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Determining what’s ‘green’ is harder than it seems

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Reporting on the climate can be inspiring and terrifying in equal measure. Every day we meet investors, activists and politicians scrambling for solutions, while temperatures and atmospheric carbon levels continue to creep up. And sometimes, as the FT’s London-based climate reporter Camilla Hodgson found out this week, writing about the climate is neither of these things — it is just downright confusing. 

Camilla has done her fair share of digging into the UK power group Drax, which is looking to reinvent itself as a clean energy pioneer. So she decided to get to the bottom of why it has been ejected from the S&P Global Clean Energy Index, when the company claims that the wood pellets it burns for energy are carbon neutral. A painful back and forth between Moral Money and S&P Global ensued. It turned out that “biogenic emissions”, or the carbon that is stored in the wood that is turned into pellets, were at the heart of the issue — read on to find out more.

Also today, we name the biggest holders and underwriters of bonds issued by coal giants, and ask whether “Denial of Re-entry” — a powerful if poorly named activist investor tool — could shake up the debt market by the time net zero targets start kicking in. (Kenza Bryan)

Britain’s biomass debate highlights ESG index confusion

UK power company Drax is a frequent target for environmentalists, who argue that its operations are not as clean and green as the company says. In July, that debate wound its way to 10 Downing Street.

Last week, more than 50 members of parliament wrote to Boris Johnson to voice concerns about Drax’s fast-growing business selling and burning wood pellets for power — an energy source that features prominently in the UK government’s net zero strategy. Drax says its “bioenergy” is carbon-neutral, but that claim has been fiercely contested by its critics.

A key piece of evidence cited in the letter was Drax’s ejection last year from a key clean energy index, which the parliamentarians said was because of “its burning of wood”, citing a media report.

Environmental groups had also seen the index change as a sign that S&P Global agreed that burning wood for energy was not “clean”. Drax, however, interpreted the index change quite differently. The company told a UK parliamentary committee last year that it did not know “the precise reasons” why it had been dropped from the S&P Global Clean Energy index, but that it believed the change “reflects legacy thermal generation (gas and coal)” — meaning that its remaining fossil fuel power generation was the problem, not the pellet burning. Drax, which remains in several other ESG indices, used to burn coal for energy, and now primarily burns wood pellets, or “biomass.” 

I was curious to unpick what had happened, but that turned out to be quite difficult.

Big sums of money flow into funds tracking these ESG indices. Just one of the funds tracking the S&P Global Clean Energy index — an exchange-traded fund run by BlackRock’s iShares — has net assets of $5.5bn. But ESG data can be confusing and providers are not always transparent about how scores and methodologies are compiled. 

The Drax case was an intriguing example of that lack of clarity. So who was right? After several phone calls and an excruciating series of emails, I finally found the answer.

According to S&P Global documents, Drax had been dropped from the clean energy index as a result of its so-called “carbon intensity” score, a measure of a company’s emissions compared with its revenue. But how that score had been compiled was unclear. 

I asked S&P Global, and we got into a head-spinning back and forth. In the end, it boiled down to three key metrics that Drax had reported to CDP, the non-profit that runs a global disclosure system: “scope 1” emissions, the company’s direct pollution generated by activities such as its remaining coal power generation; “scope 2” emissions, those related to Drax’s energy consumption; and “biogenic” emissions, the carbon stored in the wood that is turned into pellets. 

Although Drax had reported its biogenic emissions to CDP, it had also noted that “the use of sustainable biomass is considered to be carbon neutral at the point of combustion”, meaning those emissions did not need to be counted towards its overall carbon footprint. Biomass energy is circular, the industry says: new carbon-absorbing trees are planted as others are harvested, which cancel out the emissions from the burning of pellets and means the whole operation nets out at zero. 

But did S&P count the biogenic emissions? That was the key to figuring out whose interpretation of Drax’s ejection from the index was right. 

This proved difficult to ascertain, but eventually S&P Global laid it out in simple terms: “biogenic emissions were the largest contributor to Drax’s total emissions and carbon intensity, and [to] the company’s exclusion from the index”, they said. 

So Drax, and the explanation it had given parliament, had been wrong. 

In the company’s defence, this was a complicated puzzle to put together. S&P Global said it had explained the rationale for the index change in a blog. The jargon-laden piece said the “carbon screening rule was modified to improve its effectiveness” — without explaining which specific metrics had gone into the score.

S&P Global also said it “does not generally engage with individual companies” about the reasons behind index changes. 

The confusion in this case is emblematic of the problems with the ESG industry — a world of difficult-to-decipher and hard-to-compare metrics and methodologies that suggest different things to different people. And when investors, politicians and regulators are on the lookout for greenwashing, deliberate or accidental, that feels like a problem. (Camilla Hodgson)

Opt out of ‘coal bond’ refinancing, investors told

The debate around investor action on the climate has so far focused largely on the equity market, with many high-polluting companies having an easier ride in the less heavily scrutinised bond market. But that could be about to change, as pressure grows on fixed-income investors to use their massive clout to accelerate the energy transition.

Bond markets have an overlooked role financing fossil fuel expansion, according to a draft University College Dublin paper on investor impact entitled “Exit vs Voice vs Denial of Re-entry” and shared with Moral Money ahead of publication.

“Denial of Re-entry” might sound more like a nightclub policy than an investment strategy, but the academics behind it say that forcing bond issuers to cut emissions to refinance a bond at maturity could be a powerful tool for responsible fixed-income investors.

Researchers including Fabiola Schneider and Andreas Hoepner, who combine roles at UCD with membership of the European Commission’s Platform on Sustainable Finance, crunched Bloomberg data on a universe of $3tn of bonds issued in 2020 by 650 companies exposed to coal production, transportation and usage. These include the Korean power company Kepco and units of the Indian conglomerate Adani.

Coal companies with the biggest expansion plans raise 2.5 times more capital through bond issuances than bank loans, according to analysis of corporate financial statements by the Sunrise Project in May. Adani, which has struggled to raise capital from bank loans due to controversy over its Carmichael mine project in Australia, is now the largest Indian issuer of foreign-denominated bonds, according to the campaign group SumOfUs.

US banks Citigroup and JPMorgan are the largest and second-largest backers of “coal bonds”, respectively underwriting $569bn and $543bn worth, according to the UCD analysis. The value of underwritten bonds include bonds for which the bank has acted as a trustee.

A crunch moment for some of these issuers could come in the early part of the next decade, when a large chunk of their bonds will mature and require refinancing. More than $470bn of the bonds issued by coal companies since the Paris agreement in 2015 are set to mature in or after 2030 — the date when many banking commitments on emissions reduction kick in. Citigroup, for example, will introduce tighter restrictions on coal financing from 2030, such as the exclusion of power companies in richer countries that generate at least 5% their electricity from coal.

“The bond market is currently a back door, a safe harbour for companies that might struggle in the future to secure financing from traditional bank lending”, said Nick Haines, the Melbourne-based head of SumOfUs.

Vanguard and BlackRock, the two biggest owners of bonds issued by coal companies, each held $7bn of bonds due to mature in or after 2030, while JPMorgan held $3bn of these, according to the research.

Some might be surprised to see that 182 of the 12,366 bonds issued by coal-producing companies were marked green, sustainable or sustainability-linked, according to UCD’s research.

But Rhona Cormack, a senior stewardship analyst at the asset manager Insight Investment, said these sorts of assets provided a route to engage with companies over the “use of proceeds” framework governing what the money can be used for. She said: “Engagement remains the preferred option because we want to encourage progress on climate change, and denial of funding doesn’t change behaviours.”

Trym Riksen, head of portfolio management at the Norwegian pension advisory service Gabler AS, said institutional investors were starting to take sustainability issues related to securities more seriously. Scotland’s Lothian Pension Fund is one example; in May it said it would only buy new bonds if issuers’ strategies aligned with the Paris climate agreement. It cited a snappy mantra: “Engage your equities, deny your debt”.

“But this particular strategy,” said Riksen, referring to debt denial at large, “is still in its infancy and could be on shaky ground”. (Kenza Bryan)

Smart read

  • Amid the intensifying sturm und drang surrounding “woke capitalism”, it was refreshing to read this level-headed analysis in the Harvard Business Review, highlighting the flaws in the ESG paradigm — and how it could be improved. Authors Ken Pucker and Andrew King warn that today’s ESG investment sector is enabling fat fees for fund managers while distracting from the need for new regulation. As well as tough mandatory rules, they say, there needs to be a rethink of the incentive structure for asset managers, and far more work to drive funds towards key low-carbon technologies.

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