Environmental, social and corporate governance (ESG) considerations are vital when investing in the Natural Resources sector. The Natural Resources investment team explain how ESG is integrated into their investment thinking.
Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. The investor may not get back the amount originally invested.
Efficient use of natural resources is at the heart of preserving the planet for future generations. Given these high stakes, we believe environmental, social and governance (ESG) considerations to be of critical importance for the companies in which we invest; perhaps more so than it is in any other sector.
As we see it, there is positive correlation between companies that behave responsibly, with an eye to the sustainability of their business and long-term investment performance. While there will be other factors involved, we actively engage with all the companies in which we invest to identify those with strong and/or improving ESG behaviour. Companies need to have robust controls in place to minimise the chances of environmental incidents, exhibit high corporate governance standards and ensure that local communities benefit from their activities.
Digging mines and drilling for oil will inevitably have an impact on the local environment. Key is how companies manage this process, ensuring the benefits are appropriately shared among all stakeholders. The value wiped off the market cap of companies such as BP after the Macondo oil spill, and BHP and Vale, after tailings dam failures, highlights the direct link between environmental incidents and share price performance.
We believe it is vital that natural resources companies maintain their social licence to operate. Companies need to maintain broad acceptance from their employees, stakeholders, local communities and the national government or risk regulatory intervention. These are companies providing critical services and infrastructure and are naturally high profile as a result. Our site visits to companies’ assets provide us with valuable insight into these issues, which often cannot be properly understood from company reports.
Good corporate governance is critical for natural resources companies. We draw on the expertise of the BlackRock Investment Stewardship team, actively engage with companies on a wide range of governance issues including board independence, executive compensation, shareholder protection and timely disclosure. One of the most famous examples of poor corporate governance was an energy company – with the Enron scandal in 2001. In this case, management hiding losses as part of an accounting fraud resulted in a $60 billion company being reduced to zero.
The shift to a low-carbon economy
The world is moving towards lower carbon solutions in a bid to tackle climate change. This will have a major impact on global commodity demand, and we recognise that we will need to be adept at positioning the Trust for these changes as they occur.
The move to alternative energy is already building momentum. The proportion of global electricity generation accounted for by solar and wind is set to rise sharply over the next 20 years. It accounted for 84% of new energy capacity in 2018 (1).
Meanwhile, the rise of electric vehicles will eventually be a headwind for global oil demand. The International Energy Agency predicts there will be around 300 million electric vehicles on the road by 2040, cutting oil demand by around 3.3 million barrels per day (2).
But we see electric vehicles as a longer-term problem for oil and do not expect peak oil demand until the 2030s. Oil and traditional energy equities have room for at least one more up-cycle in our view, although companies will need to adapt ahead of time, or risk structural decline.
These changes will bring opportunities in new sectors. For example, the electric vehicle theme will drive demand for certain commodities used in the batteries, such as lithium, cobalt and nickel.
Finally, it is worth considering that more investors are factoring ESG criteria into their investment process. This means companies neglecting these areas will find themselves with fewer and fewer natural buyers, which in turn will put pressure on their share prices. The robust inclusion of meaningful ESG analysis into our investment process is both a vital risk management tool and, in our view, a route to more sustainable long-term returns.
Reference to the names of each company mentioned in this communication is merely for explaining the investment strategy and should not be construed as investment advice or investment recommendation of those companies.
1 International Renewable Energy Agency (Irena), April 2019
2 Reuters, November 2019
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Emerging markets: Emerging market investments are usually associated with higher investment risk than developed market investments. Therefore, the value of these investments may be unpredictable and subject to greater variation.
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