Equinor’s climate transition plan is not good enough & how we are voting for net-zero accounting
The leading global oil and gas company Equinor has published a detailed Transition Plan setting out how it will deliver its net zero by 2050 ambition. This is a critical document for shareholders as it is Equinor’s road map for reinventing itself in a carbon neutral world. It is also a critical document for the world as, alongside other carbon-intensive companies’ Transition Plans, it tells us how the promise of climate stability might actually be achieved. Shareholders have the opportunity at the coming AGM to vote on whether it is good enough.
Notwithstanding the positive steps that Equinor’s leadership is proposing to take, as a shareholder on behalf of our clients Sarasin & Partners will reject this plan. We will also vote against the annual report and audited financial statements, as well as against remuneration for the auditor – all on climate grounds.
A ‘go-slow’ transition is not good enough
The central problem is that it is a ‘go-slow’ Transition Plan, rather than one designed to show the world how oil and gas majors can become clean energy titans. At a time when the world has been learning the hard way that dependence on fossil fuels doesn’t just threaten long-term civilisation but represents an immediate energy security risk, we should be doubling down on building clean domestic energy supplies, not holding back.
What matters most in any Transition Plan is capital expenditure. It is good news that Equinor plans to increase its investment into renewables and climate solutions from just 4% in 2020 to over 50% by 2030. This is a big step up from the 13% share Equinor was previously planning for 2030. But this still leaves up to 50% of capex – amounting to tens of billions of dollars – flowing into fossil fuels. Consequently, it forecasts that in 2030 roughly 90% of its total production volumes will still be oil and gas.
The IEA has stated unequivocally that if the world is to achieve a 1.5°C outcome, there can be no new oil and gas fields1. Equinor’s plan makes no such promise.
While it is clear we cannot turn off the fossil fuel ‘taps’ overnight, Equinor needs to try harder. Its Transition Plan seems to be structured to avoid early retirement of their fossil-fuel assets:
“Due to the long-term nature of investments in energy projects it is expected that our increasing share of investments in renewable energy projects will have a delayed impact on the relativity between oil, gas and renewables in the total production profile.”.
This may be true, but Equinor could shorten the lives of some of these long-term assets for the sake of protecting the planet, and avoiding future stranded assets. In fact, they may need to retire assets early to meet their own climate targets.
Under a net-zero pathway envisaged by the IEA, Equinor states clearly that its existing portfolio could see 34% of Net Present Value written down2. That should be a red flag for long-term shareholders: Equinor is over-investing in activities that are not aligned with a 1.5°C pathway, and thereby putting capital at risk.
Winding down the brown can be balanced by a faster scaling up of the green. And if that’s not earnings accretive, Equinor should return the cash to shareholders. This would be a far more credible and sustainable investment proposition. And it should be one supported by its main shareholder, the Norwegian state, which has itself committed to a 2050 net-zero future and is a leading proponent of the Paris Climate Agreement.
As it stands, Sarasin & Partners will reject Equinor’s Energy Transition Plan.
What about the accounts?
As we have set out elsewhere, a powerful lever in the capital allocation machine is the accounts. They tell executives, boards and investors what activities make profits and what don’t. They, therefore, tell corporate leaders where to invest. If the accounts mislead by leaving out likely losses and liabilities linked to accelerating decarbonisation, the capital allocation machine will malfunction. Too much capital will flow into carbon-intensive activities.
Global regulators and standards setters have also made clear that, under existing rules, material climate risks must be incorporated into company accounts. The European Securities Market Authority has identified the inclusion of material climate risks into financial statements as a supervisory priority for 20223. The global accounting standard setter (IASB) and the audit standard setter (IAASB) have both published guidance underlining why material climate risks must be considered under existing standards4.
Equinor’s latest audited accounts provide increased disclosures on how it has considered accelerating decarbonisation and its own climate commitments. It assumes that current expected decarbonisation falls well short of a 1.5°C pathway, and in this warming world, it does not need to change any of its critical accounting judgements, whether that is long-term commodity prices, asset lives, expected production volumes or assumptions linked to asset retirement obligations. Given these assumptions, not surprisingly, it has no climate related impairments to report.
However, we would query whether it is taking adequate account of government determination to drive towards 1.5°C (and indeed their own stated ambition). When we consider its long-term oil and gas price assumptions, these appear elevated against the IEA’s less ambitious Sustainable Development Scenario. These prices are high even compared to peers. Equinor’s projected oil price, for instance, is expected to rise from $65/bbl in 2025 price to peak in 2030 at an undisclosed level, before declining to $64 in 2040. Shell, in contrast assumes a flat $60 from 2025 into the long-term. bp sees prices falling from $60 to $45 by 2050. Equinor’s gas price assumption is $3.2/mmbtu in 2030 (HH) versus $3 used by Shell and bp. Could this mean Equinor is understating the risks to capital?
But it’s not just commodity price assumptions we need to understand
Take the remaining asset lives for key fossil fuel-related assets. This is not disclosed. Are these reflecting Equinor’s climate targets? What about production volumes linked to those assets?
Asset life assumptions are also key to when they have to meet their asset retirement obligations (AROs) – if you shorten your asset lives, you bring forward clean-up obligations. None of these has changed and yet Equinor claims it is on a path of winding down fossil fuels in favour of low-carbon solutions.
In addition, there is no disclosure relating to how the costs of carbon capture and storage and other carbon removal/offset plans are being reflected in the impairment tests, if at all. These won’t be cheap.
Looking at its cost of capital, Equinor does state that it could envisage potential increases linked to rising risks associated with fossil-fuel investments. But is this reflected in the impairment testing, or does Equinor assume credit will continue to flow towards these activities? Is this reasonable, given steps by both banks and prudential regulators to ensure banks are properly reflecting the climate risks in their lending decisions?
Sensitivity to 1.5°C pathway is welcome but partial
While Equinor has not made any changes to critical accounting assumptions5, it has included a 1.5°C commodity price stress test for its upstream assets. This suggests a potential $7bn impairment, or c10% of its reported Property Plant and Equipment (their largest reported asset), in the event that we see oil prices fall to $36/bbl in 2030 and $24/bbl in 2050, gas prices fall to $1.9/mmBtu and $2/mmBtu, and carbon prices rise to $130/tCO2 and $250/tCO2. These assumptions are consistent with the IEA’s 2050 Net Zero scenario.
But what about asset lives? AROs? How might deferred tax assets or intangible assets be impacted in this pathway?
Finally, why does Equinor’s parallel sensitivity analysis using a 30% price reduction suggest a possible $9bn impairment (versus $7bn for 1.5C)6? The IEA’s NZE2050 scenario prices would seem to imply a larger price reduction than this7.
Auditor tells us too little
Turning to the auditor, EY, we welcome the climate commentary in its Key Audit Matter on “Recoverable amounts of production plants and oil and gas assets including assets under development”. However, EY makes no mention of how (or whether) it considered climate risks for their Key Audit Matter on asset retirement obligations.
EY also makes no comment on whether the financial statements reflect Equinor’s net-zero ambition, or medium-term targets. Do these not have a bearing on their assessment of the veracity of the accounts? Auditors have been clear at other oil and gas majors such as Shell (who EY also audits) and bp that this is a material consideration. Why is Equinor different?
Our votes at Equinor’s 2022 AGM
Note: As there is no vote on the Audit Committee or Auditor at Equinor’s AGM, we have focused on the most relevant alternatives.
- Energy Transition Plan (Resolution 10) – Against. While we support the publication of a clear plan to achieve Equinor’s stated net-zero ambition, we cannot support a plan that fails to align with a 1.5°C pathway. Put simply, Equinor’s needs to shift its capital expenditure more quickly into clean solutions, and also more quickly away from carbon-intensive infrastructure. Where Equinor cannot find earnings accretive options, it should return their cash to shareholders.
- Annual Report & Accounts (Resolution 9) – Against. While we welcome increased disclosures in the financial statements, including a new Note on climate considerations, the disclosures remain partial. We are unclear how remaining asset lives, expected production volumes and the timing of asset retirement obligations are consistent with Equinor’s stated climate targets. We welcome the 1.5°C sensitivity analysis (suggesting a potential $7bn impairment) but this seems low when compared to its parallel sensitivity for a 30% reduction in commodity prices ($9bn). We cannot establish whether it has included the impacts for all balance sheet items beyond property plant and equipment, or whether it considered impacts beyond lower commodity prices and carbon taxes (such as shorter asset lives etc).
- Approval of remuneration for the company’s external auditor (Resolution 22) – Against. We welcome the climate commentary in EY’s Key Audit Matter on “Recoverable amounts of production plants and oil and gas assets including assets under development”. However, it makes no mention of how it considered climate risks for their Key Audit Matter on AROs. Moreover, EY does not comment on whether the financial statement reflects Equinor’s net-zero ambition, or medium-term targets, which we would expect to have a bearing on its assessment of the veracity of the accounts.
Note: A full analysis of Equinor’s 2021 Financial Statements undertaken by the Carbon Tracker Initiative can be downloaded here.
1 Net Zero by 2050 – Analysis - IEA
2 df1f0cb19f173c1e616f83263540fd98e366212f.pdf (sanity.io)
3 European enforcers target COVID-19 and climate-related disclosures (europa.eu); News I Financial Reporting Council (frc.org.uk)
4 IFRS - Educational material: the effects of climate-related matters on financial statements prepared applying IFRS Standards, IAASB Issues Staff Audit Practice Alert on Climate-Related Risks | IFAC, Summary-FINAL.pdf (frc.org.uk)
5 Last year (2020 financial statements), they did lower commodity prices in 2020, and thus recognised impairments: PPE impairments (gross) were $5.9bn in 2020 ($3.4bn in 2019). In 2020, $4.7bn of these losses related to production plants and oil and gas assets.
6 Form 20-F, p.232
7 IEA 2050NZE oil prices: $36 (2030) and $24 (2050) versus Equinor: $65 (2025) and $60 (2050); IEA gas prices (US): $1.9/mmbtu in 2030 and $2 in 2050 versus Equinor $3.2 in 2030 and $3.3. from 2040 onwards.