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Environmental, Social, And Governance: The Growing Importance Of ESG In The Resources Sector

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Environmental, Social, And Governance: The Growing Importance Of ESG In The Resources Sector

(Editor's Note: This article is co-authored by Minh Hoang, Director, S&P Global Ratings, and Paul Bartholomew, Asia-Pacific Head of Metals News & Insight, S&P Global Platts. The article is based on a webinar, "The Growing Importance Of ESG In The Commodities Space," held on July 3, 2020.)

The death of George Floyd in the U.S. city of Minneapolis on May 25 sparked a wave of protest and significantly raised global awareness of racial and cultural issues. Within this environment, giant resources company Rio Tinto PLC attracted international opprobrium--and investor unhappiness--for the destruction of an Indigenous sacred site at Juukan Gorge in the Pilbara region of Western Australia, during the expansion of its Brockman 4 iron ore mine. The destruction of the cave, which occurred the day before Mr Floyd's death, was the subject of an Australian parliamentary inquiry in August.

The event in Western Australia--and the subsequent response to it--highlighted the issue of ESG (environmental, social, and corporate governance) and its growing importance in the mining and resources sector. S&P Global Ratings indicated that the mining sector had "well-above-average environmental credit risk" in its report, "ESG Industry Report Card: Metals & Mining", published Feb. 12, 2020, on RatingsDirect.

This year has seen major ESG developments in mining and resources. Giant investor BlackRock pledged to exit its thermal coal assets, saying they had become "less economically viable, and highly exposed to regulation because of its environmental impacts." (Sustainability as BlackRock's New Standard for Investing).

Investor groups pressured oil majors BP and Shell to set hard targets on carbon emissions in line with the Paris Agreement. In Australia, shareholders of energy companies Woodside Petroleum Ltd. and Santos Ltd. expressed similar sentiment at this year's annual general meetings.

Given the nature of the industry, mining can be prone to environmental risks and pollution--and occasionally disasters such as those that occurred at tailings dams at Brazilian iron ore operations in 2015 (BHP Group Ltd.-Vale S.A.'s Samarco dam) and in January 2019 (Vale's Brumadinho dam). These kinds of incident undermined the respective companies' environmental and social credentials, and take a long time to recover from in all respects.

Cultural Aspect Of ESG

Rio Tinto's issue in the Pilbara this year brought to the fore a "cultural" aspect of ESG that had previously received less attention. It has resulted in fellow iron ore producers BHP and Fortescue Metals Group Ltd. also addressing issues of blasting, or the potential blasting of Aboriginal heritage sites. In June, it was reported in major media outlets that BHP had planned to destroy up to 40 sacred Indigenous sites during the development of its new South Flank mine in the Pilbara. The Melbourne-headquartered company quickly put these plans on hold. On Aug. 18, 2020, BHP said South Flank would begin producing iron ore within the next 12 months.

Perth-based Fortescue Metals Group--the world's fourth-largest iron ore producer--has always promoted its work with Indigenous communities and businesses. But the expansion of its Queens mine threatened up to 70 sacred sites, including a 60,000 year-old rock shelter. The company said in August it was rethinking its expansion plan.

It is important to note that Rio Tinto and BHP had received Section 18 approvals from the Western Australian state government to blast at their respective sites. Fortescue CEO Elizabeth Gaines told analysts in early August that the miner had "paused on Section 18" (at the Queens development), pending further consultations with Indigenous groups (Investor and Analyst Call transcript for Fortescue's Full Year 2020 Results, Aug. 24, 2020). The Western Australian government is currently reviewing the Aboriginal Heritage Act, which includes Section 18.

ESG Goes Beyond Legal Obligations And Isn't Always Clear-cut

These cases highlight the fact that social risk factors go beyond legal obligations. They show that ESG issues are not always clear-cut as to what the consequences could be for a company. But the world is watching in a way it probably wasn't before the George Floyd tragedy. More pertinently in the case of major resources companies, it means investors are watching closely. Speaking at a parliamentary inquiry in August into the destruction, the Australian Council of Superannuation Investors said the inquiry had "exposed unacceptable cultural and operational failures by Rio Tinto" (ACSI statement on Parliamentary Inquiry into the destruction of 46,000 year old caves at the Juukan Gorge, Aug. 13, 2020).

Any company looking to develop a new project or expand an existing one will need to ensure all stakeholders are satisfied--above and beyond what government legislation stipulates you can or cannot do. A major investor sitting in London is less interested in the efficacy or otherwise of local government legislation on the other side of the world. But rightly or wrongly, the investor will be concerned about how things "look" to the wider market and community.

Taking extra steps to ensure all stakeholders are consulted throughout the process could result in projects taking longer to develop. Projects in Brazil have in the past been delayed for more than 12 months due to environmental reasons, or due to the discovery of a sacred cave or new species. This could result in some older mines running longer than expected, which could see a deterioration in the mining grades. Or, there may be a larger gap between one operation stopping and another starting. BHP's South Flank will eventually replace Yandi, which has capacity of 80 million metric tons per year. Mining companies will undoubtedly be circumspect when developing projects. They will look to work with local communities to avoid important heritage sites; they will not want to incur investor wrath.

ESG And Creditworthiness

ESG considerations form part of S&P Global Ratings' underlying corporate criteria. They could affect S&P Global Ratings' opinion on the creditworthiness of a corporate entity. ESG factors may have a positive or negative influence on an entity's credit quality when compared with sector peers or the broader resources sector. Comparative views of environmental and social risks are established by analysts in industry portfolio discussions with the aim of providing more insight and transparency. However, it is important to note that strong creditworthiness does not necessarily correlate with strong ESG credentials-–as a credit rating measures capacity and willingness to meet financial commitments.

This report does not constitute a rating action.

S&P Global Ratings Australia Pty Ltd holds Australian financial services license number 337565 under the Corporations Act 2001. S&P Global Ratings' credit ratings and related research are not intended for and must not be distributed to any person in Australia other than a wholesale client (as defined in Chapter 7 of the Corporations Act).

Primary Credit Analyst:Minh Hoang, Sydney (61) 2-9255-9899;
minh.hoang@spglobal.com
Contributor:Paul Bartholomew, Melbourne (61) 3-9631-2096;
paul.bartholomew@spglobal.com

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