ESG Focus: The Little Big Things – 29-08-2023 – Miners, Gas Producers, BlueScope, Adbri and Qantas

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ESG Focus: The Little Big Things – 29-08-2023 – BlueScope Steel, Santos, Woodside, Adbri, Rio Tinto, South 32, Fortescue Metals and Qantas

Macquarie counts the cost of capital for the ASX100; Jarden weighs the prospects for heavy emitters; Macquarie also examines where the downstream and upstream insurance emissions buck might stop; IEEFA spies rising credit-rating risk; and Morgan Stanley forecasts growing water capital expenditure for semiconductor and copper industries.

Compiled by Sarah Mills

Macquarie Counts Carbon Costs in ASX300

In its ESG Equity Strategy column, Macquarie observes demand for offsets are on the rise due to voluntary demand and in response to compliance measures such as the Safeguard Mechanism, and figures the time is right to determine the cost of carbon for the ASX100.

Among the Top 30 emitters on the index (which constitute 98% of total ASX100 scope 1 and 2 emissions), 83% are using or plan to use offsets, observes the broker. 

Rio Tinto ((RIO)) for example has advised it will not be able to meet its FY25 emissions target without offsets.

Checking out the impact on revenue, using an assumed carbon price of $50 a tonne and a 5% emissions offset, the broker estimates that the Top 30 emitters face a -0.5% clip on revenue. 

The broker says major emitters may also be hit with more regulatory offset demands down the track.

A few observations are offered: 

-quality of offsets will be critical and the broker observes some are already attracting premiums, such as environmental planting and savannah burning credits, and HIR (human-induced regeneration); 

-a sharp disparity exists between domestic and international offset pricing (the latter are cheaper); 

-supply of ACCUs (Australian carbon credit units) is on the rise; and

-the extent to which companies can pass these costs on to consumers will be a key factor for valuations going forward.

Winners And Losers Among The Big Emitters

Jarden’s latest ESG research examines the reformed Safeguard Mechanism and its affects on Australia’s nine top-emitting ASX-listed industrials with covered facilities.

These include Woodside Energy ((WDS)), Santos ((STO)), Adbri ((ABC)), BlueScope Steel ((BSL)), Rio Tinto ((RIO)), South32 ((S32)), Fortescue Metals ((FMG)), and Qantas Airways ((QAN)).

The broker observes industrial facilities owned by ASX-listed organisations constituted 50% of the Safeguard Mechanism-covered emissions and 25% of all Australian emissions.

Not surprisingly, Jarden expects Santos and Woodside will feel the brunt of changes due to the requirement for net zero reservoir emissions for new offshore LNG supply, which are expected to cut the former’s valuation by -3.3% and the latter’s by -1.5%.

However, Jarden warns Adbri and BlueScope’s valuation hits could eclipse those of the oil and gas producers, depending on which scenario is applied.

Under one scenario the mechanism would have zero impact on AdBri, and -1.7% on BlueScope. On the other, it would take a -17.2% and -11.2% toll. Jarden appears to be leaning towards the former scenario as the most likely, expecting the companies will receive concessional treatment as trade-exposed manufacturers.

Jarden says the degree will vary according to where the government sets its new baselines for each facility, and industry averages; and the cost of procuring carbon credits to meet shortfalls. 

The broker expected the impact on the other five major emitters to be minimal.

Insurance Companies: Where Does The Emissions Buck Stop? 

Macquarie investigates the insurance companies’ management of emissions and its survey reveals 64% of all general insurance companies in Australia have Net Zero targets but only about 36% are measuring the emissions in their portfolios.

Of those measuring Underwriting portfolio emissions, only Scope 3 emissions to set baselines are being quantified, says Macquarie.

The broker expects difficulties could present for commercial portfolios as Scope 3 measurements are rolled out across insurers’ portfolios.

All up, Macquarie forecasts unexpected economic repercussions for downstream and upstream industries, particularly transportation, depending on where the attribution buck stops.

To exemplify the dilemma, the broker says rural SMEs, particularly those conducting business in towns which exist solely to support high emitters, could become uninsurable by association.

Trouble Brewing For Bond Investors

The  Institute for Energy Economics and Financial Analysis points to an article in Global Ratings that underscores the growing risk to credit ratings from climate change.

Global Ratings advises that climate risk has become a material drivers of creditworthiness and that this accumulates over time and ipso facto investors may be sitting on unexpected risks.

This is especially the case given ratings agencies have taken very few actions over the past 18 months, says the analyst, due to a gap between pledges, regulation and low spending on these issues.

In a paragraph titled ‘Trouble is brewing for bond investors” IEEFA observes that the big three ratings agencies have been cautioned and that in March, Fitch Ratings advised 20% of global corporates (mainly oil and gas producers and their supply chain) could be downgraded by 2035.

S&P Global Market Intelligence advised in January that companies in the five most carbon-intensive industries – metals and mining, oil and gas, power generation, automotive and airlines – carried a -31% to -54% downgrade risk.

Moody’s has pointed out that these industries account for roughly 10% of outstanding rated debt.

IEEFA says this is likely to result in expensive rating volatility and instability, requiring more frequent transactions, and says institutions would need to more closely manage their portfolio liability risk and adopt materially higher capital buffers to protect against downgrades.

On the other side of the transaction, issuers may have to raise more debt or pledge more collateral, not to mention pay higher refinancing costs, says IEEFA.

Mind you, bond investors may have more things to worry about than climate risk, given an article in The Economist titled "High bond yields imperil America's stability".

The article observes that the economy appears to be growing at a rate of roughly 6% and doubts bond yields will retreat any time soon, despite a -16.4% fall in US property vacancies (pundits are forecasting a further -15% fall). 

The Economist says the situation for commercial property owners could worsen if rates continue to rise, placing more pressure on businesses unable to refinance, with a "maturity wall of US$626bn in troubled commercial-property debt … due between 2023 and 2025". Then follows the knock-on effects.

While Elon Musk expects the Fed will be forced to cut interest rates either late this year or early next year, adding climate risk into the mix doesn't sound like much fun.

Semiconductor market and copper face water capex risk

Morgan Stanley in a paper titled When Semis Meet Water observes that the critical semiconductor industry is among the most water-intensive in the technology sector, and the industry is increasingly facing competition for resources from human consumption.

This is likely to result in considerable capital expenditure going forward, posits the analyst, as companies are forced to recycle water and manage their toxic waste. This would not only affect the industry but broader market pricing.

The analysts says fabless companies (which design their own chips but outsource production) are less exposed.

The industry also faces a second water whammy in its supply chain, given copper – a key input – is often mined in arid or semi-arid areas.

Morgan Stanley advises investors assess the long-term impacts of water supply, observing even lush Taiwan has encountered less seasonal rainfall of late and reservoirs are down to less than 25% of capacity.

FNArena's dedicated ESG Focus news section zooms in on matters Environmental, Social & Governance (ESG) that are increasingly guiding investors preferences and decisions globally. For more news updates, past and future: 
https://www.fnarena.com/index.php/financial-news/daily-financial-news/category/esg-focus/

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