article 3 months old

ESG Focus: The Little Big Things – 14-09-2023 – IGO, Rio, BHP, Santos, Woodside

ESG Focus | Sep 18 2023

This story features RIO TINTO LIMITED, and other companies. For more info SHARE ANALYSIS: RIO

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:

ESG Focus: Little Big Things – 14-09- 2023 – IGO, Rio Tinto, Boral, Aurizon, BHP, Santos, Woodside

In this edition of Little Big Things, Morgan Stanley canvases the ailing carbon-credit market, tipping a nadir; Goldman Sachs examines cash flow as an investment lens; and FNArena checks out a massive, landmark native-title deal with massive implications, the ongoing failure of carbon capture projects, green deflation, and the upcoming COP28.

Compiled by Sarah Mills

Carbon Markets Approaching Tipping Point

Morgan Stanley believes the scandal-besieged US$1.6bn voluntary carbon market, which has caused huge volatility and plummeting valuations (carbon-credit futures dived -90% and spot markets -26%), is approaching a tipping point.

The Guardian reported recently that more than 90% of rainforest carbon offsets by the world’s leading certifier Verra, which supplied credits to giants such as Shell, Disney and Gucci, are almost worthless following satellite images of the areas in question, leaving those companies with a deficit, one would assume. It is just one of many scandals.

Titled Carbon Offsets: A Reckoning In Progress, the Morgan Stanley report says this will be important for credit traders sitting on huge piles of stranded assets, and for companies using the credits to underpin green claims to customers and regulators. 

One only needs to look at the high-profile announcements of carbon credit purchases during the Australian August reporting season to gauge the significance of these developments going forward.

The analyst warns that pricing in the market “reflects heightened concerns about project quality and a reluctance by buyers to risk their environmental reputation on a voluntary claim such as 'carbon neutral'".

But Morgan Stanley says buyers are sending strong signals that beyond value chain mitigation strategies are a central part of their global decarbonisation efforts.

This certainly appears to be the case with Rio Tinto ((RIO)), which announced a -US$1.75m impairment related in part to the Safeguard mechanism, and advised it would tap the market to meet its obligations.

Boral ((BLD)) and Aurizon Holdings ((AZJ)) were also caught short, and were forced to the carbon credit markets to meet Safeguard Mechanism requirements. BHP Group ((BHP)) declined to comment on the issue when approached by The Guardian.

But what’s to stop the carbon market from a repeat performance? Morgan Stanley thinks efforts from the US Commodity Futures Trading Commission roundtable, the international Voluntary Carbon Markets Integrity Initiative, and the international Integrity Council for Voluntary Carbon Markets, could restore the market’s seemingly unsalvageable reputation. (Given there is still no regulation, I’ll believe it when I see it.) Certification, they say will be the key.

The Commodity Futures Trading Commission has highlighted the need to investigate fraud and market manipulation, as both come under its remit. It is also likely to look at standards and regulation.

The analyst expects this will result in a pause in purchases until 2024, with the majority of purchases within that time frame likely to be sourced from airlines as they prepare for Phase 1 of CORSIA (carbon offsetting and reduction scheme for international aviation) in 2024. 

The analyst then reiterates its view that carbon markets will recover in a separate piece of research titled Carbon Offset Markets: Are Markets Headed For a Clean Break, and calls for a rebound in 2024.

Carbon Capture Projects Also On The Nose

From what I can tell, carbon capture purchases pose similar risks. Amazon bought its first direct air capture purchases this month. 

But BloombergNEF advises that after an US$83bn in investment in carbon capture and storage projects over the past three decades, the technology captured just 0.1% of global emissions. 

This has repercussions for Santos ((STO)) with its Moomba CCS project and Woodside Energy ((WDS)), which has been recently lamenting the lack of government support for such projects (it has two on the go). Direct air capture is also ineligible for Australian Carbon Credit Units.

BHP this year signed a carbon capture and utilisation pilot agreement with China’s HBIS Group.

The company also made a decent clip (about 7-fold on a teensy investment through BHP Ventures according to the AFR) on the US$1.72bn sale of Canadian carbon capture company Carbon Engineering (one of the world’s most advanced direct air capture companies) to Occidental Petroleum, suggesting there’s more than one way to skin a cat.

And Now To Actually Making Money: Using Cash Flow As An Investment Lens

Turning to green investments that actually make money through viable businesses, Goldman Sachs published a report in April titled The Use Of Cash Flow Through A Sustainable Investing Lens.

The broker refers to a growing “critical debate” about the contrast between ESG accounting (scores and metrics) and impact on the UN’s Sustainable Development Goals (real economy outcomes).

Goldman Sachs expects this will support companies to direct cash flow to:

-Reinvest in base business (even if non-green)

-Expand into new green businesses

-Pursue acquisitions/divestitures

-Return cash to shareholders.

The upshot is that the broker believes sustainable investors will support base business reinvestment for companies that invest in low cost, safe producers with a good environmental footprint.

As is usual with much of this type of research, the broker mainly highlighted global stocks in this respect but did give a flag to local miner IGO ((IGO)) (Buy rated).

The broker observes ESG funds are heavily overweight Water Utilities (631%) and Independent Power and Renewable Energy (410%).

Underweight sectors included Tobacco, Defence and Energy.

In the year to April, the Metals and Mining sector experienced the most positive momentum, with large diversified miners, including BHP being drawn into portfolios.

Over the same period, Oil Gas and Consumable Fuels improved their still Underweight profile dramatically, due to the Ukraine conflict.

Assets under management with zero exposure to nuclear power and fossil fuels also moderated.

Is The Transition Deflationary Or Inflationary

Morgan Stanley addresses one of my favourite topics in this report.

Basically, the analyst concludes that clean energy is driving down customer costs in most instances but says there are exceptions.

The analyst views the long-term trend in clean energy costs as downward given solar costs and renewables penetration still have a way to go, and their competitiveness with fossil fuels is rising. Wind turbines are also getting taller and wider; and low-cost battery innovation is about to sweep in.

While the bulk and overall trend is deflationary, there are some points including offshore wind that are proving to be sharply inflationary, says the analyst.

At the US consumer coalface, Morgan Stanley observes the Northeast US and California have logged utility bill increases, while the Midwest and Southern US have enjoyed lower bills.

Interestingly, renewables have cut Texas wholesale power costs by -US$27.8bn in the past decade, which correlates with an ongoing migration of Californians (a strong green state) to Texas, most likely, one assumes because of property prices and the cost of living.

Massive Landmark Native-Title Acquisition In Queensland

The Kullilli people of South-West Queensland have bought the pastoral leases to the iconic Thargomindah Station through a finance partnership with Conscious Investment Management, underpinned by carbon farming.

The 47,100-hectare purchase was made at auction and the deal was approved by the Clean Energy Regulator for the proposed Thargomindah Station Regeneration Project earlier this month, with help from Climate Friendly.

Conscious Investment Management based its financing on forecast income from the carbon farming project.

For the Kullilli Bulloo River Aboriginal Corporation, it is essentially a land-regeneration project that allows the Kullilli to return to their native lands from which they were forcibly removed between the 1880s and 1960s.

“The finance model is unique,” says CIM director Iain Wood. “It has given the Kullilli people a pathway to acquire their land and directly manage the property from day one. This structure differs from other carbon farming projects with Traditional Owner involvement, which often require the property be sold at the end of a project’s life.”

Climate Friendly and CIM hope to replicate this model with other First Nations groups.

All Aboard For COP28

This year’s COP28 (the 28th Conference Of The Parties) at which representatives from the world’s countries gather to iron out their differences and come up with solutions on climate change.

This year, the gig will be held in Dubai at the end of November.

Hot issues this year, according to Bloomberg Green, include:

-Reporting on progress to Paris Accord agreed goals, which is likely to reveal some conspicuous failures (an early report suggests governments aren’t even close).

-A likely debate over “unabated” fossil fuel emissions, with Europe expected to push for tougher emissions by 2025.

-Who will foot the bill for the transition – a hoary old COP chestnut, in which emerging countries annually ply their case to developed countries to meet the latter's US$100bn annual funding commitment – which never seems to happen. A new deal is expected to be on the table next year for a post-2025 collective goal for climate finance. 

Bloomberg says more developed countries are likely to pledge towards a loss and damage fund. Getting ahead of the critics, COP28 host and oil producer United Arab Emirates pledged US$4.5bn to help African nations accelerate clean-energy projects.

-Who benefits from carbon markets – this one is rather ironic in light of the above carbon-market vignette, which suggests no one other than creative certifiers, market manipulators, recalcitrant polluters, and purchasers who are fortunate enough to have their credits stand are likely to benefit. 

Basically, this year the COP is still likely to be trying to figure out how to make a UN-supervised carbon market work. Bloomberg says that, if an agreement is ever reached, it could form a benchmark for voluntary markets.

The journal also points out that governments are becoming increasingly aware of the value of emissions-reduction projects within their borders and says emerging economies are likely to lobby for a greater share of the pie. Bloomberg says this equates to higher political uncertainty and the risk of double-counting where both countries claim credits.

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:

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

FNArena is proud about its track record and past achievements: Ten Years On

Share on FacebookTweet about this on TwitterShare on LinkedIn

Click to view our Glossary of Financial Terms