The invasion of Ukraine has raised significant ESG questions.
Russia last week shook the world by invading Ukraine in what is the largest military operation in Europe since WW2. Following the build-up of troops on Ukrainian borders and warnings from many Western military experts, Putin finally embarked on what he calls a ‘special military operation’ with the goal of ‘demilitarisation’ and ‘de-nazification’ of Ukraine. The invasion of Ukraine has raised significant ESG questions in regards to the future of renewable energy dependency, the human rights considerations of the invasion and governance downgrades of Russia and Belarus. Below are key ESG considerations as a result of the conflict.
Ukraine-Russia Conflict has Created a Spike in Price of Natural Gas3
‘E’ Considerations: Surging Energy Prices and Transition to Renewables
Price of Oil and Natural Gas and European Oil Dependency:
• Soaring natural gas and oil prices The full-scale military invasion of Ukraine saw European natural gas prices soaring almost 70% and crude oil exceeding the $105 a barrel mark for the first time since 2014, upending global energy supplies.1 • European energy exposure to Russian conflict is high Russia supplies about one-third of European natural gas consumption, mainly used for winter heating as well as electricity generation and industrial production.2 • Geopolitical risk of European energy supply may be the most significant factor towards adoption of alternative energy sources The awareness of Europe’s geopolitical exposure towards Russia, laid bare by this crisis, may be the most significant long term accelerant towards European countries investing in alternative energy sources. Oil majors are putting Russia at arm’s length, with BP divesting from their 20% stake in Russian state-owned oil company Rosneft and Shell exiting all of their Russian operations, including a major LNG plant in which they hold a 28% stake.2 • Potential impacts of the rising price of gas include a focus on energy efficiency Additionally, in the short term, the rise in price of oil and natural gas may result in a greater emphasis on overall commercial and residential building energy efficiency, as the cost of electricity increases, as well as faster adoption of electric vehicles as consumers seek to reduce their transportation costs. • Potential additional impacts include a short to intermediate increase in price of plastics and feedstock Increasing crude oil prices can potentially drive up petrochemical costs as well as market prices for many downstream chemical intermediates and plastics.
Potential Impacts on the Future of Coal and Nuclear Power4:
• German dependence on Russian energy partially due to reduction in nuclear power Germany’s reliance on Russia stems partly from their decision on nuclear energy, with tumultuous public and political opinion and the 2011 Japan earthquake and Fukushima nuclear disaster driving the German government to officially phase out all nuclear plants by 2022. • Coal on the short term rise Germany has signaled that they might re-consider plans to phase out coal-fired power plants by 2030 in order to shore up near-term energy requirements. Italy is taking a similar route, with Mario Draghi committing to re-open select coal-fired power stations to ensure energy demands are met in the near future. • Short term increase in carbon emissions In the short term, Europe’s dependency on Russian oil and natural gas may result in higher carbon emissions as countries return to coal fired power plants.
Impact on Renewables:
• The energy crisis expedited the timeline to transition to renewables German politicians are hoping to rush through a new act to ensure that they can fulfil all of their electricity needs from renewable sources by 2035, with the aim of increasing offshore wind production and maintaining solar panel subsidies.5 • Renewables are a key component of the path to energy independence The war in Europe adds to the urgency of transitioning to clean energy sources such as solar and wind power that are harder for climate laggards like Russia to disrupt, while also securing energy independence.5 • Short term increase for renewables Further strengthening the argument for the green energy build out, shares of renewable energy companies have been on a strong run with European giants like Ørsted, Vestas, and Siemens Gamesa seeing an uptick in share prices since the outset of the war. The European Renewable Energy Index surged as much as 9.3% on Thursday, the biggest jump since the pandemic lows of March 2020, posing a stark contrast to the European market’s collapse.6 • Long road ahead Despite the short term increase in renewable energy share prices, the European transition will take time to transition. Germany’s revised plan increased onshore wind energy to 10 gigawatts by 2027 and solar power to 20 gigawatts by 2028. The development of renewable capacity will take years to build.
European Dependency on Oil has Caused Reconsideration of Energy Sources7
‘S’ and ‘G’ Considerations: Human Rights and Governance Downgrades
• MSCI downgrades Russia and removes from EM Index In response to the Russian invasion of Ukraine, MSCI ESG Research downgraded both Russia and Belarus, as of March 1, 2022. On March 2nd, MSCI announced that it will be reclassifying Russia from an Emerging Market to a Standalone Market, which will result in the country being removed from the widely followed MSCI Emerging Markets (EM) Index.8 • Russia downgraded for Social and Governance concerns Russia’s was downgraded from BBB to B and then to CCC, given their weak scores in the categories under “Political Governance”: ‘Stability and Peace,’ ‘Political Rights and Civil Liberties’ and ‘Governance Effectiveness’ with a Negative outlook. The additional downgrade was made based on the widening domestic impact of sanctions and financial isolation on the Russian economy. The “Economic Environment” and “Financial Governance” scores were also adjusted to zero in line with the “Political Governance” score.8 • Belarus downgraded for Governance concerns Belarus’s score was also downgraded, but from a BB to a B, with a Negative outlook. Just last year, Belarus was put on Sovereign watch for their political governance goal, as a result of elevated risks presented by the Russian pressure on the government. 8 • Further assessments underway MSCI initiated ‘Very Severe’ Sovereign Watch assessments for Russia’s ‘Economic Environment’ and ‘Financial Governance’ categories of the Social and Governance pillars, respectively, reducing those scores to reflect the potentially wide-reaching domestic impact of international sanctions and financial isolation on Russia’s economy. Ukraine’s score, however, has been stable at BB with a Negative outlook. 8
Asset Owner Considerations for ESG Investing
• The Russian invasion of Ukraine has brought to light ESG considerations for asset owners in the topic of sovereign debt and global equity holdings. This geopolitical event brings up an ethical and moral issue that has financial impact and is directly tied to ESG investments, with asset owners considering where the consideration should be drawn for investments. Asset owner responses to the crisis have evolved as global government responses have rapidly shifted. Select examples show the variation in response from the asset owner community: 9
- BP Plc, for example, has owned a stake in Rosneft PJSC for about a decade, unmoved by investors' concerns about the Russian energy explorer's environmental track record. This week, however, the U.K. government pressured BP to sell the holding because of the unacceptable social ramifications tied to Russia's invasion of Ukraine.9
- In Norway, the head of the country’s $1.3 trillion sovereign wealth fund said he had no intention of selling Russian assets worth roughly $3 billion — until the government said the “brutal war of aggression against Ukraine from Russia” demanded the holding be frozen and divested. 9
- Dutch pension funds are relatively insulated from this Russian financial turmoil since they have dramatically reduced their investments in the country in recent years due to ESG considerations. ABP, BpfBouw, PME and PMT placed Russian bonds on their exclusion lists in December 2020 following the imposition of an EU arms embargo against the country.10
1 Guardian, as of February 24, 2022 2 Reuters, as of February, 28 2022 3 GIR, as of February 24, 2022 4 Reuters, as of January, 27 2022 5 Reuters, as of January, 27 2022 6 Bloomberg, as of February 24, 2022 7 GIR, as of February 24, 2022 8 MSCI ESG Research: Russia and Belarus MSCI ESG Government Ratings downgraded, as of February/March 2022 9 Bloomberg, as of March 2, 2022 10 IPE, as of February 24, 2022
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