight those inconsistent with a focus on shareholder value in a world where the collective supply of oil and gas must ultimately fall (noting that demand continues to rise steadily at present). Carbon Tracker has previously covered this topic briefly in concept2. In this study we extend this to look at current practice.
Introduction
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Executives are generally paid a flat salary, benefits and pension contributions in order to compensate them for their services and provide a base level of income, elements that might collectively be termed “fixed pay”. Beyond this, there are a number of different ways of incentivising management in such a way that their take home pay varies depending on performance, and which can collectively be termed “variable pay”.
Variable pay normally consists of one or more of the following:
Paid annually in arrears (normally in cash), depending
on the executives’ performance in achieving pre-set goals in the previous year. At the executive level, annual bonuses often contain a significant number of different metrics which contribute towards the level of bonus paid.
A term used to cover a range of different ways of
incentivising over a multi-year period. This typically means a notional award of stock or cash which only becomes available (“vests”) to the grantee 3+ years later, and with proportion of the original award actually payable being dependent on performance under one or more pre-set metrics/performance conditions in this period. Performance conditions are frequently related to shareholder return. Some LTIPs have clawback options
3 For example, following the Enron and other scandals the leveraged “all or nothing” profile of options was suggested as driving an unhealthy focus on short term share price appreciation rather than long term value creation. See for example The Washington Post, “Stock Option Madness”, January 2002. Available at https://www.washingtonpost.com/archive/opinions/2002/01/30/stock-option-madness/c7203d7c-e510-4dbb-b9b5-e0c3b3f6266c/?noredirect=on&utm_term=.4193f4e711a3
where remuneration can be reclaimed by the company – but this happens rarely in practice.
Give the holder the right (but not the obligation) to
purchase a unit of the company’s stock on payment of a pre-determined exercise/strike price. They therefore represent a leveraged exposure to the company’s share price, with the options having no value to the holder (as they cannot be bought or sold when used in incentive plans) when the share price is at or below the exercise price. Awards normally vest after 3+ years, then have a set “exercise window” of 5+ years in which the executive is able to take up the option. Beyond this, unexercised or out of the money options expire unused. Options have been implicated as encouraging excessive risk-taking behaviour and volatility due to their asymmetric returns profile – high potential upside, minimal downside3.
Restricted stock – aAafter typically 1+ years. While they
do not carry performance conditions beyond continued service, they are seen to align the interests of executives with shareholders by giving them greater stock ownership and exposure to the share price. However, an award of shares with no strings attached clearly carries less of an incentive (and risk exposure to company performance) than an award of shares with multi-year
Overview of Executive Remuneration
Annual bonus
Long term incentive plan (LTIP)
Options
Restricted stock
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performance conditions.
Rather than using actual shares or options in incentive plans, companies can use synthetic versions, for example called restricted stock units (RSUs) or stock appreciation rights (SARs) respectively, the advantage of either normally being based on accounting and/or tax considerations. In this report, no distinction is made between synthetic versions of incentive instruments compared to shares or options.
While LTIPs, options and restricted stock have multi-year vesting periods, awards are typically made annually and hence overlap in order to incentivise continued performance and avoid “cliffs” that might impair long term strategic thinking or represent opportune times for executives to find new jobs.
Of these various plan types, annual bonuses are used almost universally across different industries. LTIPs with performance conditions have grown widely in use. The use of options and restricted stock is more variable by jurisdiction; these are now rarely used in Europe or Australia, but remain fairly common in the US and Canada. There are a number of factors that contribute to differences in pay practices geographically and over time, such as changing accounting treatments and variations in perception, which are outside the scope of this paper.
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Oil and gas demand is required to fall in order to meet climate goals
Global warming is linked to the cumulative amount of greenhouse gases in the atmosphere. This means that there is a limited amount of carbon dioxide that can be released while limiting global warming to a particular level – the “carbon budget”. It has been repeatedly shown that there is more than enough fossil fuels available to us in proven reserves to blow the budget implied by the goals set in Paris in 2015. The overhang of excess fuels has been termed the “carbon bubble” and has been explored by Carbon Tracker in previous works4.
Success in our international climate change goals will therefore require that the world slows the rate of increase of demand for fossil fuels, then moves to a plateau and subsequently reduces it in absolute terms as quickly as possible. This is a matter of timing rather than “if”, and applies to all fossil fuels – oil, gas and coal. Coal demand may already have peaked, but oil and gas demand continue to grow for the time being.
The use of carbon capture and storage (CCS) does not change this conclusion – for example, the International Energy Agency’s Sustainable Development Scenario5, which the IEA considers
4 See for example Carbon Tracker, “Unburnable Carbon: Are the World’s Financial Markets Carrying a Carbon Bubble?”, July 2011. Available at https://www.carbontracker.org/reports/carbon-bubble/ 5 IEA, World Energy Outlook 2018, published November 20186 Assuming an average size of 1 mtCO2/year captured7 Source: IPCC, special report on “Global Warming of 1.5ºC”, October 2018. Available at https://www.ipcc.ch/sr15/
consistent with a 1.7-1.8ºC trajectory, includes CCS plants being built at an average rate of 3 a week6 in the 2030s and does not give any details of assumptions post-2040 (when large amounts of CCS are often assumed in order to clear up any previous “overshoot” of emissions). Even so, oil demand still falls at 1.3% over the period 2017-2040 and gas demand peaks in 2030.
Eliminating coal as quickly as possible also does not change this conclusion – the same scenario has coal demand falling at 3.6% per annum.
Failure to achieve modelled assumptions in such factors, or aiming for a better global warming outcome, would imply that oil and gas demand would need to fall even sooner and faster. For example, CO2 emissions need to fall to net zero globally at around 2050 in order to deliver a 1.5ºC outcome, even in models that assume high overshoot of emissions and subsequent CCS/negative emissions technologies7.
From an oil company’s perspective, it would make commercial sense for its production to approximately mirror the overall demand pattern. Otherwise, it risks destroying value by overinvesting in “stranded assets”. It may also help oversupply the market, depressing prices and hence returns. Only the lowest
The Climate Change Context
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cost producers could consider bucking this trend. Even these companies might well see superior returns if they adhered to an energy transition scenario.
Some new oil and gas supply will probably still be needed – but not all of it
However, once an oil and/or gas field enters operation, its rate of production will naturally decline as subsurface energy is depleted over time. This means that a certain amount of new investment is required in order to maintain constant production levels, or even to maintain a slow decline in production depending on the required rate.
At a global level, this rate of natural production decline is generally expected to be faster than the rate of decline in demand for oil and gas even as the global economy undergoes a transition to lower carbon energy sources. For example, the 1.3% average decline in oil demand in the IEA Sustainable Development Scenario compares to natural field declines for oil often estimated in the range 4-7% p.a. at a global level8.
8 Although as noted previously, modelling tha assumes a higher probability of success or reduced reliance on CCS would require faster declines than assumed in the SDS – even exceeding natural decline at carbon budgets for lower warming outcomes and with limited CCS.
FIGURE 1: OIL DEMAND UNDER VARIOUS SCENARIOS, COMPARED TO A NOTIONAL 5% RATE OF PRODUCTION DECLINE
Source: IEA, CTI analysis
Note: demand levels are sourced from the IEA’s World Energy Outlook 2018. The New Policies Scenario (NPS) is the IEA’s central scenario which assumes no further climate regulation beyond that enacted or announced and is consistent with 2.7˚C warming; the Sustainable Development Scenario (SDS) is noted by the IEA as on a comparable trajectory with other models with outcomes of 1.7-1.8˚C. Linear interpo-lation between IEA datapoints performed by Carbon Tracker.
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This means that there will continue to be new investment in oil and gas fields required, even in a world where climate change is limited to a relatively benign outcome. However, there is much more available in the way of potential supply options than can be developed, leaving open the risk of oil and gas companies overinvesting in assets that ultimately become “stranded” – fail to make an adequate return as subsequent circumstances change. We have explored this risk at length in other publications9.
Discipline required for oil and gas companies
The picture for coal is straightforward, in that there is no space for new coal mines in most jurisdictions if climate targets are to be met10. The outlook for oil and gas producers is much more nuanced. As above, some new production is required, and we contend that the lowest cost supply options will be most competitive in filling limited demand. We have explored this previously through our “carbon supply cost curves” work to determine which projects might go ahead and which ones might be surplus to requirements and run the risk of destroying value.
9 See for example Carbon Tracker, “Mind The Gap: the $1.6 trillion energy transition risk”, March 2018. Available at https://www.carbontracker.org/reports/mind-the-gap/ 10 Carbon Tracker, “Mind The Gap: the $1.6 trillion energy transition risk”, March 2018. Available at https://www.carbontracker.org/reports/mind-the-gap/
FIGURE 2: UPSTREAM OIL & GAS CAPEX AND OIL PRICE, 1970-2018
Source: Rystad Energy, CTI analysis
However, the companies themselves do not necessarily know which supply options those are. Furthermore, despite any detailed scenario modelling of future demand which might be performed by oil and gas developers, upstream activity is overwhelmingly dictated by whatever the oil price happens to be at that point and in recent history.
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This means that companies are reliant on receiving the “right” investment signals from the oil price, which might be thought of as perhaps unlikely given the producer behaviours, feedback loops and so on that contribute to the oil’s (and many other commodities’) cyclical and volatile behaviour.
The transition risk to the oil and gas industry is therefore likely to be that of overinvesting, and wasting capital on projects that turn out to deliver poor returns and destroy value. While some exceptionally low-cost producers may be able to keep production steady or even grow it against a backdrop of weak or falling demand, this would need to be made up by greater reductions in production from other producers elsewhere.
We would further note that demand does not need to fall in absolute terms in order to highlight such overinvestment; a flattening of the rate of growth relative to supply would have the same effect. The oil price crash in 2014-2016 was caused by a mere 2% excess in the supply-demand balance and resulted in the S&P Global Oil Index falling by 51% between June 2014 and January 2016 – even against a backdrop of crude oil demand growing by over 3% in the same period11.
11 We would also note that in historical examples of transitions, incumbent sales have tended to peak when newcomer market share reaches around 3%.See Carbon Tracker, “Myths of the Energy Transition: Renewables are too Small to Matter”, October 2018. Available at https://www.carbontracker.org/myths-of-the-transi-tion-renewables-are-too-small/ 12 See for example Simon Flowers (Wood Mackenzie), “Managing for margin: a new way for upstream or back to basics”, October 2016. Available at https://www.woodmac.com/news/the-edge/managing-for-margin-new-idea-or-back-to-basics/ 13 Jensen’s free cash flow hypothesis posits that conflicts of interest between company management and shareholders incentivise executives in companies with excess cash flow to invest in negative NPV projects. Shareholders can limit managements discretion to do this by demanding higher cash distributions. Jensen substantiated this using the example of the oil industry in the 1970s and 1980s, when high prices resulted in high cash flows that were not returned to shareholders, but rather invested in further exploration and development projects with average returns below the cost of capital. Michael C Jensen, “Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers”, American Economic Review, May 1986
The early part of this century was characterised by declining returns even in a high oil price environment (2010-14), mainly due to overinvestment, especially in high cost, capital intensive projects. This, combined with the above volatility in oil prices, has led to increased pressure from investors on oil & gas producers to focus on capital discipline. The simple message from shareholders has been that the industry should prioritise returns rather than volume growth as was the case in 2001-2014 – captured by the mantras “value over volume” or “manage for margin”12. This shift is inadvertently a step towards the approach that investors should demand from their investee oil and gas companies if they are worried about risks from the energy transition.
Executive pay should not incentivise contrary behaviour
Rather than chasing growth therefore, oil and gas companies should focus on extracting maximum value, whether demand is growing or not – but particularly so in a low carbon transition. This means generating the highest returns for shareholders, developing low cost projects only, and focusing on per share value/return metrics. Where such opportunities are not available, capital might be returned to shareholders via increased dividends or stock buybacks13. This may mean deliberately making the
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company smaller in terms of absolute production. The term “shrink to grow” was coined by former ConocoPhillips CEO James Mulva in 200914, which fits well in this context.
If the focus is to be on returns, executives should not have pay packets that reward them for chasing growth. Yet, many oil and gas producers encourage just this sort of behaviour via their annual bonus and long term incentive plans, which may deliver financial rewards for higher growth rather than value creation.
In recent years, the renewed value focus has led some investors to object to this approach. As EQT put it, one of their CEO’s “performance highlights” was “leadership on developing a new compensation structure, in advance of shareholder pressure, to refocus employee attention on the efficient development of the Company’s reserves”15. BP’s remuneration committee stated that a “relative RRR [relative reserves replacement ratio] measure does not fit with the group’s strategic focus on ‘value over volume’”16 in response to a 2015 shareholder resolution, which it supported.
However, we believe that investors should go further in their scrutiny.
14 See for example Houston Chronicle, “ConocoPhillips shifts to a leaner strategy”, October 2009. Available at https://www.chron.com/business/energy/article/ConocoPhillips-shifts-to-a-leaner-strategy-1605203.php15 EQT Corporation, 2018 Proxy Statement, April 2018. Available at https://ir.eqt.com/sec-filings 16 BP, Annual Report and Form-20F 2016. Available at https://www.bp.com/content/dam/bp/business-sites/en/global/corporate/pdfs/investors/bp-annual-report-and-form-20f-2016.pdf
Growth metrics may be obvious – typically targets relating to production levels or reserves replacement – or they may be less obvious. We would argue that performance metrics such as earnings or cash flow also incentivise growth. For example, management could “buy” these through taking out debt and acquiring another producer in order to increase net income and operating cash flow by a greater amount than the additional debt service. However, that does not mean that the acquisition has created value.
We review these different growth metrics in the following section, and the majority of analysis in this paper will focus on highlighting them in corporate incentive structures.
Shrinking pains
Executive pay is normally decided at board level by a dedicated remuneration committee of non-executive directors, traditionally with the assistance of outside consultants who provide advice and market data to help inform the competitive context. This market data will typically include details of pay levels at the company’s peers, selected for having one or more similar attributes such as sector, market cap, revenues or production. Such data is frequently used to “benchmark” or inform recommended levels of salary and total target remuneration (i.e. including target levels for LTIP and bonus), often by reference to the median of the group.
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Ironically, increased transparency relating to executive pay is often believed to have contributed to its outsized increases, in conjunction with weaknesses in corporate governance. When provided with peer group data, if a board notes that its CEO is paid below median and increases their compensation to set them at median, this by definition increases the median. This then puts another company into the bottom half, which may then go through the same process and so on, therefore continually moving the median up. This is effect known as the “pay ratchet”.
This practice of setting overall remuneration by relation to company size may also encourage growth for the sake of growth, incentivising empire building and acquisitions without due regard for value. By the same token it may be an impediment to an organised strategy of running-off or shrinking fossil fuel operations, unless balanced by a plan to diversify into other sectors.
Shareholder influence
Rules vary by jurisdiction, but shareholders that disagree with proposed incentive structures are usually able to make this known by voting at the company’s AGM. Such votes may or may not be binding, but are taken into account by boards where not, and engagement prior to the actual vote may also have the desired effect. There have been several examples where investor pressure has led to a shift in company approach. For example at BP, shareholder complaints prior to the vote led to the board using
17 See “BP cuts chief’s pay by 40% to $11.6m to avoid shareholder revolt”, Financial Times, April 2017. Available at https://www.ft.com/content/2eef10ba-1ab4-11e7-bcac-6d03d067f81f18 For further detail see for example ShareAction “’Aiming for A’: Where Are We Now?”, October 2017. Available at https://shareaction.org/resources/two-years-after-aiming-for-a-where-are-we-now-bp-plc/
its discretion to make significant cuts to CEO Bob Dudley’s pay annual bonus and LTIP vesting17. The aforementioned 2015 “Aiming for A” shareholder resolution18 at the same company has resulted in a rebalancing away from growth measures for the 2018 structure – reserves replacement and operating cashflow metrics have been replaced in the 2018 LTIP by the introduction of return on average capital employed (ROACE) and an increased emphasis on total shareholder return (both growth neutral metrics).
The introduction of new equity-based incentive plans, or the amendment of existing ones, may also require formal shareholder approval.
We believe that shareholders should seek to challenge remuneration practices that incentivise companies to chase growth, and that value and return related metrics are preferable.
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In this report we distinguish four categories of incentive metric:
Direct growth measures – measures that directly incentivise executives to develop and produce as much oil and gas as possible, for example reserves replacement, production, and revenues.
These metrics should be avoided.
Indirect growth measures – measures that encourage growth but are also influenced by other factors, for example EBITDA, cash flow, and net income.These measures do therefore also incorporate a
value angle as well as a growth angle, and we highlight that investors should consider these in the context of other incentive measures applicable to the executive and consider alternatives or refinement.
In these cases, there might be better ways to achieve the same end. For example, if we assume that EBITDA is primarily influenced by oil/gas prices, production volumes, and production costs – prices
19 A recent paper noted that executive pay at US oil and gas companies is closely tied to oil prices, hence executives are “rewarded for luck”. It was further noted that there is “less pay-for-luck at better governed companies, and that pay-for-luck is asymmetric – rising with increasing oil prices more than it falls with decreasing oil pric-es”. Lucas Davis and Catherine Hausman, “Are Energy Executives Rewarded for Luck?”, September 2018. Available at https://ei.haas.berkeley.edu/research/papers/WP293.pdf 20 The payment of dividends theoretically reduces company share price by a commensurate amount (ignoring tax considerations), as assets are moved out of the company. However, dividends are not paid to holders of options, and the payment made on exercise of an option is determined solely by share price of the underlying share. Accordingly, higher dividend payments from the underlying share mean a lower share price, and therefore a lower option value (all else being equal). This is not true of performance shares, which generally accrue dividends during the vesting period. The use of options is generally not encouraged for other reasons, for example their high leverage effect, and are infrequent in pay packages outside North America.
cannot be directly controlled19 and production volumes should notbe incentivised in this context. Therefore it might be preferable to incentivise production costs in isolation.
Further, measures in this category incentivise growth to different degrees – cash flow from operations, which does not incorporate capex, is perhaps likely to incentivise investment in new projects more than free cash flow for example.
As a further illustration of the importance of context, a company may have an annual bonus where pay-out is related to desirable metrics, for example return on capital employed. However, the bonus may have a threshold condition that a certain level of cash flow is achieved before payment, to assure affordability. We prefer this rationale compared to a bonus that simply pays out more the higher the cash flow achieved.
In this category we also include those measures that encourage share price growth at the expense of dividends, for example share price growth conditions and the use of options20. This incentivises
Identifying Growth Metrics
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continued investment as a use of cash. Total shareholder return(TSR) does not have this issue, as it includes the cumulative value of reinvested dividends.
Growth neutral – measures that encourage improved performance but without incentivising growth, for example return on capital employed (ROCE), production costs, TSR, and safety.
Financial measures should reward improvements in returns and value. Although we prefer such metrics from the climate change perspective, they are not necessarily all equal or appropriate in all situations. For example, return on equity incentivises increased leverage whereas return on capital employed does not.
Climate measures – measures that directly link executive pay to initiatives that contribute towards mitigating climate change, e.g. emissions intensity and investments in renewables.
We do not think that an oil & gas company necessarily needs to have such climate measures to have an appropriate incentive structure; it could achieve this by deprioritising growth and using other metrics as above. However, we flag as indicative of increased attention to environmental issues, and all efforts to mitigate emissions are important and welcome (although upstream emissions will only account for a minority of total emissions from a given unit of fossil fuels, the majority being released in combustion). A company board that is mindful of such environmental issues is likely to be a lower risk company in our view. We therefore encourage companies to adopt such measures in their remuneration practice, and are heartened at the increasing number that do (see conclusions). However, we note that climate metrics may simply be introduced at the expense of other environmental metrics – for example, the 10% of Shell’s 2017 bonus that relates to GHG intensity and flaring displaced an equivalent weighting of other metrics covering water use, oil spill volumes and refining energy intensity the year prior.
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The overall level of executive pay has been in the spotlight in recent years for the extent to which it has outgrown wages in the rest of the economy21, and questions over the extent to which handsome rewards do actually reflect exceptional performance. In this study we will refrain from commenting on quantum of pay or the balance between the different elements, and leave those to the consideration of remuneration committees and shareholders. Nor will we comment on the appropriateness of precise targets, vesting levels or vesting schedules under the metrics used, or adherence to other guidelines or best practice.
Under norms of good corporate governance, non-executive directors are usually paid a flat fee (in cash and/or stock) without further targets. This reflects their role as outside strategic advisors, whose judgement shouldn’t be compromised by short term motives. Accordingly, in this study the scope will be restricted to looking at executive directors only.
The analysis in this paper is based on publicly-available disclosures, typically contained within company annual reports and proxy statements. In common with many features of corporate reporting, disclosure standards are highly variable between jurisdictions. We have chosen a basket of 40 of the largest companies with upstream operations from North America, Europe and Australia listed in the S&P Global Oil Index for inclusion, due to the greater transparency in those regions.
21 For example, in 2017 FTSE 100 CEO mean pay rose by 23% and median pay by 11%, compared to 2.5% mean salary increase for all workers in the UK. FTSE 100 CEO pay rose on average 6.5% p.a. 2009-2017. CIPD, “Executive pay 2018: review of FTSE 100 executive pay packages”, August 2018. Available at https://www.cipd.co.uk/knowledge/strategy/reward/executive-pay-ftse-100-2018
One-off measures have generally been excluded from this report, which focuses on the normal course of business. Good practice dictates that such measures should not be used other than in exceptional circumstances.
Where there is variation between the metrics applied to different executives at a single company, we will focus on the CEO’s performance metrics only.
Scope of Research
FIGURE 3: COMPANY UNIVERSE BY LOCATION OF HEADQUARTERS
Source: CTI analysis
www.carbontracker.org18
Full details of the incentive metrics used in the company universe and the basis for our findings are given in the appendix, with growth measures highlighted.
Growth metrics show a poor or negative correlation with shareholder returns
If we attempt to control for some confounding factors by looking at a sample of larger US E&P companies22, we find that companies that had a lower weighting of growth metrics in their bonus structures outperformed more growth-oriented companies in the recent market downturn23.
The below table shows the correlations between a) % of production/reserves24/returns metrics in company annual bonus schemes relating to 2013, and b) company TSR over the 6, 12, 24, 36, and 48 month periods following summer 2014 - the start of the sharp decline in oil prices. In other words, the first row is the correlations of those annual bonus metrics with 6m TSR, the second row correlations with 12m TSR, etc.
22 US E&P companies with market capitalisation above $10bn were drawn from the S&P Global Oil Index as of 30 June 2014, a sample of 18 companies. This bas-ket was chosen as the largest group with approximately comparable operating activities, hence being subject to fewer other different influences than a more geographically diverse group. Integrated companies were excluded due to focus on upstream businesses.23 Precise weightings of different metrics within annual bonuses are frequently not disclosed or not attributed within a basket of metrics. Where this is the case, we have assumed equal weighting of disclosed bonus metrics within any weightings that are disclosed (e.g. if a company discloses that 20% of bonus relates to 4 metrics, we have assumed 5% each).24 In this section, “reserves” metrics includes metrics that incentivise resource additions and exploration.25 We are wary of drawing firm conclusions in terms of causation due to small sample sizes, the potential skewing effect of outliers, and the many other factors which influence shareholder returns.
There is some negative correlation exhibited between the proportion of production and reserves/resources related metrics in the preceding year’s annual bonus plan and total shareholder returns during the crash. Conversely, financial returns-based metrics show a positive correlation. In other words, a greater proportion of annual bonus being related to production or reserves is associated with an increasingly negative TSR outcome; a greater proportion related to returns is associated with an increasingly positive total shareholder return (TSR) outcome25.
Research Findings
Paying with Fire – How oil and gas executives are rewarded for chasing growth and why shareholders could get burned 19
In the two years following the start of the downturn, an equally-weighted index of the companies with low proportions of growth metrics in annual bonus outperformed an index of those with high proportions by CAGRs of 7%, and outperformed those with growth metrics in both annual bonus and LTIPs by 24%.
TABLE 1 – CORRELATIONS BETWEEN ANNUAL BONUS METRICS AND TOTAL SHAREHOLDER RETURN
Source: Bloomberg, company reports, CTI analysis
% of 2013 annual bonus
Production Reserves/resources/exploration
Returns
TSR in months
following 30 June 2014
6 -0.28 -0.38 0.20
12 -0.22 -0.22 0.00
24 -0.16 -0.17 0.07
36 -0.16 -0.23 0.23
48 -0.02 -0.28 0.30
FIGURE 4 – TOTAL SHAREHOLDER RETURN (REBASED) OF EQUALLY-WEIGHTED INDEXES OF US E&P COMPANIES
Source: Bloomberg, company reports, CTI analysis
Note: “Growth” is aggregate of production and reserves-re-lated metrics. Sample sizes are companies with growth metrics in bonus and LTIP (2), companies with 0-20% growth in bonus (3), and companies with 50-100% growth in bonus (6). The latter two categories exclude the companies that also have growth metrics in LTIP.
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We also note consistent research by Evercore ISI which shows that, over 5 year and 10 year periods for a basket of integrated and E&P companies, production growth metrics carry a negative correlation with total shareholder return (TSR) and reserve additions only a small positive correlation. By contrast, return on capital employed (ROCE) and cash return on capital invested (CROCI) have multi-year positive correlations approximately in the 0.3-0.4 range26.
A large majority of companies directly incentivise management to pursue growth
Returning to our basket of 40 companies in North America, Europe and Australia, of the 38 companies that disclose their bonus and LTIP metrics used in 2017 in sufficient detail27, 92% included measures relating to either production or reserves, or both. 32 rewarded based on production levels, 27 on reserves/resources/drilling inventory/acreage, and 24 included both.
Only three (Galp Energia, Diamondback Energy and Origin Energy) did not directly incentivise their executives to pursue growth via either production or reserve/resource in 2017. These were joined by BP and Equinor in 2018, both of whom removed reserves conditions from their incentive structures. BP retains a strategic priority to “grow gas and advantaged oil” but only mentions measuring this via
26 Research shows that “value-based CEO pay incentives hold higher correlation… to TSR than growth-based incentives…”. See Doug Terreson, Stephen Richard-son, Sioban Hickie, Chai Zhao, and Daniel Walk, “The Path to Prosperity? Big Oil and E&P Compensation Review 2018”, June 2018 (Evercore ISI). The authors include free cash flow and earnings as value-based measures; we would argue they indirectly incentivise growth as well, hence will become more important in a world with challenged demand. We note however the value link and that the historic positive correlation between these (and others such as EBITDAX and EPS) and TSR is only slightly less than ROCE and CROCI in this research.27 Lundin Petroleum and Aker BP do not disclose their bonus metrics.
FIGURE 5: INCLUSION OF PRODUCTION AND RESERVE/RESOURCE TARGETS IN COMPANY BONUS OR LTIPS, 2017
Source: company reports, CTI analysis
production costs and proportion of gas – in the absence of further detail we give the benefit of the doubt for now, but will review the extent to which this actually just encourages growth when further disclosures are provided.
Direct growth targets are most commonly included in annual bonuses, although some companies also include them in their LTIPs.
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There is wide variation in weighting of growth metrics
Companies frequently do not disclose the precise weightings of individual performance conditions in their bonus plans, sometimes just providing a number of metrics that are considered rather than a firm structure.
We highlight Anadarko, Cabot Oil & Gas, CNRL and Oil Search as amongst the companies with the highest growth orientation of incentives based on disclosures. CNRL has 33% of its LTIP relating to reserves replacement (as well as also including production in its bonus). Anadarko, Cabot and Oil Search have at least 40% of their bonuses relating to production and reserves/resources.
While having the highest weightings of these growth metrics, some of these companies do however measure them on a per debt-adjusted share (DAS) basis, which reduces the impact of growth paid for by increasing debt. Both Cabot and Anadarko shifted to per DAS measurement in 2018. While making this change Anadarko also increased the aggregate weighting of production/reserves, the only company to do so year on year, whereas Cabot reduced it.
In contrast, some companies have only a very small minority weighting – for example at Total, steering strategy and strategic negotiations, production and reserve targets in aggregate comprise 8% of bonus, and at Repsol production accounts for 10% of bonus with no reserves target.
28 Of the two companies that do not give full disclosure, one does still disclose the use of an indirect growth metrics in its LTIP (share price for Aker BP).
Indirect growth measures
Although metrics that reward executives for growing production and reserves are the most obvious form of growth metric, there are many others that can be seen as rewarding growth in conjunction with other factors. For the purposes of this paper, we term these “indirect growth” measures.
Such metrics are also common, and incorporated by 36 of the 38 companies giving full disclosure for 2017 (including options)28.
FIGURE 6: INCLUSION OF INDIRECT GROWTH METRICS IN COMPANY BONUS OR LTIPS, 2017
Source: company reports, CTI analysis
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The only two companies that didn’t include indirect growth metrics in 2017 - Parsley and Pioneer – each had production and/or reserve metrics. This means that every company reviewed had an incentive for growth in 2017, either via direct and/or indirect means.
As noted above, from 2018 Galp Energia, BP, Equinor, Origin Energy and Diamondback will not have any direct growth incentives. However, the first four of these do retain indirect growth metrics29.
Diamondback Energy is the only company with no growth incentives
We highlight Diamondback Energy as the only company in our universe of review companies which will not include any growth metrics in its 2018 incentive package, direct or indirect, having determined to remove the EBITDA condition from its bonus. Its bonus metrics are now entirely centred on costs and returns, with its LTIP based on total shareholder return and no options being granted.
We note that Equinor’s sole indirect growth metric is a cash flow threshold condition for bonus payment and can be justified on the grounds of making sure that bonus payments are affordable, which we favour compared to inclusion as one of the main metrics driving bonus payment quantum.
29 These include underlying replacement cost profit and operating cash flow for BP, a cash flow from operations threshold condition for Equinor, EBITDA for Galp Energia, and EPS and net cash from operating and investing activities for Origin Energy30 We also note that metrics that compare share price performance to peers (rather than total shareholder return) may give an unfair advantage to companies that
We therefore consider Diamondback and Equinor’s incentive structures as preferable compared to the rest of the universe, from a growth point of view.
Options remain common in North America
The use of options remains prevalent at North America-based companies. Eleven US companies (55%) awarded options to their executives in 2017, although ConocoPhillips will not be granting options in 2018. Five of the 6 Canadian companies award options to executives.
This is in contrast to Europe, where none of the companies award options, and Australia where the only company to award options in 2017 (Origin Energy) will not be granting them further.
We consider the use of options to be an indirect growth incentive. They reward growth in share price, which is lowered by the payment of dividends; options therefore incentivise a growth rather than harvest model. If executives are penalised for returning cash to shareholders, they are presumably more likely to reinvest it instead.
We note intent to align the interests of executives with shareholders by providing leveraged upside to share price performance; however we believe that there are better ways to incentivise executives that do not reward the non-payment of dividends. Relative total shareholder return targets, which include cumulative dividends, do not have this issue. The same logic applies to share price conditions in LTIPs or bonuses, for example as at Aker BP30.
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Price volatility has led to increased popularity of returns measures
Exhaustively interpreting year on year changes on a prospective basis is somewhat difficult due to variations in disclosure practice. While nearly all companies give reasonable detail on historic metrics used, many are less detailed on the plans that they intend to use for the forthcoming year. There may be a variety of reasons for this –parameters may not be fully set, or presumably companies may simply not draw attention to future plans because no changes are planned (although positive statements that affirm this being the case are welcome).
That said, there has been a clear trend towards the inclusion of returns metrics – particularly based on capital employed. This reflects a broader shift in narrative to a returns focus since the 2014-16 price crash, and pressure from investors to prioritise finances over growth. How long this shift lasts has yet to be seen.
In 2017, 19 of the 38 companies with full disclosure (50%) included returns metrics in their incentive plans.
Ten companies (26%) disclosed added or increased priority on returns measures in 2018 over 2017. Despite this shift, there are still 11 companies which don’t disclose including returns metrics in their incentive plans at all.
do not pay dividends compared to those that do.31 2 companies don’t use TSR in their LTIPs because they either don’t have LTIPs or have atypical structures (Continental and Equinor – both of which include TSR in their bonuses); 2 companies don’t include TSR but do use share price (Cimarex and Aker BP), and one company does not have an LTIP and doesn’t include TSR in their bonus plan (Imperial).32 Doug Terreson, Stephen Richardson, Sioban Hickie, Chai Zhao and Daniel Walk, “The Path to Prosperity? Big Oil and E&P Compensation Review 2018”, June 2018 (Evercore ISI)33 As is used at ConocoPhillips, Occidental, Shell, Husky, Origin Energy and Santos. BP and EQT have introduced this structure for 2018. BP, Origin, Marathon and ConocoPhillips also incentivise absolute TSR as well as relative via a variety of methods, for example preventing (Origin Energy) or capping (Marathon) vesting in the event
TSR is dominant in LTIPs
Relative TSR is by far the most commonly used metric in long term incentive plans. Of the companies providing enough disclosure, 85% use LTIPs with TSR performance conditions, and 46% use TSR exclusively. All but one use TSR in either their bonus or LTIP (or both)31.
The main argument used to support the use of TSR is to align the incentives of executives with those of shareholders, which clearly has value. We prefer the use of TSR to that of share price, which penalises the payment of dividends as discussed above.
The use of TSR relative to a peer group (and indeed other relative metrics which are compared to peers, although they are only used by a minority) has a particular application in commodity industries – it allows executives that outperform their peers to be rewarded throughout the cycle, including during downturns. However, we also note the argument that its prevalence may contribute towards herd behaviour rather than absolute value creation - “Accordingly, when the industry is in value destruction mode, executive wealth can rise as long as management teams destroy less value than their peers”32.
Hence, use in conjunction with other absolute return metrics may be preferable33.
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Direct climate change measures increasing in relevance
Of the 40 companies in our universe, 9 disclosed the inclusion of metrics directly relating to reduced emissions or climate change issues. As might be expected, these are much more prevalent in European companies, with nearly half including a climate measure compared to just one US company (5% of US companies in the universe) and 2 Canadian companies (33%).
Seven of these were included in 2017 remuneration; Shell, Equinor, Repsol, Eni, CNRL and ExxonMobil incorporated metrics relating to GHG emissions, and Suncor incorporated energy intensity. Exxon further included targets relating to its algae and CCS research.
These were joined by two more in 2018. Total and BP added metrics relating to their renewables/low carbon businesses, with BP including consideration of emissions in the underpin to its LTIP. Shell increased the GHG coverage of its portfolio included in incentives. In contrast to some of its peers, Shell declined to add a metric relating to its low carbon business, citing its early stage and small scale. Emissions targets generally relate to scope 1 and 2 only, although Shell has announced that it will be including a metric relating to its net carbon footprint ambition, subject to a vote at its 2020 AGM34. Although not relevant for 2018, Occidental has committed to incorporate a metric relating to carbon capture and storage in future35.
of negative TSR.34 “Joint statement between institutional investors on behalf of Climate Action 100+ and Royal Dutch Shell plc (Shell)”, December 2018. Available at https://www.shell.com/media/news-and-media-releases/2018/joint-statement-between-institutional-investors-on-behalf-of-climate-action-and-shell.html 35 Occidental Petroleum, “Climate-Related Risks and Opportunities: Positioning for a Lower-Carbon Economy”, March 2018
Although increasing in popularity, such measures typically only represent a small fraction of target pay. We also highlight that we have set a very low benchmark for what constitutes a climate related metric for the purposes of this report, without reference to likely strategic impact or to what degree their achievement represents a genuine stretch.
Furthermore, they are usually accompanied by metrics that incentivise fossil fuel production, and primarily directly (6 companies have production or reserves targets alongside climate ones). Just including a minority climate measure while chasing continued oil and gas production is not sufficient to satisfactorily manage transition risk.
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In the below table, we give a summary of some of the key families of measures used at the companies reviewed in this note. The list is not intended to be exhaustive or include all metrics (for example, share price and NPV-based incentives are not included), but to give an indication of methodology in this note. A larger table with full detail is given in the appendix
Measures have been organised into rough families – for example, “cash flow” includes net cash flow, cash flow from operations,
EBITDAX etc. “X” in the table denotes that the company has one or more metrics in its incentive structure relating to that family.Companies have been categorised according to whether their incentive structure (bonus, LTIP and other plans) includes direct or indirect growth metrics. Outside these categories, companies are grouped by region.
Key to colour coding:
Appendix I: Summary of growth metrics usedat company level
Direct growth metrics Indirect growth metrics
Company Country of HQ
Financial year
Production/sales
Reserves/ resources/ exploration
Earnings Cash flow Options
Diamondback Energy US 2018 - - - - -
Equinor Norway 2018 - - - Thresh. only -
Galp Energia Portugal 2017 - - - X -
BP UK 2018 - - X X -
Origin Energy Aus 2018 - - X X -
ExxonMobil US 2017 X X - - -
TABLE 2 – SUMMARY OF KEY INCENTIVE MEASURES AT SELECTED COMPANIES
No direct or indirect growth metrics
No direct growth metrics, but indirect growth metrics
Incentive structure includes direct growth metrics
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Direct growth metrics Indirect growth metrics
Company Country of HQ
Financial year
Production/sales
Reserves/ resources/ exploration
Earnings Cash flow Options
Chevron US 2017 X - X X X
ConocoPhillips US 2018 X - - - -
EOG Resources US 2017 X X X X
Occidental Petroleum US 2017 X - X - -
Anadarko US 2018 X X - - X
Pioneer Natural Re-sources
US 2017 X X - - -
Concho Resources US 2017 X X - - -
Continental Resources US 2018 X X - X -
Devon Energy US 2017 X X (removed for 2018)
- - -
Hess Corporation US 2017 X X - - X
Marathon Oil US 2017 X X - X X
Apache US 2017 X X - X X
Noble Energy US 2017 X X - X X
EQT US 2018 X - - X X
Cabot Oil & Gas US 2018 X X - - -
Parsley Energy US 2018 X X - - -
Cimarex Energy US 2018 X X - - -
WPX US 2017 X X - X X
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Direct growth metrics Indirect growth metrics
Company Country of HQ
Financial year
Production/sales
Reserves/ resources/ exploration
Earnings Cash flow Options
Royal Dutch Shell Netherl. 2018 X - - X -
Total France 2018 X X X X -
Eni Italy 2017 X X X X -
Repsol Spain 2017 X - X X -
OMV Austria 2017 - X X X -
Aker BP Norway 2017 Not disclosed
Lundin Petroleum Sweden 2017 Not disclosed
Suncor Energy Canada 2017 X - - X X
CNRL Canada 2017 X X - X X
Imperial Oil Canada 2017 X - X X -
Husky Energy Canada 2017 X X X X X
Cenovus Energy Canada 2017 X X - X X
Encana Canada 2017 X - - X X
Woodside Aus 2017 X X X - -
Oil Search Aus 2017 X X - X -
Santos Aus 2017 X X X - -
Source: company reports, CTI analysisNote: above based on Carbon Tracker simplification of complex and detailed disclosures. Refer to appendix and disclosures for further detail and underlying data.
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The below table shows performance conditions in place at the basket of companies under review in this document, as far as disclosed. The intention of this table is to review plans that are in active operation and awarded on an ongoing basis, hence “Not granted” denotes no grants in the years under review although there may be legacy plans with outstanding awards or one-off awards. We have highlighted in particular direct growth metrics, indirect growth metrics and direct climate metrics. A glossary of abbreviations is contained at the end of this paper.
Appendix II: Company incentive plan performance conditions
Company Annual bonus LTIP Options Restricted StockUnited States
ExxonMobil Bonus pool determined by annual earnings, committee can use discretion to lower due to individual performance
Half of bonus deferred until cumulative EPS reaches target level
Not granted Not granted 2017Value granted determined by:Relative safety and operations integrityRelative cashflow from op-erations and asset salesRelative ROACE Relative TSR Strategic objectives, business results, project execution. Includes adding to reserve and resource portfolio at upstream, production capacity added, environmental (algae research and CCS research, methane reduction programme)
Chevron 201740% financials – EPS; net cash flow; divestiture proceeds30% capital management – ROCE; Capital and exploratory expenditures; major milestones15% operating performance - net production growth; operat-ing expenses + selling, G&A expenses; refining utilisation15% health, environmental and safety - personal safety measures; process safety and environmental (loss of containment, spill volume)
100% relative TSR No conditions No conditions
TABLE 3 – COMPANY INCENTIVE PLAN PERFORMANCE CONDITIONS
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Company Annual bonus LTIP Options Restricted StockConocoPhillips 20% health, safety and environmental – total recordable rate;
process safety events20% financial - relative adjusted ROCE; relative adjusted CROCE 20% operational – production; operating & overhead; capital; operational milestones20% strategic milestones – optimise portfolio through strategic dispositions; maintain strong balance sheet and reduce debt; provide distinctive stockholder distributions with annual dividend growth and share repurchase programme; focus on improving absolute financial returns20% relative TSR
50% relative TSR30% ROCE – relative adjusted ROCE; relative adjusted CROCE (CROCE is calculated adding back depreciation and amortisation)20% strategic objectives – maintain financial strength and flexibility and optimise portfolio; controllable cost reduction (absolute and per boe); improve HSE performance
2018Not granted
2017No conditions
2018No conditions
2017Not granted
EOG Resources 201730% direct after-tax rate of return and all-in after-tax rate of return on total capex15% production, unit cost10% relative stock price performance, relative forward-year cash flow multiple5% balance discretionary cashflow to capex plus dividend, reduce net debt-to-total capitalisation ratio 40% strategic and operational goals e.g. achieve positive ROCE, increase “premium” drilling inventory by 30%, reduce finding costs, prove one new “premium” exploration play, others
100% TSR No conditions Not granted
OccidentalPetroleum
2018 Not disclosedOccidental notes it intends to add “an executive compensation metric related to the advancement of CCUS”
201730% strategic - execution of business plan (monetise assets as necessary, manage portfolio for value creation, allocate capital in accordance with cash usage priorities, maintain balance sheet), progress towards cash flow neutrality25% operational - production from ongoing operations, development spend per boe, oil & gas operating expense per boe30% financial - returns on net invested capital, core EPS15% safety/environmental - combined employee/contractor IR, combined employee/contractor DART, oil spills, risk
201836% CROCE64% TSR
2017100% TSR
Not granted No conditions
Anadarko 201840% operational - reserve additions growth per debt adjusted share (20%); sales volume growth per debt adjusted share (20%)40% financial – cash flow return on invested capital (20%); controllable cash costs (20%)20% HSE performance - total recordable incident rate (10%); level 3 incidents (10%)
201735% operational - reserve additions (15%); sales volumes (20%)55% financial - capital expenditures (15%); cash operating income per boe (25%); controllable cash costs (15%)10% safety - total recordable incident rate
100% TSR No conditions No conditions
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Company Annual bonus LTIP Options Restricted StockPioneer Natural Resources
2018To incorporate ROCE and changing production and proved reserves growth to production per share and proved reserves growth per share
201715% production growth15% ratio of net debt to EBITDAX15% proved reserve replacement15% base lease operating and G&A costs/boe 10% health, safety and environmental30% certain strategic goals - preserving balance sheet strength, managing overhead costs/boe, well optimisation programme, implementing resource planning system, establishing internal strategy teams, maintaining culture and expanding workforce diversity initiatives
Discretionary adjustment – not more than +/- 33%
100% TSR Not granted No conditions
Concho Resources 2018Increased weight of 3 year production growth per debt adjusted share with commensurate decrease in absolute production metric, weighting not disclosed
201720% capital productivity - absolute production growth (10%); ratio of capex excluding acquisitions and midstream system expansion costs to after tax cash flow (10%)20% cost control - direct lease operating expense per boe (10%); cash G&A expense per boe 10%10% absolute stock performance10% 3-year production growth per debt-adjusted share 40% discretionary – considered productivity and efficiency improvements; optimisation of organisation size and structure; managing successful portfolio through acquisitions, trades and divestitures; reduction of controllable costs; reduction of long term debt. Also noted that Committee may evaluate other factors such as operational execution, productivity improvements, changes in estimated proved reserves, resource identification, health and safety, acquisition and divestiture activity, balance sheet management and relative stock price performance.
100% TSR (relative and absolute) Not granted No conditions
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Company Annual bonus LTIP Options Restricted StockContinental Resources
201830% net cash from operating activities25% ROCE15% relative TSR15% production growth10% reserve growth5% proved developed F&D costs per boe
2017Target pool size determined by:40% production growth30% net cash provided by operating activities15% proved developed F&D cost per boe15% reserve growthDiscretion to adjust based on performance in other areas e.g. shareholder return, health, safety and environmental, production costs and cycle times, maintenance of financial and other ratios, budget compliance, business process improvements and achieve-ment of cash neutral operationsAlso subject to individual performance multiplier based on subjective evaluation.
Not granted Not granted No conditions
Devon Energy 2018Added cash return on capital employed, all-in return on capitalRemoved oil and gas reserves additions, other measures removed or de-emphasisedFurther detail not disclosed
201715% relative TSR v peers 15% lease operating, gathering and transportation expenses 15% reserves additions 15% total capex 10% production 10% value of Devon’s risked portfolio 10% environmental, health and safety5% internal and external stakeholder alignment5% business process improvement
100% TSR Not granted No conditions
Hess Corporation 201720% environment, health and safety20% production20% capital and exploratory spend20% controllable operated cash costs10% CROCE10% exploration resource additions
100% relative TSR No conditions Not granted
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Company Annual bonus LTIP Options Restricted StockMarathon Oil 2017
7% total recordable incidents rate17.5% production17.5% cash costs $/boe7% F&D costs $/boe reserve3.5% reserve replacement17.5% EBITDAX30% strategic – balance sheet protection; portfolio management; improvement of one-year relative TSR; total resource addi-tions; days with no serious events/recordable injuries/spills
100% relative TSR with cap if absolute TSR is negative
No conditions No conditions
Apache 2018Operational goals (60%): includes CROIC (20%)Strategic goals (40%): includes new strategic goal related to double-digit ROCE
201750% Operational goals -Absolute production target (10%)Replace 145% of 2017 production at $10.50 per barrel through exploration and development additions (10%)Maximise cash flow per barrel sold through cost management - G&A spend/boe, LOE/boe targets (10%)Achieve 15% pre-tax rate of return on 2017 drilling programme (10%)Health, safety, environmental (10%)50% strategic goals:Formulate a robust development model for Alpine HighReturn Permian basin oil production to growth trajectoryContinue to advance market understanding of strategy to sustain free cash flow capacity from Egypt and North SeaDeliver cash flow within the plan for 2017 while maintaining credit ratingActively assess and manage asset portfolio utilising long term view of integrated planning model
50% TSR25% cashflow from operations25% reserve additions per debt-adjust-ed share
No conditions No conditions
Noble Energy 2018Including cash flow per debt adjusted share growth, ROACE, CROCI (cash return on capital invested)
201715% free cash flow15% onshore drill and complete rate of return10% production10% cash cost per boe10% relative cash costs/revenue40% qualitative measures – strategic initiatives; environmental, health and safety performance; TSR; weighted average rate of return; reserve additions/proved exploration perfor-mance
100% relative TSR No conditions No conditions
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Company Annual bonus LTIP Options Restricted StockEQT 2018
Similar to 2017
2017Pool determined by 100% EBITDAIndividual awards adjusted for company, business unit, and indi-vidual value drivers. For CEO, considerations included:SafetyTransition to CEOOperational results including productionLand acquisition activityDebt offeringDeveloping new compensation schemeBusiness unit driversShareholder engagement
201850% relative TSR25% opex per Mcfe produced25% capex per Mcfe producedUp to 10% modifier - ROCE
2017Matrix of:Relative TSRSales volume growth
No conditions No conditions
Diamondback Energy
201820% well costs per lateral foot, Midland basin 10% well costs per lateral foot, Delaware basin 20% total PD F&D costs/boe15% lease operating expense $/boe15% G&A cost $/boe20% ROCE
201720% capital efficiency, Midland basin ($/lateral foot)10% capital efficiency, Delaware basin ($/lateral foot)20% capital efficiency, Midland basin (PDP F&D costs/boe)10% capital efficiency, Delaware basin (PDP F&D costs/boe)15% lease operating expense $/boe10% G&A cost $/boe15% EBITDA
100% relative TSR Not granted No conditions
Cabot Oil & Gas 201820% reserve growth per debt-adjusted share15% finding costs20% production growth per debt-adjusted share15% unit costs10% ROCE20% strategic evaluation
201725% reserve growth15% finding cost25% production growth15% unit cost20% strategic evaluation
2018No changes to metrics disclosed
2017100% relative TSR
Not granted 2018No changes to metrics disclosed
201725% vest in each of first two years, with 50% vesting in the third year subject to the company having a certain level of operating cash flow
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Company Annual bonus LTIP Options Restricted StockParsley Energy 2018
Same metrics, but the weighting of quantitative factors increased relative to that of qualitative factors, and increased weightings of LOE, PDP F&D and cash G&A
2017Quantitative metrics (50%) – including production; lease operating expense per boe; finding and development cost for proved developed producing reserves (PDP F&D) per boe; cash G&A expense per boeQualitative metrics (50%) – determined by committee’s discretion, considerations include strategic initiatives (including fully hedged 2018 production volumes, acreage additions, increased drilling locations, cost performance, acreage trades); talent development; health/safety/environmental
100% relative TSR Not granted No conditions
Cimarex Energy 2018ROICBalance sheet management - debt adjusted production per share; debt adjusted reserves per shareStaffing and succession planningHealth, safety and the environment.Quarterly and annual productionPrepare a comprehensive and data-driven analysis of optimal E&P capital investment pace and return of capital.Continue to optimize midstream operations and expenditures.Continue to develop and advance field automation and water sourcing, disposal, and recycling solutions for development projects.Be opportunistic in business development arena.Continue to pursue technological advancement.
2017ROICBalance sheet management – noted production on a debt adjusted per share basis; reserves on a debt adjusted per share basis; debt; cash on handStaffing and succession planningHealth, safety, environmentQuarterly and annual productionIdentify and understand the risks around induced seismicityDevelop long term water sourcing and disposalsolutions for Cimarex development projectsContinue to develop and advance field automationIncrease corporate environmental disclosure
100% relative share price Not granted No conditions
WPX Energy 201725% adjusted EBITDAX25% production 20% capital efficiency (capex/EUR)10% safety20% discretionary – based on e.g. prior year reserve revi-sions, organisational rationalisation, cost initiatives, maintaining liquidity
100% relative TSRSubject to absolute TSR underpin
No conditions No conditions
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Company Annual bonus LTIP Options Restricted StockEurope
Royal Dutch Shell 2018Similar, with greenhouse gas metrics expanded to cover “close to 90% of the operated portfolio emissions” (2017: c.60%)
201730% cash flow from operations50% operational excellence – production; LNG liquefaction volumes; refinery and chemical plant availability; project delivery on schedule; project delivery on budget20% sustainable development – injury frequency; safety events; refining GHG intensity; chemicals GHG intensity; upstream flaring
25% free cash flow (absolute)25% relative TSR25% ROACE growth25% cash flow from operations growthNon-TSR measures subject to absolute TSR underpin, which can cap pay-out at 50% of maximum
Not granted Not granted
Total 201811% safety – total recordable injury rate; fatality incident rate; evolution of number of tiers 1+2 incidents17% return on equity22% net debt to equity ratio28% relative net incomeCEO personal contribution:8% steering strategy and strategic negotiations, production and reserve targets6% Performance and outlook for downstream, group’s gas-elec-tricity-renewables growth strategy8% corporate social responsibility
201711% safety – total recordable injury rate; fatality incident rate; evolution of number of tiers 1+2 incidents17% return on equity22% net debt to equity ratio28% relative net incomeCEO personal contribution:6% steering strategy and strategic negotiations,6% production and reserve targets6% Performance and outlook for downstream6% corporate social responsibility
50% relative TSR50% net cash flow per share
Not granted Not granted
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Company Annual bonus LTIP Options Restricted StockBP 2018
Similar to 2017, with “upstream operating efficiency” replaced by “BP-operated upstream plant reliability” (100% less ratio of unplanned plant deferrals divided by production capacity)
201720% safety:
• 10% tier 1 process safety events• 10% recordable injury frequency
30% reliability:• 15% refining availability (% of year that a unit is available
for processing after subtracting time lost due to turnaround activity and unplanned downtime)
• 15% upstream operating efficiency (production divided by production capacity)
50% financial:• 20% operating cashflow (excluding Gulf of Mexico oil spill
payments)• 20% underlying replacement cost profit• 10% upstream unit production costs
201850% Relative TSR30% ROACE20% strategic priorities, including - growing gas and “advantaged oil” in upstream (including assessment of proportion of gas in portfolio, movement of unit production costs); market led growth in downstream; venturing and low carbon; gas, power and renewables trading and marketing growth
Vesting to be considered in light of absolute TSR and safety/environmental factors including around carbon and climate change (e.g. reducing emissions, improving products and creating low carbon businesses)
[CTI note – in the absence of further detail, we have given BP the benefit of the doubt and as-sumed that there are no growth metrics in their “growing gas and advantaged oil” measure. We will review pending further disclosures]
201733% Relative TSR33% operating cash flow11% reserves replacement11% major project delivery11% safety (safety events and injury frequency)
Not granted Not granted
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Paying with Fire – How oil and gas executives are rewarded for chasing growth and why shareholders could get burned 37
Company Annual bonus LTIP Options Restricted StockEquinor Threshold condition of payment: cash flow from operations,
net debt ratio and development, overall operational and financial developmentCompany performance modifier:50% relative TSR50% ROACE
2018Safety, security and sustainability - serious incident frequency, CO2 intensity for upstreamMarket - fixed operating and SG&A expenses (per boe)Results - relative TSR, relative ROACE
2017Safety, security and sustainability - serious incident frequency, recordable injury frequency, oil & gas leakages, CO2 intensity for upstream, positioning in IOGP company reportPeople and organisation - employee engagement/people developmentOperations - production, relative unit production cost, production efficiencyMarket - reserve replacement ratio >1, organic capex, value creation from explorationFinance - relative TSR, relative ROACE, cash flow improvement programmeWeightings not disclosed
Not granted Not granted Threshold condition of grant: cash flow from operations, net debt ratio and development, overall operational and financial development
ENI 25% economic and financial results – EBT (12.5%), free cash flow (12.5%)25% operating results and sustainability of economic perfor-mance – hydrocarbon production (12.5%), exploration resources (12.5%)25% environmental sustainability and human capital - CO2 emis-sions target for operated production (12.5%), severity incident rate (12.5%)25% efficiency and financial strength – ROACE (12.5%), Debt/EBITDA (12.5%)
50% relative TSR50% NPV of proven reserves relative to peer group
Not granted Not granted
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Company Annual bonus LTIP Options Restricted StockRepsol 2018
20% strategic - new strategic plan30% efficiency - efficiencies and commitments – “AB 18” 15%, breakeven of Repsol FCF 15%45% operations - net profit 20%, net debt 10%, production 10%, utilisation of conversion capacity 5%5% sustainability - total accident frequency and fatality rate
201740% efficiency - budgeted efficiencies and synergies 30%, Repsol FCF breakeven 10%45% operational - net profit 15%, net debt 10%, production 10%, utilisation of conversion capacity 5%, E&P capex 5%5% sustainability - total accident frequency rate and fatalities 10% value creation - share price vs comparable compa-nies
2018Not disclosed – to be announced after finalisation of new strategic plan (launched June 2018)
201730% upstream – annual FCF breakeven (15%), optimisation of investments (5%), implemen-tation of specific projects within deadlines and budgets (5%), operating cost/barrel relative to peers (5%)20% downstream – integrated refining and marketing margin vs sector (10%), cash flow generation (10%)40% value creation and resiliency – opex efficiency and synergies programme (10%), net profit (10%), divestment plan (10%), TSR (10%)10% sustainability – total accident frequency rate (5%), reduction of emissions (5%)
Not granted Not granted
OMV 2018 Not disclosed
201760% financial - clean CCS NOPAT (20%), FCF before divi-dends and excluding divestments/acquisitions (30%), reported ROACE (10%)40% efficiency: Execution of capital projects in time and budget and cost savings+/- 10% multiplier sustainabilityDiscretionary multiplier Financial targets and performance - discre-tionary within disclosed limits, adjustment in case of major changes in external factors, assess overall performance
60% relative TSR10% free cash flow10% sustainability10% performance in divestments and acqui-sitions10% reserve replacement
Not granted None – deferred portion of an-nual bonus
Galp Energia 22% economic value added22% relative TSR22% EBITDA at replacement cost35% qualitative performanceSubject to net profit underpin
33% relative TSR33% EBITDA at replacement cost35% qualitative performance
Not granted Not granted
Aker BP Not disclosed – “company-wide KPIs and priorities” 100% relative share price Not granted Not granted
Lundin Petroleum Not disclosed 100% relative TSR Not granted Not granted
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Company Annual bonus LTIP Options Restricted StockCanada
Suncor Energy 30% corporate – funds from operations (FFO) 20%, ROCE 10%50% business unit - for unit heads, 30% of own business and 70% WAV of others. For CEO WAV of all units. Weighted scorecard of “Suncor’s value drivers” – safety (recordable injury frequency, loss of primary containment, other business unit specific measures), sustainability (number of environmental regulatory non-compli-ances, energy intensity, other business unit specific measures), base business (production, cash costs, asset availability, other measures), growth (execution of growth plan, projects, other measures), workforce and organisational performance (business unit specific). 20% personalMinimum FFO must be achieved before any pay-out (ensure affordability)
100% TSR No conditions Not granted
CNRL 201730% financial - balance sheet strength (Debt to book, Debt/EBITDA), capital expenditures, ROE, ROACE, cash flows from operations, cash flows per common share30% strategic development of assets; capital allocation - mid and long term projects, opportunistic acquisitions and disposals, distributions to shareholders30% operational - production, operating costs10% safety, asset integrity and environmental - recordable injury frequency, lost time injury frequency, greenhouse gas emis-sions, pipeline leaks
33% relative reserves growth per share67% relative TSR
No conditions Not granted
Imperial Oil Net income, company performance 50% deferred with timing dependent on cumulative EPS
Not granted Not granted No conditions once granted. Grant value determined after considera-tion of various factors. 2017Considered:Safety, operational integrity, risk managementNet incomeCash flow from operationsDistributions to shareholdersOperating performance including production, refining results, product sales, expansion of fuels business, chemical earnings, reduction in above-field costsOpportunities to add value – investmentsResearch investments
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Company Annual bonus LTIP Options Restricted StockHusky Energy 2018
Not disclosed
2017Considered: Recordable incident rateROCEROCIUFunds from operationsNet earningsAdjusted net earningsUpstream productionRefining throughputReserves replacement ratioDisposalsAcquisitionsSafety and incident response
50% relative TSR50% return on capital in use (excludes assets that are not generating cash flows)
No conditions Not granted
Cenovus Energy 55% operational - production, operating costs, steam to oil ratio, reserves, safety, environmental (38% absolute + 17% relative)5% environmental - specific actions e.g. wildlife mitigation, fresh water usage reduction25% consolidated financial performance - F&D costs, G&A costs, netbacks, recycle ratio, adjusted funds flow, net debt to capitalisation, net debt to adjusted EBITDA (17% absolute + 8% relative)15% strategic accomplishments - e.g. innovation, environmental achievements
100% relative TSR No conditions Not granted
Encana 2018Not disclosed – includes growth in non-GAAP cash flow; growth in non-GAAP cash flow margin.
2017Total productionTotal capitalCapital efficiencyQ4 production – core assetsNet debtTotal costsOperating marginSafety modifier +/- 20%Discretion +/- 25%
2018Not disclosed - includes non-GAAP cash flow per share growth; net debt toadjusted EBITDA.
201750% relative TSR20% non-GAAP cash flow margin per boe20% net debt to adjusted EBITDA 10% portfolio and drilling inventory improve-ments
No conditions No conditions
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Company Annual bonus LTIP Options Restricted StockAustralia
Woodside 2017Corporate scorecard:NPAT ProductionSafetyDelivery against business plan commitments – “grow the portfolio” (resource replacement, concept select decisions, commercial-isation of international assets, tie-back opportunities), “grow the market” (capture new markets, mature gas to power opportunities), “operating excellence” (opex, unit production costs, reliability), “capability” (diversity, social licence to operate, disciplined opportunity financing)Individual KPIs (CEO):“+ Growth agenda: Assesses the alignment of growth opportuni-ties to shareholder return; portfolio balance; the achievement ofchallenging business objectives.+ Effective execution: Assesses the maintenance, operation and profitability of existing assets; project delivery to achieve budget,schedule and stated performance; cost reduction; achievement of health, safety and community expectations.+ Enterprise capability: Assesses leadership development; work-force planning; executive succession; Indigenous participation anddiversity; effective risk identification and management.+ Culture and reputation: Assesses performance culture and emphasis on values; engagement and enablement; improved employeeclimate; Woodside’s brand as a partner of choice.+ Shareholder focus: Assesses whether decisions are made with a long term shareholder return focus; effective and timelycommunication to shareholders, market analysts and fund manag-ers; the focus on shareholder return throughout the organisation.”
100% relative TSR Not granted No conditions – deferred portion of annual bonus
Origin Energy
Note – year endat 30 June
2019No changes to metrics
201860% financials - including EPS, NCOIA (net cash from operating and investing activities), EBITDA, opex20% customer – including customer recommendations20% people – including safety, engagement, gender
201730% EPS30% NCOIA (net cash from operating and investing activities)6.6% total recordable injury frequency rate6.6% serious actual consequence incidence frequency rate6.6% group engagement score20% personal KPIs – customer; transformation; stakeholder engagement; people and culture
201850% ROCE50% relative TSR plus positive share price growth requirement
2017100% ROCE
2018Not granted
2017100% TSR
Not granted
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Company Annual bonus LTIP Options Restricted StockOil Search 2017
Pool determined by:10% safety – various indicators20% production20% costs5% EBITDAX15% 2C gas resources15% 2C oil resources15% strategic and growth initiatives, including “matu-ration of material incremental oil opportunities, Kutubu Pipeline System optimisation and the expansion of the exploration portfolio in PNG.”
100% relative TSR
2018 one-offAdditional one-off transition LTIP relat-ed to PNG LNG expansion. 75% achieving investment sanction for the LNG expansion projects within a defined period25% scorecard of pre-requisite objectives for sanction – precise metrics not disclosed, but include deliverables such as equity and project financing; LNG sales and purchase agreements; engineering, design and contracting; reserves certification; licencing; commercial agreements
Not granted None once awarded as deferred part of annual bonus
Santos 2018No changes to metrics disclosed
201720% operational integrity – personnel safety; process safety; environmental incidents; Santos Management System60% financial and operating performance – production; adjust-ed net debt, free cash flow breakeven point; ROACE; NPAT15% value creation – 2P reserves replacement; new 2C resource; core asset portfolio build5% leadership and culture
50% relative TSR25% free cash flow breakeven point (oil price at which cash flow from operations equals cash flow from investing activities)25% ROACE
Not granted Not granted
Source: company disclosures
Note: metrics shown are for CEO if there is any difference between executives. Metrics are shown for most recent year and current year where disclosed/relevant. Individual performance modifiers and remuneration committee discretion have generally been excluded. Restricted stock granted as a deferral of annual bonus has not been included separately. Standard conditions such as continued service have been excluded. Percentages may not add up due to rounding. Above based on Carbon Tracker simplification of complex and detailed disclosures. Please refer to disclosures for further detail and underlying data.
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Glossary of abbreviations
Boe – barrel of oil equivalentCROCI – cash return on capital investedEBITDA – earnings before interest, tax, depreciation and amortisationEBITDAX – earnings before interest, tax, depreciation and amortisation, exploration costsF&D – finding and developmentFCF – free cash flowG&A – general and administrative (costs)KPI – key performance indicatorLOE – lease operating expensePDP – proven developed reservesNPAT – net profit after taxROACE – return on average capital deployedROCE – return on capital employedROIC – return on invested capitalTSR – total shareholder return
Disclaimer
Carbon Tracker is a non-profit company set up to produce new thinking on climate risk. The organisation is funded by a range of European and American foun-dations. Carbon Tracker is not an investment adviser, and makes no representation regarding the advisability of investing in any particular company or investment fund or other vehicle. A decision to invest in any such investment fund or other entity should not be made in reliance on any of the state-ments set forth in this publication. While the organisations have obtained information believed to be reliable, they shall not be liable for any claims or losses of any nature in connection with information contained in this document, including but not limited to, lost profits or punitive or consequential damages. The information used to compile this report has been collected from a number of sources in the public domain and from Carbon Tracker licensors. Some of its content may be proprietary and belong to Carbon Tracker or its licensors. The information contained in this research report does not constitute an offer to sell securities or the solicitation of an offer to buy, or recommenda-tion for investment in, any securities within any jurisdiction. The information is not intended as financial advice. This research report provides gen-eral information only. The information and opinions constitute a judgment as at the date indicated and are subject to change without notice. The information may therefore not be accurate or current. The information and opinions contained in this report have been compiled or arrived at from sources believed to be reliable and in good faith, but no representation or warranty, express or implied, is made by Carbon Tracker as to their accuracy, completeness or correctness and Carbon Tracker does also not warrant that the information is up-to-date.
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