When ESG doesn’t work

Robert Armstrong’s email this morning is a cautionary tale to those who think that having an ESG strategy is enough. Clearly some ESG strategies are more successful than others. In the hope that Glencore feels some pain from people’s reading of its ignoble behavior, I republish that mail.

From the Financial Times, over the weekend:

BlackRock and MFS Investment Management both voted against Glencore’s climate plan at the Swiss miner’s annual general meeting earlier this year . . .

The new disclosures made in US securities filings show that many big institutional shareholders supported Glencore’s climate report, which passed with 70 per cent approval even though dissent increased to 30 per cent, up from 24 per cent in 2022.

BlackRock is Glencore’s third-largest shareholder, holding an 8.2 per cent stake worth more than £4bn

The Glencore/ESG story, which has been rolling along for a while, is interesting. How the environmental, social and governance investment movement handles the world’s most profitable coal company is a fascinating test case. It is also a nice thumbnail illustration of one reason why ESG investing fails to have the positive impact it promises.

The main mechanism by which ESG hopes to change corporate behaviour is increasing the cost of capital of badly behaved companies. If the marginal investor refuses to invest in misbehaving companies, or threatens to do so, either management will be forced to make changes, or the company’s cost of equity and debt will rise. If the latter, the hurdle rate for new investments in “dirty” projects will increase, reducing the amount of investment.

But this is not how things work in a world awash in capital, hungry for high returns, and conflicted on basic questions of value, as the case of Glencore shows. The problem is that even if ESG shareholder pressure drives the cost of capital for poorly behaved companies up (it’s not totally clear that it does), it by definition drives expected returns and yields for that company up, drawing in capital with different scruples or no scruples at all.

Glencore has had a lot of back and forth with investors over its coal business. It has spoken in the past about running down its coal mines and not replacing them. That seems an odd fit, however, with its decision to bid for the coal business of Teck Resources this summer. It’s not quite as odd as it seems at first, because the Teck unit produces mostly steelmaking coal rather than coal for power plants. Still, one can see why BlackRock has concerns about “inconsistencies” in Glencore’s climate strategy in light of the Teck bid.

If the acquisition goes through, Glencore plans to spins off the combined coal units into a separate company. Part of the rationale for the provisional spin-off plan is presumably that having the dirty coal business, profitable as it is, drags down the valuation of Glencore’s other assets. The spin-off will therefore release value, and Glencore would become an ESG-friendlier company.

Meanwhile, the whole exercise, from BlackRock’s meaningless vote to Glencore’s strategic vacillations, will have no effect whatsoever on the amount of global coal mining and coal burning.

Any pressure on Glencore’s cost of capital in the absence of a spin-off won’t make any difference to production levels: last year the company’s coal operations made $15bn in operating income, and capital expenditure was $1bn. The unit does not need new capital, so the price of capital hardly matters.

Will the hypothetical SpinCo have a higher cost of capital (that is, a lower price/earnings valuation on its equity, or higher-cost debt financing), and therefore a higher hurdle rate for investment in new mines? And would the hurdle rate be sufficiently higher to make any difference? Perhaps; it depends on whether the return on new coal projects is anywhere close to the SpinCo’s cost of capital, which depends in turn on coal prices. More importantly, though, a pure-play coal company seems more likely to reinvest internal capital in new coal projects than a diversified commodities company like Glencore. Indeed, that may be part of the strategic logic here.

The previous Glencore CEO, Ivan Glasenberg, grasped the point that changing ownership structures does not change emissions, saying at an FT event in 2020 that “some competitors are selling their coal mines . . . but how does this help the world to meet the Paris accord? They’re going to the hands of other players in the industry which may have no intention of reducing their Scope 3 [indirect] emissions and may have a free hand to produce more.”

After Glencore’s third-largest shareholder, and the most important asset manager in the world, voted — along with other shareholders — against the company climate plan, CEO Gary Nagle blamed the votes against on “some ESG person in the basement in office number 27”. This icy put-down of BlackRock and other ESG advocates stings because there is so much truth in it. The main impact of the ESG movement is the creation of a bureaucracy that companies must nod to and work around, while the real world of business spins on.

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FT author
US Financial Commentator
September 12 2023
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About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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