Whiplash or transition? (2/3)

South Africa in a carbon-constrained world & the role of institutional investors

This blog is the first of a three part series of articles looking into the implications of a net zero emissions future on South Africa and the role that the investment community can play to help or hinder that transition. The first blog can be found here. Written by Blaise Dobson with the acknowledgment of inputs from Ameil Harikishun, Lowell Scarr, Adhila Mayet & others along the way.

If we accept the premise that climate change requires South Africa to think in a fundamentally different way about our relationship with one of the core economic commodities (i.e. coal) that has underpinned our growth since the 1900s, what types of actions are required to be taken? By whom? By when and in what sequence. These are core questions that will define how “just” and fair any transition towards a net zero emissions economy may be. Whilst this is a collective effort involving every actor within society, there are interesting discussions and within the investment community about their responsibilities in managing the long term capital wealth of South Africans to steward us towards this transition.

The fossil fuel divestment movement & the case of the University of Cape Town

An interesting example of how nuanced these discussions can become is that of a movement of University of Cape Town (UCT) alumni, employees and students looking to have UCT divest its pension and endowments from coal, oil and gas. The movement is part of a global one to lobby higher education institutions to take the lead to transition their investments into assets classes that will not undermine efforts to address global climate change. The local campaign is looking for UCT to request its investment managers (institutional investment managers acting on behalf of UCT) to invest UCT’s assets in low-emitting greenhouse gas technologies (e.g. renewable energy) whilst progressively divesting UCT funds held in the coal, oil and gas sectors. However, how difficult is this to do in the South African context given the make up our economy? According to cursory interactions with asset managers it would appear that it is not as simple as picking a different stock on the Johannesburg Stock Exchange. The range of options of listed stocks for institutional investors to transition to is extremely limited.

For example, UCT enlist the services of a South African institutional investor Allan Gray who are one of a number of service providers that attend to the university’s pension and endowment funding management. In this capacity, Allan Gray act as a fiduciary for UCT resources. In carrying out their fiduciary responsibilities, Allan Gray publishes highlights of their responses to good environmental, social and governance principles in an  annual Stewardship Report. Embedded within Allan Gray’s 2016 Stewardship Report is a statement about Allan Gray Invest Counsel’s 8.1% investment in Sasol Limited (JSE: SOL; NYSE: SSL) and the risk of the stock being exposed to stranded assets.

In summary, a four paragraph note is made about Allan Gray’s engagement with the Sasol Board in relation to the businesses’ emissions and environmental sustainability at Secunda – the largest synthetic fuels production facility in the world. The note outlines Sasol’s continued reliance on lobbying the Minister of Environmental Affairs for an exemption from the Air Quality Act, which sets out Minimum Emissions Standards, so that the Secunda plant can remain operational. “… In order to achieve full compliance for Secunda, Sasol estimates that it would have to spend billions of rands and close the facility for an extended period of time, making it economically unfeasible. If Sasol is forced to close its Secunda facility permanently due to non-compliance with the MES, the impact on the South African economy would be severe…”. The note goes on to summarise Allan Gray’s efforts to deal with the investment risk presented by Sasol by saying that the risk (given the impact climate change regulations have on the businesses productive assets) has been included in Allan Gray’s assessment of the stock’s “intrinsic value”.

In essence, Allan Gray is reassuring their clients that they have “priced in the risk” into their model. However, they make no statement about the climate science that presents an argument for the need to transition from fossil fuels in the short to medium term. Pricing the risk is complex task as shown by energy modelers at the UCT’s Energy Research Centre who present a particularly negative view of the future of fossil fuel production facilities like Secunda. Using the example of Sasol in particular, there has been research that shows that their Secunda facility is a stranded asset given South Africa’s GHG emission trajectories. Burton’s research has profound impacts on fiduciary responsibility placed on South African institutional investors with significant exposure to fossil-fuel intensive assets. How short or long term are the “compliance postponement” provisions being afforded to Sasol continue? There are a number of policy uncertainties in this regard over and above the previous Minister of Energy recent remarks that other strategic South African utilities – like ESKOM – would be subject to emission standards.

Furthermore, there is scant regard for Sasol’s continued disregard for South African environmental regulations. Sasol’s track record on environmental compliance is far from exemplary. On the topic to which the Allan Gray team engaged the Sasol Board on – there are still some questions outstanding: “The 2016 NECER notes that environmental regulators have found that Sasol is not in compliance with some of the conditions of the Secunda refinery’s atmospheric emission licence. What steps has Sasol taken to ensure compliance with the conditions of its AEL? What is the current status of compliance with the conditions of the AEL at the Secunda refinery, and at other facilities? And in relation to Sasol’s current applications for further postponement of compliance with the minimum emission standards, what is the company’s plan should these postponement applications not be approved?”

What is the appropriate response from role of institutional investors?

Sasol is considered a “bread-and-butter” stock for South African pension funds and institutional investors to hold because it has been viewed as a (historically) strategic industry for the South African Government to prop up with subsidies. Under the Apartheid regime, Sasol was set up to commercialise the Fischer-Tropsch process to produce liquid petroleum from coal in the response to increasing international isolation. Today, Sasol is a public company that continues to enjoy significant shareholdings from public sector entities in South Africa (e.g. the Government Employees Pension Fund holds 12.9% and the Industrial Development Corporation of South Africa Limited with 8.20%). The national strategic importance of the business coupled with a track record of predictable returns within a country deeply embedded in a minerals-energy complex makes it a “no brainer” for the investment community.

It makes logical, short term, sense for a portfolio manager especially if beating your performance benchmark is a significant reward trigger. In response, some investment managers will argue that the act of disclosing the risk to their clients is good enough in terms their fiduciary responsibility. Some pundits would argue that Allan Gray have done exactly what is required of them by disclosing the risk that Sasol presents. More generally, in South Africa, there is evidence to suggest that “most asset managers consider climate change risks to be important to their investment portfolios and that the majority of them do integrate this risk within their equity investment decision making processes”. However, the recent recommendations note that institutional investors need to go further that simply disclosing the risks their portfolios face in relation to climate change.

Moreover, from a socioeconomic perspective, what should institutions and individuals putting their funds into organisations like Allan Gray expect as a course of action? The achievement our our Paris Agreement commitments (through the permanent shutdown of facilities like Secunda as it is uneconomical to retool the facility) will have a “severe impact” within the South African. Whilst this is a unlikely in the short term, a recent example can be seen in the reactions from the South African trade unions (COSATU and NUM) regarding the shutdown of five coal-fired power plants in South Africa’s coal belt.

COSATU call for the same “just transition” that the South African Government speak to within the country’s Paris Agreement commitment. However, in the same statement on a “just transition”, COSATU take aim at (arguably) an effective public-private partnership renewable energy procurement programme (i.e. the Renewable Independent Power Producers Programme – REIPPPP) as not being progressive enough. There is a good reason COSATU and others should be concerned about climate change and “stranded jobs” – conservative estimates have estimated job losses in the South African coal sector to be as high as 17 000 due to the need to reduce GHG emissions. That number feels low given the subsequent Paris Agreement commitment that South Africa has made. The South African Renewable Energy Council has cited the South African Chamber of Mines as having estimating that coal mining in South Africa employs approximately 80 000 people.

Perhaps closing out this blog, it would be good to give the last word to the perspective of a trade unionist on climate change. Jospeh Mathunjwa wrote in his capacity as the President of the Association of Mineworkers and Construction Union (AMCU): “Yet AMCU cannot be expected to bear the costs of dealing with the climate crisis. This is why we need a just transition to a wage-led, low carbon economy; a negotiated transition that is the outcome of careful planning by government, business and labour; a transition that guarantees affected workers a decent, alternative job and wage. It is only on this basis that you can reasonably expect any worker to be won to the fight against global warming and of doing something to halt the climate crisis.”

So where does this leave institutional investors that have significant capital held within South African and offshore fossil fuel investments? There are so many actors involved in the transition that it can be a dizzying array of coordination that is seemingly required to make it happen. In the third blog of this series we’ll explore some of the first steps in the process that could allow investors to acknowledge and begin to address their exposure to fossil fuel investments.

[To be continued]

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