ISS ESG recommends that client ESG practices combine revenue thresholds with other means of identifying fossil fuel companies, such as global production thresholds or deeper dives.

September 9, 2020

10 Lessons From 10 Years of Helping Investors to Tackle Climate Change

In 2010, ISS ESG’s head of Climate Solutions Max Horster started one of the first companies to measure the climate impact on investments. From investment carbon footprinting to climate scenario analysis, from climate-linked proxy voting to climate neutral investments via offsets: Over the years, the team pioneered a wide range of today’s leading methodologies and approaches across all asset classes. In 2017, Max and his team joined ISS ESG to form the first climate specialist unit of a global ESG service provider. Today, they cover over 25,000 issuers on up to 600 individual climate-linked data points and have screened over $4 trillion of AUM on their climate risks and impact. On the occasion of its 10th anniversary, the ISS ESG Climate Team shares 10 lessons from 10 years of helping investors to tackle climate change. 

Lesson 2: What Is Essential Is Often Invisible to the Eye

Going fossil free is more complex than most investors think.

Let’s start with a little quiz: Say you are building a concentrated portfolio of car manufacturer Toyota, trading house Mitsubishi, beverage firm Coca-Cola Amatil and financial firm Berkshire Hathaway: Which of those four firms owns Oil, Coal or Gas reserves?

Around 2010, the divestment movement in U.S. university endowments helped put climate change on investors’ agendas. The call to no longer invest in climate-harming oil, coal and gas found tremendous support worldwide and by 2020, around 2,000 institutions and 60,000 individuals, representing $14 trillion assets worldwide, have begun or committed to divest from fossil fuels.

On the surface, going fossil free seems to be straight forward: Just exclude all energy and extractive companies from your portfolio and you are done.

Well, it is not that easy. The responsible investing industry can tell many stories of investors who first proudly claimed fossil free portfolios by avoiding relevant sectors, and then had to wake up to uncomfortable headlines about unwanted oil, coal or gas skeletons in the closet.

The reason is that there are many companies that own oil, coal and gas reserves without being categorized as Energy, Materials or Utility companies.

Fossil Reserve Owning Companies in Non-Obvious Sectors, Anybody?

Which of the four companies in the introductory paragraph own fossil reserves? You might have guessed it: All four of them. As a matter of fact, ISS ESG collects data on over 100 companies that fall into the category of “unexpected fossil reserve owners.” These unexpected fossil reserve owners can be divided into three major groups:

  1. Conglomerates with diversified businesses. This includes for example many Japanese companies that have diversified into fossil fuel extraction/reserves to secure raw materials for their industrial businesses, such as Mitsubishi Corp., ITOCHU Corp., Mitsui & Co. Ltd., Marubeni Corp., Sojitz Corp. and Sumitomo Corp.
  2. Holding companies involved through subsidiaries/associates. This includes for example some Indonesian companies, such as Jardine Matheson Holdings Ltd., PT Astra International Tbk and PT United Tractors Tbk (operating subsidiary that owns coal reserves).
  3. Outliers. This includes companies whose ties to fossil fuels are completely unrelated to its other business operations, such as Coca-Cola Amatil, Toyota Motor and Berkshire Hathaway.

Fossil Reserve Owning Companies in Non-Obvious Sectors

Capital Markets3
Construction & Engineering4
Construction Materials7
Diversified Financial Services4
Electrical Equipment1
Energy Equipment & Services4
Food & Staples Retailing1
Gas Utilities10
Hotels, Restaurants & Leisure2
Independent Power & Renewable Electricity Producers25
Industrial Conglomerates19
IT Services1
Real Estate Management & Development5
Trading Companies & Distributors19
Transportation Infrastructure1
Water Utilities1
Table: Number of companies by GICS sector in the ISS ESG universe that own fossil reserves, but don’t belong to the obvious reserve-owning GICS sectors.

The Catch of Thresholds

But it gets more complex when investor dive deeper. Take, for instance, an investor who allows for limited fossil investments and sets the relatively common threshold of investing only in companies with less than 30 percent revenue from oil, coal and gas. While the intention might be to avoid exposure to climate harming business practices, the outcome might be the opposite: Such a threshold-governed portfolio might result in holding the single largest coal producers worldwide.

How so? Well, take Glencore PLC and Anglo American PLC for example: These firms report only five percent and 19 percent coal mining revenues, respectively, so they would both make the cut under a 30 percent threshold, as the remaining revenues come from other business activities.

Glencore is however, one of the world’s largest coal producers with its annual coal production accounting for nearly two percent of global coal production! It also ranks #10 in ISS ESG’s top coal reserves owners list. Anglo American accounts for nearly one percent of global coal production.

But there are even less obvious cases. BASF SE is another holding that could end up in a portfolio with intended reduced fossil exposure as the oil and gas reserves of the firm are not easily recognizable  As of May 2019, the chemical giant moved its oil and gas business into the Wintershall Dea joint venture and no longer consolidates its fossil revenues into its overall revenue disclosure – and its share of Wintershall Dea’s income is often overlooked under a revenue-based approach. Despite BASF’s 72.7 percent ownership of that business with oil and gas operations across Europe, North Africa, Russia, South America and the Middle East, the firm manages to appear fossil light at first glance thanks to legal – but somewhat misleading – oil and gas revenue accounting practices.

Because of cases like these, ISS ESG recommends that client ESG practices combine revenue thresholds with other means of identifying fossil fuel companies, such as global production thresholds or deeper dives.

The Helping Hands in Fossil Extraction

Still not complex enough? Well, a dedicated “fossil free” investor might want to not only avoid reserve owning companies, but also companies that are indispensable to the extraction and processing of fossil reserves. Especially unconventional extraction – hydraulic fracturing (“fracking”) might be in focus, for instance, and it is often not the most obvious companies that drive these practices.

Take firms like Siemens AG, ABB Ltd, General Electric Company or Ingersoll Rand. With these industrial conglomerates in the portfolio, investors are, often unintentionally, exposed to highly specialized and customized products and services for unconventional fossil fuels. Critical components for fracking come, inter alia, from chemical holdings in a portfolio such as Dow Inc. and DuPont de Nemours, Inc. And through a financial firm like Brookfield Asset Management Inc., an unaware investor is exposed to the extraction of coal-bed methane, hydraulic fracturing, coiled tubing, wireline, pressure pumping and other complementary oilfield services.

What is essential is often invisible to the eye. However, the good news is that it is no longer impossible for investors to navigate this space. At ISS ESG, our automated Climate Impact Reports help detect all cases of exposure to fossil fuel ownership and involvement in controversial extracting practices. We can provide such information due to our dedicated Energy and Extractives team that works exclusively on creating transparency in this – often non-transparent – field to help investors going truly fossil free.

Now you can enjoy your can of Coke in your Toyota with the security of fully understanding the producers’ role in the fossil fuel production cycle!

By Dr. Maximilian Horster, Head of Climate Solutions, ISS ESG

Contributor: Xuan Li, Team Lead of Energy & Extractives Screening, ISS ESG

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