Fiduciaries for our largest pension funds and universities ignored signs of systemic decline.
Royal Dutch Shell is the first oil major to get honest: Our business model is broken and we are a lousy investment. Slashing its dividend for the first time since World War II, Shell broke the spell on investors who had become so hooked on the promise of easy quarterly cash that they ignored the signposts of a sector entering its terminal phase. After the news, Warren Buffett validated voices that have been warning investors to pull out of fossil fuels for years: “Any shareholder in any oil-producing company, you join me in having made a mistake.”
Despite oil industry efforts to cast COVID-19 as a black swan that suddenly knocked them off course, investors were on notice that a crash was a long time coming. Divestment advocates have been warning about the financial risk, and moral cost, of holding onto fossil fuels for close to a decade. Research was clear that the dividend was a house of cards standing on a shaky pile of growing debt. Nevertheless, fiduciaries who should have known better — including prominent endowments like Harvard and climate-minded pension trustees in New York state and California — made an unspoken deal with the oil majors: Keep the oil dividend flowing and we won’t ask too many questions.
With oil majors historically offering dividend yields of 5 to 8 percent, institutional investors naturally came to rely on the steady flow of cash to grow and sustain their funds. For most of the past century, the oil dividend did what it was supposed to do: It rewarded shareholders for investing in a booming industry that brought billions of people from darkness into light. Yet oil’s heyday has long since passed as the world continues its rapid transition to electric vehicles and renewable energy. The industry has been under incredible strain and systemic decline for many years — the deep cracks in its business model now laid bare by the COVID-19 crisis.
A dividend as “the part of the profit of a company that is paid to shareholders.” To any layperson, the dividend is something extra – paid out when a business is thriving and there is an excess of profit to be returned to shareholders. Not so with the oil majors, who resorted to accounting tricks to keep the house of cards standing. As documented by the Institute for Energy Economics and Financial Analysis, ExxonMobil, BP, Chevron, Total, and Shell have been unable to sustain the dividend with free cash flow for a decade, borrowing money and selling assets at alarming rates in order to maintain the dividend and keep investors pacified.
Paying a dividend on credit should raise red flags with any prudent fiduciary. Yet investors enabled the practice. Even as debt ballooned on industry balance sheets, the message of shareholders remained the same: Sustain the dividend at all costs. “There is total inconsistency in what investors tell you except for one thing: Can you please sustain the dividend?” Shell CEO Ben van Beurden said in October 2019. “And that is fine. We have every intention to do so.”
Six months later, even Van Beurden’s best intentions were not enough. As COVID-19 decimated global oil demand, Shell slashed its quarterly payout from 47 cents to 16 cents — collapsing its dividend yield to around 2 percent. That’s a raw deal when the underlying stock is as weak and volatile: Oil stocks have badly underperformed the market for more than a decade costing investors billions in foreign gains.
The pandemic has squeezed the oil industry to such an extent that drastic cuts to the dividend, and to capital spending, are the only defensible options. Yet most investors breathed a sigh of relief when the other supermajors — BP, Chevron, Total and Exxon — pledged to preserve their dividend in the second quarter and keep the charade going a little while longer. This obsession with short-term gains, an irrational discounting of future pain and a dogged commitment to delaying the inevitable are the drivers of the climate crisis itself.
Before COVID-19 forced the oil dividend onto the chopping block, institutional investors were content to look the other way: They invested in the house of cards so long as they received their dividend yields north of 5 percent. Shell may have been the first major to cut its dividend, but it will not be the last. Fiduciaries — particularly university endowments and public pension trustees with a legal duty to protect benefits over the long-term — have no business left in fossil fuels.
Clara Vondrich is the former head of Divest Invest and the current director of climate finance at STAND.earth. She is a lawyer and served as counsel to President Obama’s National Commission on the BP Deepwater Horizon Oil Spill in 2010.