Mining and oil companies present some of the toughest challenges for ESG investors. With climate change top of the agenda after the UN Climate Action Summit in New York in September, companies that are actively contributing to greenhouse gas emissions are on the back foot.
Firms such as Exxon Mobil and BHP, some of the largest in the world by market capitalisation, may be spending heavily to promote the idea that they are moving towards a sustainable future, but they are struggling to convince a sceptical public.
The managers of the BlackRock Energy and Resources Income Trust (BERI) argue the public perception that these are “bad” companies is hard to shift – and it’s weighing on share price valuations. “The mining sector doesn’t do a good enough job of promoting what it does,” argues co-manager Tom Holl.
Scope for Change
Investors are now focusing on these “scope 3” - or indirect- emissions to get a better picture of the total carbon footprint of a company.
“Scope” is a reporting system that takes into account a number of different factors (not just basic metrics such as how much coal a firm extracts from the ground) in order to measure a firm's carbon emissions more accurately. This makes it easier for stakeholders – lobbyists, fund groups and private investors – to pin down what changes they want to see.
For example, a mining company extracts coal (scope 1), but scope 3 takes in the carbon emissions that are being produced in transporting it and then burning it in a power station.
Scope 3 also covers a wider range of harmful impacts – how many flights are company executives taking every year? Mining extracts metals that are used in smartphones, but do these products end up in landfill?
FTSE 100 diversified miner BHP (BHP), which is listed in the UK and Australia, has recently stolen a march on rival Rio Tinto (RIO) by saying it will include Scope 3 emissions in its new sustainability goals, while lobby groups in Australia are pushing Rio to follow suit.
Can an energy fund with large holdings in oil and mining firms also be sustainable? BlackRock Energy & Resources Income Trust managers think so. Just under 7% of the trust is focused on “energy transition” - but 58% is focused on mining and 41% on energy, which includes exploration and production giants such as Exxon Mobil.
BHP is the biggest holding in the trust, accounting for 7.8% of assets, Shell makes up 6.7%, BP 5.4%, Chevron 5.4%, Rio Tinto 5.1% and Exxon Mobil 4.9%. The energy transition segment of the trust is investing in companies such as those making batteries for electric vehicles (EV) in China.
Co-manager of the trust Tom Holl argues that these firms still have a central role to play in the global economy, whether the public likes them or not: “Investors realise that hydocarbons form an important part of the energy mix today and in our future", he says.
While you might think a mining company would struggle to tick the "S" - the social - box of ESG, Holl points to initiatives in these developing countries, such as schooling, healthcare and housing as examples of where mining companies fulfil the criteria.
The “E” or environmental aspect of mining and oil exploration is a tougher case to argue, he admits, but he is encouraged by the debate over scope 3 emissions and thinks it’s healthy there is more accountability.
BlackRock also runs the five-star rated Sustainable Energy Fund, which has a five globe Morningstar Sustainability Rating, the highest rating a fund can achieve.
US Giants Waking Up
To mitigate part of the ESG risk, America’s largest energy companies are starting to engage with ESG concerns for the first time, according to the BlackRock portfolio manager Mark Hume, who focuses on energy companies.
As yet, sustainability targets are not part of the remuneration package of US companies, but the debate is shifting in positive ways, Hume says. European energy companies like BP, Shell and Total are much further ahead than their US counterparts currently, Hume says, especially as the compensation at these firms is now linked to sustainable targets.
The tone of the sustainable investing debate has shifted in recent years away from “exclusion” investing, ie. rejecting those companies you don’t want in your portfolio such as energy firms, to “impact”, where companies are making a positive difference to the world.
UBP Positive Impact Equity fund manager Victoria Leggett looks at a company’s “direction of travel” as much as what it used to do in the past. Co-manager Rupert Welchman says oil firms could be included in an impact fund in the future, but to do so they would need to make a radical choice to commit 100% to renewables.
What’s often overlooked, is that both oil and mining firms may be cutting their carbon emissions anyway through their new conservative approach to projects. Shareholders and investors are now expecting these companies to show a much greater degree of capital discipline than in the past. Debt has been reduced and companies are returning cash to shareholders rather than opening new mines or exploring new oil fields.
However, the risk of Middle East conflict has heightened so if oil prices go back to $100a barrel, as some more bullish analysts are predicting, it might be harder to hold back companies, and indeed Opec countries, from taking advantage and turning on the taps again.
Sustainability Gets Harder
From October 31, Morningstar’s new sustainability ratings will make the hurdle for energy and mining companies harder to clear. Companies will be judged not only against their sector peers but also against companies in other sectors.
For example, an oil company could still score well relative to other oil companies because of its better ESG credentials but it will rate poorly compared with firms that operate in more sustainable sectors like healthcare and technology.
Hortense Bioy, Morningstar’s head of sustainability research in Europe, says. “With the new Morningstar sustainability rating for funds, we wanted to reflect the fact that funds that overweight companies in less sustainable sectors like oil and mining are exposed to more ESG risk”.
