Clean Oil?

There are two broad schools of thought about how people can invest in commodities in an environmentally friendly way. The first, practiced by many SRI fund managers, involves sorting through companies in industries such as mining and oil drilling to find those with the strongest environmental track records among their peers. The second group of investors view metal recyclers and alternative energy producers as the new commodity plays for the 21st century.

The division will grow more important as more investors seek commodities for their portfolios through stocks, mutual funds and exchange-traded funds. Last year, assets in ETFs following commodity prices rose 105%, according to State Street Global Advisors and at year’s end, they held some $67 billion in assets. Even after a year of record commodity investment, institutional investors appear ready to increase their exposure even more in 2010, according to a survey by Barclays Capital. While portfolio diversification is still the reason why many investors seek a commodities play, 60% of respondents to the Barclays survey cited absolute return as their motivation for investment. Those investors are likely gearing up for improving economies and higher inflation, which tends to drive commodity prices higher.

For environmentally friendly investors, the question is how to enter a sector that, by its nature, seems environmentally unfriendly. The operations necessary to extract oil from the ocean floor or metal from a deep mine, for example, can cause enormous harm to nature and violate fair labour practices. As Jack Robinson of Winslow Green Growth Fund states flatly, “There is no such thing as clean oil. Either an investment is green or it is not”.

Those in Robinson’s camp seek alternatives to traditional commodity investments, including alternative energy and recycling companies, to capitalise on higher commodity prices. Robinson says metal recyclers such as Sims Metal Management, one of his fund’s holdings, can benefit from the same inflationary trends that help commodities elsewhere because the prices for the end products rise and fall in the same way. Sims, for example, buys scrap metal from sources such as demolition firms, auto wreckers and manufacturers generating industrial metals. The company then processes those metals for resale to end users such as steel mills and metal brokers.

Winslow also invests in a number of alternative energy companies such as First Solar and Vestas Wind Systems. Robinson believes that such companies can act as inflation hedges since alternative energy becomes more desirable as the prices of traditional energy sources increase.

“If credit conditions improve in 2010,” he says, “these companies and other innovative green technology firms are poised to benefit from the potential acceleration of new clear energy project development”.

But the connection between green energy and rising commodity prices is not always clear-cut. Alternative energy companies tend to be small and more volatile businesses whose fortunes and stock prices hinge heavily on the availability of financing and favourable government regulations. Their stocks tend to march to their own drummer, which is one reason why the returns of alternative energy companies and exchange-traded funds often bear little resemblance to those of traditional oil and gas energy investments.

Many people do not view alternative energy companies in the same light as traditional commodity plays, according to Craig Metrick, the head of US responsible investing at Mercer in New York who works mainly with institutional investors such as pension funds and hedge funds.

“The investors we work with tend to see renewable energy as more of a growth or profit play than an inflation hedge,” Metrick says. His clients do not necessarily rule out companies in traditional commodity sectors, but they do favour those companies with the best environmental track records among their peers.

Other SRI funds take that moderate stance as well.

“We do not go to the extreme of calling all oil companies bad,” says Tessie Petion, an analyst at Domini Social Investments.

“But we try to take a balanced view by considering what companies are doing to mitigate the impact they have on the environment.”

To that end, Petion and her group typically prefer gas companies for energy exposure because they produce a cleaner form of energy than oil companies. In addition to using environmental screens, Domini also monitors companies’ human rights track records – a big area of concern in these industries, since the work is labour-intensive and often goes on in countries with lax regulation. Domini works with other SRI investors in advocating for these rights.

Domini also weeds out environmental slackers from its portfolio. One company that got the boot from the firm’s approved list in late-2009 was oil and gas exploration company Statoil. For years, the company took steps to reduce greenhouse gas emissions. But its environmental track record has taken a turn for the worse with its more recent forays into oil sands production, which requires a large amount of energy. By contrast, Energen, a diversified energy company, gets the nod because it derives more than 40% of its revenue from the distribution of natural gas, generally considered to be more clean-burning than fossil fuels.

Other SRI funds invest in what they consider environmentally responsible material companies whose fortunes are tied closely to commodity prices. Portfolio 21, for example, likes metal manufacturer Nucor. Although steel manufacturing is a polluting, energy-intensive endeavour, Nucor is one of the largest users of scrap steel in the US and the average amount of recycled content in its products is more than 85%. The Parnassus Fund, meanwhile, has a stake in Valero, the largest US independent petroleum refiner. Valero has taken steps to reduce sulphur dioxide emissions and has implemented a low-sulphur gasoline and diesel program.

The Appleseed Fund, another SRI offering, has had holdings in traditional energy companies as well as a substantial allocation to precious metals. Among the former is Noble Corporation, the only offshore contract driller that produces a sustainability report. According to fund manager Adam Strauss, Noble is “the only company among its peers that posts a proactive policy to address climate change. We have also looked at their environmental record in regards to emissions, spills and EPA fines, and Noble matches up very well against its peers in terms of the environmental impact of their operations”.

Appleseed also owns a substantial position in gold through ETFs such as the SPDR Gold Trust and the iShares COMEX Gold Trust. Since both are backed by gold bullion held by a bank custodian on behalf of the respective trusts, Strauss says they follow gold prices well and provide an effective portfolio hedge while buffering investors from the poor environmental and labour practices of many gold mining companies.

Since ETFs have become the entry point of choice for many commodity investors, it has become critical for SRI investors to examine how such funds gain exposure to the markets. Some ETFs use stores of metal or futures contracts to mimic commodity prices – a strategy deemed acceptable to some socially responsible investors because it is not a direct investment in the companies themselves. Other ETFs, however, may take a stake in a mining company, even though it does not have a stellar environmental track record.

The MarketVectors Gold Miners ETF, for example, seeks to closely replicate the performance of the NYSE Arca Gold Miners Index, which is composed of publicly-traded companies worldwide involved primarily in gold mining. The fund’s top holding is Barrick Gold, a major Canadian miner. Barrick faces environmental litigation related to its subsidiary Placer Dome, which, before it was bought by Barrick, was involved in a well-publicised mining disaster in the Philippines that had a devastating impact on the area’s waterways.

The lesson here is, when it comes to commodity investments, environmental track records are relevant not only to green investors, but to anyone concerned about the long-term risk to a company’s business.

This article first appeared in the March 2010 issue of FA Green. For more related articles, please go to