At first glance, recent progress towards transparency in corporate climate-risk disclosures seems exceptional. Over 2,000 companies now publish annual reports showing their carbon emissions data (although most self-interestedly omit Scope 3 data). Many (including most recently ExxonMobil) have made a pledge to move to “net zero” carbon emissions by a given date (usually 2050, but some much sooner). We are awaiting SEC rules that will make ESG disclosures mandatory and likely compel U.S. issuers to use common metrics (and thereby make issuer-specific reports relatively comparable). The Financial Stability Oversight Council’s October 2021 report stressed that climate risk represents a serious threat to the stability of our financial system, and that recognition adds a second string to the regulator’s bow. In Europe the Task Force on Climate-Related Financial Disclosures has established a template for financial disclosures that has received general acceptance and will probably influence the SEC’s forthcoming standards. Taken together, all this sounds impressive.

But, first glances can be deceiving. Progress towards politically controversial goals is often a bumpy series of two steps forward, one step back. As usual, the market finds ways to outflank regulatory reforms, and that is quietly happening. Here, it is important to recognize that a small minority of firms are disproportionately responsible for the major share of overall carbon emissions. An increasing percentage of these firms are privately held, meaning both that they are exempt from SEC periodic-disclosure rules and that their stock is typically not held by the major institutional investors that are pressuring publicly held companies for increased ESG disclosures. As ESG disclosure becomes more costly (and it will), we may see the ratio between public and private firms owning “dirty energy” assets shift significantly towards a higher percentage of private companies. In such a world, “dirty energy” does not decrease; it just shifts towards private owners.

Let’s consider two examples: (1) Canada’s Athabasca oil sands in Alberta; and (2) the U.S. Permian Basin. Canada’s oil sands represent the fourth largest oil reserve in the world (after Saudi Arabia, Venezuela, and Iran) and probably, according to the Wall Street Journal, “the most environmentally unfriendly.”¹ Today, new investment in the oil sands has stalled, as banks are refusing to fund new projects. But, as international energy companies have moved out of Alberta, “smaller independents and private investors have come in, and some have moved to increase production.”² This is problematic, as Alberta’s oil sands generate “roughly 160 pounds of carbon emissions per barrel, a higher green-house-gas emission than any other oil in the world.”³ In comparison, even U.S. shale oil production generates only 26 pounds of emissions per barrel (resulting in a greater than 6 to 1 ratio by which Alberta’s oil sands emissions exceed those of fracking).

Nonetheless, oil production for the Canadian oil sands is estimated to have increased significantly in 2021 over 2020. Why? One private investor that has bought three oil-sands projects in the last two years explained to the Wall Street Journal that as a private investor, “it doesn’t have to answer to public shareholders.”⁴

A second example involves the Permian Basin. Subject to greater legal and shareholder pressure in The Netherlands, Royal Dutch Shell sold its Permian Basin assets to ConocoPhillips in 2021 for $9.5 billion.⁵ The stock prices of both Royal Dutch Shell and ConocoPhillips went up. Why? It appears that Royal Dutch Shell’s shareholders were happy both that Shell was becoming cleaner and that it was distributing $7 billion out of its $9.5 billion sale price to its shareholders (rather than investing the proceeds in renewable energy). ConocoPhillips’ shareholders were told that the transaction reduced its “emissions intensity” and probably believed that it had received a bargain price.

The key point here is that if these transactions continue, the major oil firms (which are much more sensitive to legal and shareholder pressure) may significantly divest themselves of “dirty energy” assets, but total industry production of “dirty energy” could remain stable (or even increase). At bottom, this prediction rests on the undeniable fact that much of the world (most clearly, Africa) needs cheap energy to sustain economic growth and thus will accept “dirty energy” if necessary. The only long-term answer to this problem would be subsidies from wealthier countries (or international organizations) to poorer ones.

Another area of dispute involves Scope 3 emissions. This category is defined by the Greenhouse Gas (“GHG”) Protocol as the emissions by parties upstream and downstream from the corporate issuer (for example, the upstream supply chain firms that mine or manufacture the company’s raw materials and the downstream consumers who use its gasoline). In Europe, Scope 3 data is mandated (and companies like BP and Shell regularly disclose it). In the U.S., absent mandatory disclosure, practices vary, but the majority of firms omit Scope 3 data (as, for example, did ExxonMobil when it announced its pledge to go “net zero” by 2050). As a result, investors are comparing apples and oranges when they look at the very different disclosures by firms that include or exclude Scope 3 data (which often exceed the sum of Scope 1 and Scope 2 data).

From a policy perspective, the bottom line is that we need (1) to discourage the shift of “dirty energy” assets to private companies or private investors (which both tend to be immune from institutional investor pressure and SEC rules), and (2) to encourage the use of common metrics (so that the data becomes truly comparable). Otherwise, large public companies will report great progress, but this progress is largely illusory, because overall industry carbon emissions may not shrink much.

But how do we do this? The most obvious way is also the least feasible: Enact legislation. For example, if the JOBS Act were amended to reduce the point at which a company must become a “reporting company” (and thereby make periodic disclosure to the SEC) from 2,000 shareholders of record back to the old 500 shareholder standard, this might subject many privately-held companies to SEC reporting and ESG disclosures. Or, one could even more directly address this problem by requiring companies to count their beneficial holders and not just their shareholders of record. But these are pipedreams, unless the filibuster were first abolished (and that is not about to happen). Alternatively, the SEC is considering a possible rule that would require private companies (such as venture capital and private equity firms to count their shareholders as shareholders of the firms in which they invest).⁶ This might solve much of the problem, but it is effectively reversing the JOBS Act without new legislation, and this seems legally vulnerable.

So what options are left? Here, public policy needs to exploit the fact that large institutional investors can pressure the large public companies that hold “dirty energy.” Effectively, these investors can influence the seller much more than the buyer of such assets. In that light, they could seek to enforce a norm: Public companies should not sell significant emissions-creating assets unless the buyer agrees to observe a “net zero” emissions pledge roughly comparable to its seller’s. For example, if Royal Dutch Shell had made a pledge to attain “net zero” status by 2050, it could not sell its “dirty assets” to ConocoPhillips, unless the latter made a comparable pledge. If this norm were violated, large institutional investors (including the increasingly activist Big Three – BlackRock, State Street and Vanguard) would indicate a willingness to vote against the re-election of the incumbent directors at the seller who had supported the transaction.

The logic of this proposal lies in the fact that the seller is exposed to shareholder pressure, even if the buyer is not. What would be the impact of this proposal? It would probably lower the sales price for “dirty assets” (because a private buyer could not increase production after its acquisition). To be sure, a private buyer might agree to make such a pledge and then breach or renege on it (possibly even securing support of its own shareholders for its decision to breach). Both the enforceability of this promise and the damages for breach are uncertain. Ultimately, if such agreements cannot be enforced adequately, then the next step would be to insist that public companies sell “dirty assets” only to other public companies. Again, this would imply a reduced sales price for the “dirty assets”.

Shareholder pressure can work (and it has in the recent past). Attempts to force private companies to become “reporting companies” seem more Quixotic than realistic. Apparently, some progressives prefer a gallant losing gesture to a more pragmatic compromise.

The unique fact about climate change activism is that private actors (mainly institutional investors) are more aggressive and willing to take action than are governmental agencies. Greater ESG disclosure and greater transparency thus triggers better informed shareholder action. But this system is subject to evasion. Dumping “dirty assets” on private investors and private companies undercuts any meaningful attempt to measure progress on emissions reduction.

ENDNOTES

1. See Vipal Monga, “One of the Dirtiest Oil Patches is Pumping More Than Ever,” The Wall Street Journal, January 14, 2022 at p. A1.

2. Id. at p. A9.

3. Id.

4. Id.

5. See Rupert Steiner, “Buybacks, Dividends Will Help Boost Shell Stock,” Barron’s, January 17, 2022 at p. 46. Shell has announced an attempt to achieve a 50% reduction from 2016 levels in its carbon emissions by 2030 – a date well ahead of its rivals.

6. See “SEC Eyes Expanded Oversight,” The Wall Street Journal, January 11, 2022 at p. A5.

This post comes to us from John C. Coffee, Jr., the Adolf A. Berle Professor of Law at Columbia University Law School and Director of its Center on Corporate Governance.