ESG Focus: ASX200 Off And Running, Part 2

ESG Focus | Mar 21 2022

This story features FORTESCUE METALS GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: FMG

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: 
https://www.fnarena.com/index.php/financial-news/daily-financial-news/category/esg-focus/

ESG Focus: ASX200 Off And Running – Part 2

By Sarah Mills

The recent reporting season proved a watershed for ESG as miners led the ASX200 in sustainability announcements and this article shines the spotlight on the industry’s leaders.

-Leaders emerging in the mining and mining services sector
-Is hydrogen coming of age?
-Carbon capture storage the big laggard

By Sarah Mills

The December-half reporting season proved a watershed for decarbonisation as markets witnessed a clear shift from reporting on ESG metrics to strategic action, several companies positioning themselves for “future-Australia”.

In Part 1 of this series, we examined the broad-based shifts across several ESG thematics during the February reporting season.

In Part 2 and Part 3, we report in greater depth on the early initiatives of ASX200 companies in the mining, steel, aluminium, metal recycling and mining services sectors that demonstrated clear indications of ESG strategic shifts during the December half. 

Given decarbonisation was the dominant theme during the reporting season, we kick off with green themes, starting with miners, steel and aluminium producers, mining services companies and metal recyclers.

Sustainability leaders are emerging, those companies generating green revenue streams finding favour over straight decarbonisers from a long-term view.

Some of the strategies to emerge in the December half are ambitious and risky, and successes and failures are only likely to emerge in years to come.

But the ESG press release suggests the ESG investment community is likely to support sustainability risk-takers in the near to medium term through periods of market volatility in a bid to hasten innovation. Or will they?

Investors will be keeping a keen eye to the way ESG investors respond to “ambitious” resources companies once the future-facing commodities boom peaks.

In the short term, the metals and mining sector has experienced, and will continue to experience, strong earnings growth through its exposure to future-facing commodities.

And while future-facing commodities represent a source of “green” revenue for miners, it really is business as usual activity and offers little in terms of ESG ambition which encompasses themes such as circularity and vertical integration.

Meanwhile, the longer the boom in future-facing commodities continues, the higher the risks to earnings, suggests Morgans.

Morgans senior analyst Adrian Prendergast notes the further up-cycles extend and the longer earnings remain elevated, the harder it becomes for miners to maintain capital discipline.

Future-facing commodities are really just business as usual for miners, and demonstrate very little “impactful” or innovative activity that many ESG investors are seeking around circularity, vertical integration and downstream and upstream initiatives.

FNArena will cover circularity, vertical integration and divestments, ESG M&A and institutional public offerings in Part 4 of this series.

Decarbonisation Off And Running, Miners Lead The Way

Australia has enjoyed the strongest recovery in the mining sector in more than a decade thanks to a boom in future-facing commodities, and future earnings and decarbonisation plans dominated the December reporting season.

The mining industry is subject to international agreements that its customers have signed and will be penalised for if they cannot demonstrate progress on decarbonisation. 

Financing is also increasingly being linked to decarbonisation creating another penalty mechanism. 

As a result, Macquarie reports decarbonisation disclosure rose sharply during reporting season.

Decarbonisation winners and losers

When it came to specifics, Fortescue Metals Group ((FMG)) proved the most interesting on the operational decarbonisation front (not covering ESG divestments) during the December half.

The iron ore company announced it had developed successful combustion technology to use more than 80% of ammonia as fuel for rail and that it has purchased two battery electric locomotives and plans to run its ships on green ammonia. 

Fortescue has built a hydrogen power-haul truck prototype and has a battery prototype under development.

The company’s approach to green steel (outside of hydrogen which is a longer term play) is unclear but at this stage, it appears to be leaving many green steel initiatives to downstream producers.

In the December half, the company committed to fully decarbonising its operations and supply chains, including a shift to green steel processing and hydrogen-fuelled shipping by 2040 – but only 7% by 2030. 

This makes it unclear how the company will reach carbon neutrality by 2030, as promised by CEO Elizabeth Gaines, but increasingly expensive carbon credits are always the fallback position.

Fortescue is an interesting stock from an ESG impact prospect given Fortescue Future Industries ((FFI)) holds the prospect of both diversification and innovation. 

In this respect it leads the resources pack in terms of stated ambition and commitment to impact. But ambition is one thing and revenue and actual impact is another.

It does appear, however, that a divide is emerging within the majors between those taking a conservative approach to decarbonisation (suggesting stronger short-term returns), and those such as Fortescue that are supposedly orienting to reinvention.

Green steel production is disruptive to Fortescue’s traditional iron ore business and the company’s transition from a pure-play iron ore producer to a green renewables-and-resources company will rely heavily on the FFI strategy.

Fortescue recently announced developments and targets that barely cut the mustard, and analysts are still awaiting greater financial details on FFI (and are getting impatient), to which 10% of annual profits are awarded in any given year.

The company has committed to becoming a hydrogen giant and has announced a preference for partners in ESG-oriented ventures. Already a multi-billion pound deal has been announced with construction giant JC Bamford Excavators and Ryze Hydrogen in November.

But hydrogen is a longer-dated investment so, for now, these deals are primarily hot air (excuse the pun) and there is plenty of revenue ground to be hoed between now and then. 

The company has also been earning ESG favour through the award of contracts to Aboriginal businesses and FFI has committed to award $1bn in Aboriginal businesses and joint ventures on green energy projects by 2030.

It simultaneously hit the gender card with the award of Brindabella Resources, established by five prominent indigenous women.

In November, the company proposed a $5bn hydropower deal in Papua New Guinea (seven hydropower and 18 clean energy projects), which should garner ESG investor favour for investing in emerging economies as well as green brownie points.

The company also continues its commitment to indigenous communities. FFI also struck deals with the Kingdom of Jordan.

Most recently, FFI and the Fortescue family business Tattarang spent $3bn acquiring the largest renewables farm in the southern hemisphere, which should deliver some sustainable revenue and provide a carbon offset.

FFI also announced the first stage of the company’s green energy manufacturing centre (GEM) in Gladstone, Queensland – a hydrogen to ammonia project with the first electrolyser set for completion in early 2023.

It is also considering converting Incitec Pivot’s ((IPL)) Gibson Island plant into a hydrogen user and purchased a battery storage systems company, Williams Advanced Engineering, for $310m.

All in all, the scale of investment and number and breadth of announcements in the past eight months would position Fortescue Metals as the out-and-out sector leader from an ESG perspective. 

This suggests that, in theory, the company should gain long-term ESG investor favour, especially in the event of a potential contraction in global demand for iron ore (pending greater transparency through to the FFI strategy and earnings profile).

In practice, it might prove another matter.

Morgans senior analyst Adrian Prendergast believes FFI’s expensive push into hydrogen could mean a long period of losses for the company, particularly if demand for steel peaks in 2022, and says it will be interesting to see how the company’s ESG framework sustains a down-cycle.

All eyes will no doubt be peeled to the response of ESG investors when the time comes.

Fortescue Metals will prove a critical litmus test to the pronounced long-term commitment of the ESG community; as will the community’s response to laggards.

Lower-impact decarbonisers

While innovation and impact are the holy grails of ESG, many companies are taking a more conservative approach and dealing with the simple operational challenge of decarbonising the business.

Among the more innovative decarbonisers in the December half, South32 ((S32)) announced it would restart its aluminium smelter in Brazil using green energy. This is an achievable short-term goal and does tick the impact box and offers a green-revenue stream.

The company announced it was targeting green aluminium growth of 100% by FY23, with first production targeted for the December quarter.

South32 also plans to increase its exposure to critical transition metals such as aluminium, copper, zinc-lead silver and nickel (although one would expect this as given for resources companies and hardly innovative). 

Management remains positive on the future of metallurgical coal over thermal coal for use in green steel in the near term and allocated $1.4bn towards emissions reduction, improved energy use and water efficiency towards the industry.

Credit Suisse says one of the most compelling opportunities presented during the reporting season was presented by Alumina Ltd ((AWC)) with its forecast of 39% growth in aluminium out to 2030 due to decarbonisation initiatives.

BlueScope Steel ((BSL)) meanwhile outlined a plan to get to net zero emissions by 2030, backed by a resource allocation, but investors would largely perceive that ambition as standard and are awaiting more information on BlueScope’s green revenue-generation plans – perhaps they will emerge this half.

Rio Tinto ((RIO)) announced the most substantial overall decarbonisation capital expenditure at US$7.5bn from 2022 to 2030 plus an extra US$3bn for growth capital expenditure on future-facing commodities. 

The company plans to halve its Scope 1 and Scope 2 emissions by 2030 by using renewable power in its operations and is commissioning one gigawatt of wind and solar power for its Pilbara iron ore operations.

In August, the company also announced it would (with partners CSR ((CSR)) and Hydro Aluminium) switch Tomago (Australia’s largest aluminium smelter) to renewable energy by 2029. The company cannot be accused of being overly hasty.

It is also examining greener steel making pathways for its iron ore through the use of biomass and hydrogen (again, a long-term plan and the company has yet to take a serious first step). 

Rio Tinto's announcements appear to be lagging peers such as FFI in ambition, scope, pace and expenditure in ESG priorities, with commitments focused on decarbonising rather than building green revenue (save for investing in future facing commodities – an extra US$3bn was allocated, which one would expect as standard behaviour from a resources company). 

Similarly, Woodside Petroleum ((WPL)) allocated US$5bn to new energy products and lower carbon services by 2030 – again, it was a matter of more style than substance.

Likewise, BHP Group ((BHP)), which has continued to increase its allocation to ESG thematics, has been relatively light on details.

BHP announced plans to spend an extra US$4bn on top of the US$2bn to US$4bn previously announced to decarbonise operations plus the company announced renewable power contracts in Chile. Like Fortescue, the company continues to build community partners.

Extra decommissioning capital expenditure came in at US$3.9bn and the company progressed on the divestment of coal assets.

Elsewhere, BHP announced an investment in the Jansen Stage 1 potash project (a feed-the-world ESG play).

The divestment of BHP’s petroleum business into Woodside Petroleum to create a $41bn merged entity was perceived as a plus for BHP and most-likely a must-do for Woodside.

The merged entity also stands to benefit from Europe’s recent announcement that it would accept gas in its green taxonomy as a transition fuel.

During the December half, Newcrest Mining ((NCM)) announced a wind farm partnership with Tilt Renewables.

Several future-facing commodities companies also hit the ASX, including 29 Metals ((29M)), nickel explorer Nimy Resources ((NIM)), and lithium-sulphur battery producer Li-S Energy ((LIS)). 

Downstream decarbonisation

Downstream decarbonisation (reducing Scope 3 emissions), is a critical step for Australia's mining majors given steel and aluminium production comprises such a large percentage of their emissions. The global iron and steel industry comprises 8% of human-generated carbon-dioxide emissions.

Rio Tinto announced a partnership in October with Bluescope Steel to use Rio Tinto ores in developing low-carbon pathways for steel development, with the specific nomination of green hydrogen for the Port Kembla plant. Direct reduction of iron is another possibilities. These types of partnerships are generally viewed favourably by the ESG investment community but the timelines are uncertain and success unclear.

Fortescue Metals appears to be a laggard on downstream partnerships, although much of its iron ore goes to China and China is going hell for leather at decarbonising its steel operations. While China had planned to decarbonise its steel production by 2025, it has since pushed that date out to 2030, which while potentially positive for iron-ore demand has created a counterbalance on the decarbonisation front.

Fortescue's focus on hydrogen, and also Rio Tinto's Bluescope partnership, may have broader implications. 

Credit Suisse reports that Australian hydrogen technology company Hysata has developed an ultra-high efficiency electrolyser, which is a major breakthrough for the industry's ambitions to produce a kilogram of hydrogen for under $2. 

The company capillary fed electrolysis cell can produce hydrogen from water at 95% cell energy efficiency, compared with the current peak of 75%. Management says it is the first step-change for electrolysers in 50 years and that it will get the industry comfortably to under $2 by 2025. Given other developments in hydrogen-fuelled steel production abroad, the early 2025 date for carbon-fired steel appears to be closing in.

While hydrogen is only part of the answer (it is forecast to apply primarily to aviation, shipping, heavy vehicles, grids and cables and some heavy industry energy applications), it at least has a clear future (not so carbon capture storage). 

Carbon Capture Storage Hubs And Carbon Offsets The Market Laggards

The ESG laggards this reporting season were too numerous to highlight, but big laggards were those miners and energy producers leaning heavily on carbon capture storage and increasingly expensive carbon-credit offsets.

Still, in a move that seriously undermines the credentials of the ESG movement, analysts are forecasting that trillions of dollars will be dedicated to carbon-capture storage.

Santos ((STO)) has announced three carbon capture storage (CCS) hubs but, given no company in the world has been able to make carbon capture pay, and given the rate at which solar renewables prices are falling, it appears to be more of a subsidy pitch than a serious long-term strategy, particularly given the pace of development in renewable technology.

Solar energy no longer needs subsidies, and prices are still forecast to fall another 90% from current levels. According to Credit Suisse, hydrogen production has just comfortably cracked the $2/kg mark and will be commercially available at that price by 2025. There would need to be massive shifts in climate within the next three to five years to justify carbon capture storage at this rate.

On top of that, much of the carbon-capture budget is likely to be directed to biodiversity which should hit markets within the next 18 months – maintaining forests – with Brazil already scoring major concessions to stop deforestation of the Amazon at the last COP25. And there are other carbon capture technologies such as carbon-eating bacteria in the offing (just to name one).

Add to that the fact that failed carbon capture operations around the world have recently released carbon back into the atmosphere, further damaging the industry’s reputation.

Santos has its hand out and is already receiving (and is likely to receive more) considerable government subsidies in this respect. 

As a carbon play, Santos is succeeding. But as a long-term ESG investment, Santos is likely to earn scant regard from ESG investors, save for the use of gas as a transition fuel (Europe has just accepted gas in its taxonomy).

The company now has three CCS hubs and hopes to use them to decarbonise and produce clean fuels such as hydrogen and ammonia.

In the December half, Santos allocated $50m to $100m in sustainable capital expenditure to the Cooper Basin Project and another $50m to Corporate and Exploration, which includes Energy Solutions and Clean Fuels – a paltry sum compared to peers.

Similarly, Beach Petroleum ((BPT)) announced that the Clean Energy Regulator has approved its carbon-capture storage methodology.

Meanwhile, Woodside may need to buy offsets to meet its net equity emission reduction targets of -15% by 2025 and -30% by 2030, say analysts. 

But the offset market is tightening, carbon credit prices soaring during 2021.

Australia's oil and gas producers remain strong short-term carbon plays, but solid ESG plays they are not.

Part 2 examines green revenue streams, the mining services industry and scrap metal producers.

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: 
https://www.fnarena.com/index.php/financial-news/daily-financial-news/category/esg-focus/

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CHARTS

29M AWC BHP BPT BSL CSR FFI FMG IPL LIS NCM NIM RIO S32 STO

For more info SHARE ANALYSIS: 29M - 29METALS LIMITED

For more info SHARE ANALYSIS: AWC - ALUMINA LIMITED

For more info SHARE ANALYSIS: BHP - BHP GROUP LIMITED

For more info SHARE ANALYSIS: BPT - BEACH ENERGY LIMITED

For more info SHARE ANALYSIS: BSL - BLUESCOPE STEEL LIMITED

For more info SHARE ANALYSIS: CSR - CSR LIMITED

For more info SHARE ANALYSIS: FFI - F.F.I. HOLDINGS LIMITED

For more info SHARE ANALYSIS: FMG - FORTESCUE METALS GROUP LIMITED

For more info SHARE ANALYSIS: IPL - INCITEC PIVOT LIMITED

For more info SHARE ANALYSIS: LIS - LI-S ENERGY LIMITED

For more info SHARE ANALYSIS: NCM - NEWCREST MINING LIMITED

For more info SHARE ANALYSIS: NIM - NIMY RESOURCES LIMITED

For more info SHARE ANALYSIS: RIO - RIO TINTO LIMITED

For more info SHARE ANALYSIS: S32 - SOUTH32 LIMITED

For more info SHARE ANALYSIS: STO - SANTOS LIMITED