ESG

Fossil Fuels And Transition: What's The Direction Of Travel?

Editorial Staff, 13 September 2022

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A commentator on ESG and sustainability talks to this publication about the transition from fossil fuels – not necessarily a straightforward process, as suggested by the disruption to global energy markets caused by the pandemic and Russia's invasion of Ukraine.

Patrick Wood Uribe, chief executive of Util, spoke to this news service a few weeks ago about whether arms and weapons should ever be held in the portfolios of those buying into environmental, social and governance (ESG) principles – an example of the kind of controversies he has waded into. He also has views on how oil firms should respond to the ESG agenda,

(Util, based in Washington DC and London, has developed its data analytics dashboard to allow users to run reports on any listed company globally to gauge how its revenue affects the UN’s Sustainable Development Goals.) 

Currently, the demands of dealing with 'stranded assets', navigating geopolitics and meeting Net Zero targets has made moving towards renewable energy more difficult than some might have imagined. The UK government, led by recently-installed prime minister, Liz Truss, is even reconsidering fracking, albeit with certain caveats. North Sea oil production is being pushed. The EU recently changed its taxonomy for “green,” as it applies to gas and nuclear energy. And in the US, rises in gasoline pump prices, along with soaring electricity bills, are likely to lead to heated debate in the November mid-terms.

Oil producing nations are diversifying into areas such as solar, wind and other renewables. For example, Norway’s Climate Investment Fund and the country’s biggest pension company, KLP, are set to invest in a 420-megawatt solar power project being developed in Rajasthan, India. In light of the fact that the term “green transition” covers a vast and wide process, this news service asked Patrick Wood Uribe about the practicalities, where major oil producers stand now, and how the shift to new technologies is creating new challenges.

(Editor's note: This news service recently held its inaugural Wealth For Good Awards. Details of the winners are covered in the Acclaim publication. The next edition of the awards will be launched this November.)

What are the “better incentives” that asset managers need for moving towards renewables, etc? What concrete examples can you provide? Is there any data?
Rewarding long-term conviction and active engagement is a good start. Recent weeks have spawned lots of debate about what ESG actually means. Prompted by its mischaracterisation at the hands of the GOP, the industry has mounted a concerted and long overdue campaign to untangle years of confusion. One definition frames ESG as “risk management,” with environmental, social, and governance factors originating to provide extra insight into the potential risk-adjusted returns of an asset. The other, more popular definition characterises ESG as “impact investing,” in which context the E, S and G are objectives  inputs versus outcomes, very different goals, and very different concepts. 

The unbundling of terms is absolutely necessary and something for which we, as an impact data company, have been vocally in favour. That said, the distinction between "financial factors" and "impact factors"  while important to understand  is not entirely straightforward. Explosive flows into funds marketed as "green" or "sustainable" signal that investors want to express their values while earning a return. For asset managers, that (growing) demand represents, already, one financial incentive to allocate capital towards sustainable projects. The problem and, indeed, motive for mis-selling pure-play financial products as sustainable products – is the time horizon in which those funds are assessed.

For as long as asset managers are incentivised to maximise returns in the short term, with fund managers evaluated and rewarded according to their one- or three-year performance, the financial viability of “impact investing” will be overlooked. They are not just feelgood factors to be used in conjunction with company research and engagement, but are impact factors which help investors anticipate, drive, and reap the rewards of long-term economic change. While the long-term financial benefits are significant, taking an investment position on socially transformative concerns such as climate change and energy transition, requires fund managers and boards to take a structural rather than a cyclical perspective; organisations need to adjust financial incentives accordingly.

Can you give examples of “outcome-based impacts” that regulators can set? I know that the SEC has its new ESG disclosure requirements, but do these really get to the guts of the issue?
SEC climate disclosures are a great start but, over time as regulation grows more sophisticated (and companies develop their ESG capacity and bring strategy to the board level), we would expect a) disclosures to become more holistic (i.e. attention to Scope 3; disclosures based on more social and environmental issues than, simply, emissions); b) regulatory action to shift from "disclose" to "comply;" and c) regulator, company, and investor focus to move from individual company performance to systems-wide change. A potentially undesirable outcome of more rigorous ESG disclosures would be if companies were to burnish their credentials  which they have every incentive to do, if it reduces their cost of capital  by burying their negative impacts further down the value or supply chain.

This is an area that will never stop evolving, thanks to two exponential factors  global economic complexity, and technological sophistication. The number and type of sustainability issues will develop over time, as will the technology we use to track them. Access to third-party alternative data will continue to give asset managers an investment edge as disclosures become ubiquitous.

What is your view on how asset managers should deal with “stranded assets” such as a mine or steelworks being hit as a result of decarbonisation policy resulting in thousands of people losing their jobs? It might seem crass to tell them to “learn to code,” etc. Can you explain what ESG investors should think about this and what solutions need to be part of the equation?
In recent years, we’ve seen an uptick in the number of asset managers engaging with companies on transition risk in terms of human as well as physical capital. The benefit of impact data like ours is that it can shine a light on which industries are likely to face structural change due to sustainability issues, and what those sustainability issues are, before they fully register as ESG risks (i.e. consumer, investor, or regulatory pressure). 

Asset managers can then work with companies to establish the correct policies, such as workforce training, with ample (and necessary) foresight. In an era of frequent disruption, however caused not just by climate change, but also ny technological innovation, new ways of working etc. it’s not something that can be left to the investment industry to solve. Governments have a critical role to play.

There is obviously a tremendous amount of focus on energy costs at the moment. It is a geopolitical, economic and technology issue. How do you view the position of Big Oil today compared with, say, four years ago before worries about supply chains became urgent? How should activist investors think about the current crisis possibly affecting returns and their ability to put pressure on boards, etc?
Well before this year, we were advocating for more grown-up thinking about supply chains. The current emphasis on Scope 1 and 2 disclosures, coupled with oversight of Scope 3, encourages companies to offload or offset "brown" activities (or, as we’ve seen oil companies do, acquire and potentially mismanage ‘clean’ business). It also encourages investors and governments to push "brown" business off their balance sheets. Unfortunately, companies, investors, and governments still rely on those activities. 

The result is that ‘brown’ activities are pushed out of sight, out of mind, which is where the real damage begins. Take renewables. Looking beyond Russia’s oil, we need to talk about China’s rare earth minerals. Rare earth minerals and metals are critical for digital and renewable development. Unfortunately, they’re also a very dirty business. Our analytics consistently find metal mining to be one of the worst industries for most of the UN Sustainable Development Goals. That doesn’t mean they need to be shunned. Far from it. They need to be managed meticulously, with a view to social and environmental outcomes. Unfortunately, investors and governments have divested from environmentally unfriendly projects in their respective ways: asset managers, erasing drilling from their portfolios; governments, digging from the continent. Sure, it makes your climate figures look better. In practice, however, both groups have ceded economic benefits and ideological influence to less responsible shareholders or regimes.
 
With regards to renewables, a recent IEA report warns that the world is almost “completely” reliant on China for solar panel components. The supply chain concentration represents a “considerable vulnerability,” curtailing Europe’s energy security, real climate impact (shipping is highly pollutive), and the ability to enforce anti-slavery policy. Economic, environmental, and social issues indeed!

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