1996 was a watershed year for the tobacco industry. Grady Carter, a former air-traffic controller who had smoked for 43 years and subsequently suffered from lung cancer, won the first-ever individual judgement against big tobacco.
On the day of the verdict, the share prices of the tobacco companies fell dramatically – some by over 10% that day – wiping billions of dollars from the value of the industry.
Yesterday (26 May), after multiple false starts over a decade, big oil suffered a significant and similar defeat. A Dutch court ruled that Royal Dutch Shell* must “limit…the aggregate annual volume of all CO2 emissions into the atmosphere (Scope 1, 2 and 3)…to such an extent that this volume will have reduced by at least net 45% at end 2030, relative to 2019 levels.”
Yet in contrast to the tobacco companies, Shell’s share price barely budged. Given the decision appears to have been something of a surprise, it is unlikely that the market was discounting a significant impact ahead of time. This suggests two potential alternative views: either that the market concluded the verdict will be successfully appealed (which may well be true), or that it will have little impact.
We are less sanguine, as reading the judgement throws up some remarkable statements that made us sit up and pay attention.
Supply and demand
The first is that the court accepts what up until now has been, in our opinion, a minority view in both academic literature and broader financial markets: the argument that one company reducing oil supply unilaterally will change the quantity of oil that is consumed globally.
Historically it has been accepted (correctly, we think) that forcing one oil company to stop producing oil – without changing either the demand for oil or the broader policy environment – just creates space for another oil company to step into their place and produce it instead. The court disagreed. We think this is potentially a very significant development.
The second observation (made, we think, by implication) is that, according to this ruling, Shell can be held accountable for things it does outside the Netherlands in relation to the harm that consuming its products will cause in the future. Even more significantly, the judge appears to accept this, even though that harm can’t be directly attributed specifically to any given barrel that Shell itself produces.
As the number of cases about climate issues more than doubled between 2018 and 2020, both of these points, if accepted in other courts considering climate lawsuits against big oil around the world, may be very significant. So the market’s apparent view that the judgement is a ‘non-event’ and can be ignored does surprise us.
Paris and petroleum’s price
What about the impact on climate change itself? We aren’t convinced this is necessarily a helpful development. We believe it’s vital that the global oil industry aligns its production to the Paris goals. But that must be done in step with policy, changes to the demand side, and the rebuilding of the world’s energy system. Forcing one company to do so in the courts may (if it is effective at all) only result in higher prices and foregone profits.
The courts do not, to us, appear to be the optimal venue in which to fix the world’s climate crisis; pursuing climate policy this way risks imposing the cost of transitioning onto the shoulders of the world’s poorest through the blunt tool of pricing, rather than a just and equitable transition that spreads the cost amongst those who are most able to pay.
This reinforces the crucial role of the upcoming COP26 climate conference, and the urgency for governments to increase their climate ambitions. But “waiting” for policy change doesn’t get the oil industry off the hook. The industry must, in our view, respond to these increasing pressures – not just from courts, but from all corners of society. How they respond is something we will cover in a follow-up post.
*For illustrative purposes only. Reference to a particular security is on a historical basis and does not mean that the security is currently held or will be held within an LGIM portfolio. The above information does not constitute a recommendation to buy or sell any security.