ESG Focus | Oct 21 2022
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ESG Focus: ASX300 Rush To Decarbonise
The Ukraine conflict intensified the ASX300s decarbonisation drive in the June half, companies shifting to alternative fuels, fleet upgrades, hedging, technology partnerships and asset sales – a process which only intensified in the September quarter along with capital expenditure bills.
-Ukraine conflict drives focus on energy
-Energy hedging and gas uptake feature
-Growing market for alternative fuels
-Green steel – Australia’s Captain Plod
-Capital expenditure estimates rising
-Renewables and energy retailers under the pump
By Sarah Mills
In Part 1 of FNArena’s summary of the ASX300 reporting season, we examined the key high-level ESG themes to dominate the August reporting season, as well as the escalation in target-setting and emissions commitments.
In this article (Part 2), we take a deeper dive into individual companies’ progress on decarbonising and hedging energy costs. In Part 3 we examine companies’ progress on developing green revenues.
Macquarie, Jarden, Morgan Stanley and J.P. Morgan are the key sources of research for this article, which focuses on the main movers and shakers, given the amount of activity recorded in the season was too large to be contained within one article.
Also, the steps being made by the frontrunners are so large as to dwarf those making small changes, thereby rendering small changes materially insignificant, and possibly a relative step backwards.
Every year the financial consequences of inaction compound.
Ukraine Conflict Sparks Flurry Of Activity
The Ukraine conflict intensified the ASX300’s focus on emissions during the June half, as companies rushed to deal with soaring energy costs and an elevated need for energy independence and security.
Globally and domestically, companies sought to kill two birds with one stone: reducing their dependence on coal and gas, while simultaneously extracting an ESG advantage and pivoting to the transition.
Nearly all ASX300 companies highlighted the effects of energy costs on operations and earnings, and the initiatives they were adopting to drive efficiency, such as hedging, adoption of green fleets, and the uptake of alternative fuels.
So while fossil fuel companies generally enjoyed windfall profits, their future demise was also likely accelerated over this period.
All of this came hand in hand with a hefty capital expenditure bill, and Bloomberg NEF says energy transition investment will need to double in the next three years over 2021 levels, and double again before 2030.
Many companies reported increased emissions but analysts say this partly reflects improved reporting, rather than a material rise in actual emissions.
Meanwhile, AEMO advised wholesale energy prices rose 141% in the year to March 30, 2022 and in June 2022 imposed a $300MWh price cap before being forced to suspend the NEM for 9 days.
After falling through the floor in March when the invasion was announced, carbon-credit offsets tracked up to be trading near the December-half peaks.
Quick Summary And Market Highlights
The number of ASX300 companies pivoting towards the transition rose sharply.
In an FY22 presentation, Worley ((WOR)) advised the addressable market size for each of its four targeted decarbonisation markets by 2025 was: $40bn for low-carbon fuels; $3bn for low-carbon hydrogen; $3bn for carbon capture and storage; and $10bn for battery metals.
Much of the carbon-capture market is still considered a poor investment, particularly among energy producers, although some areas, such as Cleanaway Waste’s ((CWY)) landfill methane capture, do have legs.
Worley pulled in more than $1bn in green revenue from decarbonisation alone in the half, and decarbonisation proved a major theme this reporting season.
Many companies set more ambitious Scope 1 and Scope 2 emissions, accelerating the shift away from fossil fuels.
Cleanaway Waste Management, for example, plans to reduce emissions by -34% by 2030 and -57% by 2040 – at the moment emissions constitute 78% of the company’s total carbon footprint.
Others were busy on the asset sale and de-merger front.
Origin Energy ((ORG)) reset emissions targets just after reporting season upon confirming the sale of its Beetaloo Basin and Tamboran Resources interests for $60m, well below book value.
AGL Energy ((AGL)) withdrew its de-merger proposal in the light of growing pressure to decarbonise, and its board stoush with Mike Cannon Brookes continues. The chairman, two board members and the CEO all called it quits this year.
Macquarie’s utilities analyst expects the company’s closure of its coal operations are independent of the merger and rely on government support.
Other companies began sourcing alternative fuels (see below).
Gas enjoyed a renaissance after the Ukraine conflict ensured its inclusion in the European green taxonomy, both Woodside Energy ((WDS)) and Santos ((STO)) rising sharply in the June half.
It was a similar story for nuclear energy.
Reporting on Scope 3 emissions made its first substantial appearance on the Australian stage, hastening the decarbonisation journey and paving the way for green revenue markets.
Hedging Energy Costs Features Across The Board
Companies across the board rushed to hedge their energy positions as prices soared.
Many were cushioned from global developments by renewable energy PPAs and a rise was registered in PPA purchases during the period, others adopted traditional commodities hedges.
Coles Group ((COL)) and Telstra ((TLS)) outlined their use of renewable energy and other hedging opportunities to offset rising energy costs.
Coles announced it had secured its transition to 100% renewable energy by 2025 and was implementing energy savings through initiatives such as LED light adoption and eCommerce van route optimisation.
Macquarie notes Telstra, certified carbon neutral in 2020, guided to an additional $50m energy bill in FY23, but advised the company’s Energy PPA should mostly offset this at the earnings (EBITDA) line.
Telstra announced it would enable renewable energy generation equivalent to 100% of its consumption by 2025. Telstra is assessing the effects of its focus on the retail energy market on its scope 3 emissions.
Overall though, company’s actual decarbonisation achievements seemed vague.
Energy Producers – A Tale Of Two Cities
Fossil fuel producers fared well thanks to Mr Putin, reeling in windfall profits, with coal enjoying the second to last laugh.
Renewables energy stocks fared less well, thanks to rising cost inflation, which was unable to be offset by price rises given fixed Power Purchasing Agreements, although those exposed to spot prices did well.
Demand Rises For Alternative Fuels
Many companies turned to alternative fuels to deal with spiralling energy costs, which was at least one positive for renewable energy companies, and definitely for gas (although many point out that gas is not a true green fuel).
According to National Energy Market data, gas generation rose 50% year-on-year from May 2021.
Worley ((WOR)) highlighted in its report the addressable market for low-carbon fuels will hit $40bn by 2025, and singled out gas.
“Russia’s invasion of Ukraine is elevating the need for energy independence and security … The European Union is actively seeking to reduce its dependency on Russian gas. This opens up opportunities for gas importation to Europe, along with other energy sources.
“We expect to see an acceleration in the development of diverse energy supplies, including low-carbon energy, in the near-to-medium term to reduce reliance on Russian supply.
“80% of our customers by revenue have net-zero commitments. And the company’s factored sales pipeline for low carbon fuels has risen 75% (and low-carbon hydrogen is up 80%)."
This led to an uptick in investments in hydrogen, energy networks and storage, CCUS and integrated gas, as well as everything from wind farms to solar and nuclear energy.
Worley also reported that of $30bn in projects under way, more than 80% related to green commodities.
LendLease ((LLC)) announced an alternative fuels policy, setting a target of 98% sustainably sourced fuel for its UK construction business.
Ampol ((ALD)) advised it was examining renewable diesel and SAF fuel options, solar installation at some sites, renewable energy agreements and decarbonising its renewed distribution fleet.
Viva Energy ((VEA)) said it was considering co-processing biomass and waste streams to produce alternatives such as SAF and biodiesel.
Cleanaway expected its rising fuel costs would ultimately be recovered through contractual mechanisms but said energy inflation was temporarily compressing margins.
Cleanaway managed to sharply increase the capture of land fill gas that was turned into electricity and fed into the grid, accelerating its energy from waste projects to create revenue while simultaneously reducing its climate exposure. These count as high-quality carbon credits.
Macquarie notes the company improved landfill gas capture efficiency to 75% from 61% and announced it would apply a final cap to landfills to achieve 95% capture.
The company is also examining optimising fleet fuel usage and electrifying its fleet, starting with light vehicles.
Qantas Airways ((QAN)) set a 10% SAF fuel target, and Auckland International Airport ((AIA)) focused on decarbonising infrastructure such as low-emissions technology and fuel.
On the renewable energy front, five top renewable energy share performers during the half were Origin Energy ((ORG)), Meridian Energy ((MEZ)), Mercury NZ, Infratil, Genesis Energy. Four of the five were NZ companies.
Rio Tinto ((RIO)) allocated US$1.5bn to decarbonisation over three years, and confirmed its -US$7.5bn in capital expenditure out to 2030, most of which is skewed to the second half of the decade.
Fortescue Metals ((FMG)) reduced diesel usage after buying renewable power from Alinta Energy through the Chichester solar gas hybrid project. Its diesel useage fell by -80m litres and this is expected to fall by -95m in FY23.
Boral ((BLD)) set a target of the FY23 June quarter for the commissioning of its Berrima Cement Chlorine Bypass, which will help increase alternative fuel use to 30% and then help raise it to 60% by FY25. This compares with 15% at June 30, 2022.
Fletcher Building ((FBU)) cut emissions by -10% in FY22, by using alternative fuels for coal and is continuing to reduce coal in cement production. It started gas reduction projects within its steel products; solar installation in Australia and New Zealand; and constructed a new energy-efficient wallboard plant.
This follows on its 2020 adoption of biofuels derived from end-of-life tyres.
Orora ((ORA)) guided to sustainability capital expenditure of -$40m for FY23 and FY25 (-$12.5m of which is subsidised by the government), to upgrade its glass furnace to oxyfuel in 2024, making it one of the top-10 energy efficient furnaces worldwide.
Green Steel – Australia’s Captain Plod
The slow process of decarbonising steel ground onward.
BlueScope Steel ((BSL)) announced an initial investment in Hysata, a hydrogen electrolyser start-up in August as a co-investor in the company’s Series A funding round.
Adopting hydrogen technology will be critical for decarbonising the steel company’s operations and assuring future sales; especially given global rivals such as Sweden’s SSAB are already producing and shipping green steel using Hybrit’s patented technology.
While SSAB’s sale of green steel to Volvo was as much a public relations stunt as anything, it does show how swiftly global steel rivals are progressing. BlueScope does not expect to reach commercialisation of Hysata’s green steel until 2030.
Hysata is an Australian hydrogen technology company, which has developed an ultra-high efficiency electrolyser that aims to reach the commercial milestone of producing a kilogram of hydrogen for under $2. We take a deep dive into green steel in a separate story.
Meanwhile, in May BlueScope established BlueScopX, a vehicle to make direct investment in small-scale start-ups and businesses in the decarbonisation of the steel value chain (including raw material and energy inputs).
The start-up also aims to create efficient building spaces via new and improved products and processes, such as prefabrication to gain on-site efficiencies, thermal efficiency improved design and aesthetics.
BlueScope Steel also set a recycling target of 40% scrap self-sufficiency through investment technology and a new scrap-processing site, which further decarbonises its operations.
Meanwhile, the company’s collaboration with Rio Tinto to produce direct reduced iron has yet to bear fruit.
BlueScope may have a few surprises up its product sleeve (we discuss green revenue streams in the Part 3 of this series), and has enough political clout, not to mention a virtual monopoly position (at least for now), to benefit from the domestic renewables revolution, which will require a lot of steel.
If the cost of hydrogen falls to US$1 per kilogram within the next five years, this will have implications for the scrap industry, which carries an Australian price for the most-used steel grades of $1.01pkg to $1.68pkg.
The Wildly Ambitious Fortescue Metals
Which takes us, of course, to the Fortescue Metals ((FMG)) decarbonisation plan and its future-facing subsidiary Fortescue Future Industries.
The pair’s focus is so broad that it is sometimes difficult to separate decarbonisation projects from green revenue projects (for Part 3), but we do our best.
Fortescue Metals is the most ambitious of ASX heavyweights.
Fortescue’s interests span tech ownership, manufacturing capability, green energy generation and distribution across entire value chain. It has positioned itself as both a straight iron ore commodities play and a green-revenue growth prospect.
On the decarbonisation front, the company has pledged to replace diesel with renewable energy at its mines and plans to remove all fossil fuel price risks, which will require significant capital expenditure
The company believes this will place it in a market-leading position, which has been confirmed by Morgan Stanley’s September 2022 Mining ESG report. OZ Minerals ((OZL)) and Fortescue Metals led the resources pack on carbon intensity.
Fortescue is decarbonising its heavy equipment fleet through electrification to remove reliance on imported diesel, and is working on the Pilbara Energy Connect, a US$700m grid transmission project to provide electricity links to key facilities.
The company is also introducing a battery electric locomotive.
During the half, Fortescue contracted Liebherr to develop and supply green mining haul trucks. Green iron, ammonia powered marine engines.
This year, the company announced the purchase of UK-based WAE, which provides critical technology and expertise in high-performance battery systems and electrification.
Fortescue Metals issued its first green bond, raising $700m through a 10-year issue at 6.125%. The proceeds will be used to fund its Iron Bridge project, which will produce high-quality ore for low-emission steelmaking.
The company is also a founding member of the US President Biden’s First Movers Coalition, which should place the company in good stead with big capital going forward, provided it delivers on its promises, providing a floor during an expensive and fraught transition.
Other Resources Stocks
Elsewhere among resources companies the focus was on fleets and renewable power.
Mineral Resources ((MIN)) announced it would introduce fully autonomous electric road trains by 2025.
IGO ((IGO)) is electrifying its mines and announced it is partnering with Zenith Energy to complete its solar farm and battery storage project at the Nova nickel mine to reduce emissions, expecting it will be an industry first.
Rio Tinto recently signed a memorandum of agreement to supply sustainable supply chains for battery and low-carbon materials to be used in Ford vehicles.
This initiative was low on details and if, as Macquarie suggests, Rio is back-ending capital expenditure, then this would suggest Ford might be doing the same.
The pair also signed an MOU with Salzgitter to support carbon-free steelmaking, using Rio Tinto’s high-quality Australian and Canadian iron-ore.
Again, it is just an “exploration” and Rio Tinto appears to be lagging on the decarbonisation front. Morgan Stanley’s rankings place it in 14th place, well behind rivals such as Fortescue Metals and BHP Group ((BHP)).
Similarly, Rio Tinto’s direct reduced iron project with BlueScope, while showing “encouraging early results”, appears a long way off delivering.
Decarbonisaton Partnerships On The Rise
Many companies recognised the need to collaborate with technology companies and other companies across sectors to accelerate their decarbonisation.
For example, Adbri ((ABC)) partnered with Calix ((CXL)) to develop a Calix calciner for lime production with carbon capture technology, which it hopes will create a commercial scale, zero-emissions lime production facility. It is also partnering with Hilt CRC and SmartCrete.
The IGO and Zenith Energy partnership, we mentioned above.
AGL Energy and Fortescue Future Industries joined forces to produce a green hydrogen feasibility study in the Hunter region.
AGL and Brickworks partnered up to conduct a green hydrogen energy hub study to repurpose AGL’s Torrens Island power station site in Adelaide.
Similarly, Aurizon Holdings ((AZJ)) partnered with Anglo American for a feasibility study into hydrogen powered trains.
Boral and Calix received a $30m grant from government for carbon tech, to establish a pilot mineralised carbon products project.
At this stage, all these are more noise than materiality.
Capital Expenditure And Details On Transition Pathway
Despite all these commitments, carbon-expenditure details were thin on the ground.
While the number of companies to divulge capital expenditure expectations also rose (and many provided more information on their transition pathway), investors are still waiting to be handed the final quote.
Santos ((STO)), APA Group ((APA)), Origin Energy, Boral, Seven Group Holdings ((SVW)), Kelsian Group ((KLS)), Century Communities ((CCS)), Austal ((ASB)), and Rio Tinto (which back-ended estimates) were among those to venture new estimates.
Fortescue Metals was the standout in this regard.
Hot on the heels of reporting season, Fortescue announced in September -US$6.2bn in capital expenditure by 2030 to eliminate fossil fuels (carbon neutral by 2030) and cut operating costs by -US$818m a year (based on current energy prices) and provide a return on capital by 2034.
Executive Chairman Andrew Forrest says the move will protect the company’s cost base and improve margins while generating strong green business opportunities.
Most investment is planned for between FY24 and FY28 and much of the return is expected to be derived from a sharp cut in carbon offset purchases, energy savings, improved asset integrity and a lower risk cost profile.
Miners and mining services companies, meanwhile, delayed fleet upgrades, waiting for lower emissions products, and analysts expect this will bump up capital expenditure costs across the sector.
Energy Retailers and Renewables Under The Pump
Despite the desperate race for alternative fuels, renewables and energy retailers posted a mixed performance, as inflation outpaced revenue.
A handful of generators with spot-market exposures enjoyed windfall gains, but most were locked into contracts (many purchasing power agreement cap price increases at the lower of CPI or 2.5%).
This fell well short of the gains posted in the energy price (renewable Generators are underpinned by long-dated Power Purchase Agreements and don’t benefit from higher spot prices) and was also shy of broad-based inflation.
Several energy retailers becoming non-competitive, some failed and others lost customers.
The AEMO’s suspension of the National Energy Market triggered potentially large compensation payments to generators, which were to be passed on to energy retailers and then customers.
Australia’s largest energy retailers Origin Energy, EnergyAustralia and AGL hold a combined market share of about 70%.
Meanwhile, inflation in materials and labour, combined with supply-chain disruption have been hitting renewables industries hard and undermined the economics of projects. Insurance and maintenance costs also rose.
PWC estimates global manufacturing costs rose 30% during the year.
Meanwhile, Rystad reported a 30% rise in the price of polysilicon, which is used in solar, as China’s lockdowns continued ahead of the party elections.
China has a stranglehold on the polysilicon market, which also holds modern slavery issues, and polysilicon supply has also has found its way onto the US government’s national security radar, along with semiconductor chips.
On the upside, more companies adopted PPAs during the period, and the Labor government pledged to invest -$20bn in Australia’s electricity grid and support the building of new transmission lines – a major stumbling block for the industry.
Meanwhile, fund managers stepped in and scooped up Australian operating solar farms and battery storage projects.
Next, FNArena looks at the development of green revenue streams among the ASX300.
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