November 9 2016
Compensating Executives During Oil & Gas Volatility
The volatility of the oil & gas industry has induced significant pressure on domestic and global markets over the span of the last 12 to 18 months. Indeed, the reintroduction of Iranian crude to the global market coupled with increased Russian and Saudi Arabian production output levels created a global supply glut that plummeted crude prices and hampered global markets. However, speculation regarding potential coordination of OPEC nations to reduce global supply has raised share prices of some of the largest domestic and global crude producers. The potential curtailing of production is a welcome sign for the global markets, though the effects of the decline and recovery of crude pricing remain to be seen.
Of particular interest are the executive compensation practices at some of the largest producers during this time period. In an era of emphasis on pay for performance, a dramatic decline in a commodities price invites analysis of the potential ramifications on executive pay.
For example, the share price of Exxon Mobile (XOM) illustrates the industry’s duress, where on January 1, 2015 the share price closed at $92.45. Fast forward to December 31, 2015 and the stock had plummeted to $77.95—a 15.7% decline over the calendar year. The start of the New Year provided no relief as the stock would reach its 2016 low in January at $71.55 a share. Analysis of BP PLC (BP) and Chevron (CVX) illustrated similar volatility in the share price leading to pronounced lows in the first quarter of 2016. BP took a direct route of engagement with shareholders in discussing the difficulties, devoting an entire page in its annual report detailing the global supply glut and resulting pricing decline.
Executive Compensation in the Volatile Oil and Gas Industry – Metrics
The hardships of fiscal 2015 and initial struggles in 2016 would seem to suggest that executives’ performance-based pay would suffer. Instead, and despite the uniform difficulty in the markets, performance-based compensation in many cases remained relatively steady. The reasoning lies in the metrics favored by the largest crude producers for performance-based equity awards. Exxon Mobil detailed seven separate metrics used to determine performance equity payouts—commonly used metrics such as total shareholder return (TSR) and cash flow are disclosed. However, Exxon also maintains multiple industry specific performance measures, such as safety and operations integrity.
Indeed, performance equity payouts are ultimately determined by a blend of financial and industry specific metrics. Much like Exxon, Chevron details process safety and environmental performance in addition to earnings per share (EPS) and TSR. The mix of financial and industry specific metrics has allowed the amount of awarded performance equity to remain relatively constant or even increase.
Executive Compensation in the Volatile Oil and Gas Industry – Grant Size
Share prices determining the value of this equity creates another set of challenges. Exxon Mobil CEO and Chair Rex Tillerson received a year-end equity award of 225,000 restricted stock units in each of the previous two fiscal years. The value of the award was $21,420,000 in November of 2014. Yet when awarded the same amount of equity in November of 2015 the awards value was $18,288,000—a 17.1% year-over-year drop.
Recognizing the potential loss of value, some boards are upping the number of shares since the onset of market volatility to ensure a more consistent award valuation. Chevron granted CEO and Chair John Watson, CFO Patricia Yarrington and Executive Vice President, Upstream James Johnson 662,000, 164,600 and 164,000 stock options, respectively, in January 2015. Yet when the January 2016 options were awarded each received a significantly larger grant (964,000, 239,000 and 311,700). In light of poor market performance, these executives saw the number of options increase.
|Chevron Executive||January 2015 LTIP Option Grant||January 2016 LTIP Option Grant|
|John Watson-CEO Chair||662,000||964,000|
|Patricia Yarrington-VP and CFO||164,600||239,900|
|James Johnson-EVP, Upstream||164,600||311,700|
Upon further analysis in spite of extreme market volatility executive compensation at many of the largest crude producers remained fairly consistent. The structure of performance incentive plans allowed for industry specific metrics to offset some of the poor market performance and ensured that the value of performance equity remained on an even keel.
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For more information on Equilar’s research and data analysis, please contact Dan Marcec, Director of Content & Marketing Communications at email@example.com. Roy Schwartz, research analyst, authored this post.