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Hedge Fund Monthly
 
Gulf Lessons
Jerilyn Klein Bier           
FA Green
Sep 2010
 

"To BP or not to BP?", a frequently asked question in recent months, was being debated in the socially responsible investment space long before the major oil company's spill in the Gulf of Mexico. Some SRI asset managers had already distanced themselves from the company given BP's fossil fuel focus, poor safety record and retreat from a previously strong commitment to sustainability.

So how did BP retain high responsibility ratings despite these significant concerns and why are some SRI mutual funds and separate accounts continuing to hold the company in their portfolios when it is reportedly responsible for the worst environmental disaster in US history?

The incident also raises broader investment questions. First, can corporate responsibility reports really teach us about a company's efforts when BP's Sustainability Review 2009, published just days before its Deepwater Horizon rig exploded in April, made no mention of the dangers of deepwater drilling? Second, what environmental, social and governance (ESG) implications does it have for companies in general?

The BP spill is "a wake-up call for mainstream investors and SRI alike to take non-financial risks deadly seriously [and evaluate] the potential materiality of certain risks," says Bennett Freeman, senior vice president of Sustainability Research and Policy for the Bethesda, Maryland-based Calvert Asset Management Company. "Safety issues have to loom larger than ever before."

Need more convincing? Freeman points to three more crises this year that he says also drive home the point: Toyota Motor Corporation's massive safety recalls; Massey Energy Company's West Virginia coal mine explosion, the industry's deadliest accident in over two decades; and the Securities and Exchange Commission's allegations that Goldman Sachs was betting against the failing mortgage securities it was selling to uninformed institutional clients.

BP – despite huge investments in alternative energy and other industry-leading environmental efforts – was never 'green' enough for Calvert's Signature portfolios. But it was held until 21 June in the Calvert Large Cap Value Fund, what it calls an 'enhanced engagement' portfolio, which is open to companies that fail to meet all its core ESG criteria. Calvert dialogues with many such companies to help them identify and meet objectives focused on reducing their ESG-related risks. It plans to continue these efforts with BP. "We have to make a real effort to engage with as many companies as possible to ask questions," says Freeman.

"These are business questions, not just environmental questions sitting out there in an environmental zone," says Tim Smith, director of the Environmental, Social and Governance Group at Walden Asset Management in Boston. "Traditional analysts should be ready to answer these questions as much as us [ESG analysts]."

We will discuss how to dig deeper for answers in a moment, but first, let us consider why BP, dropped from the Dow Jones Sustainability Indexes on 31 May, remained a 'green' contender for so long despite its serious issues.

BP's 2005 commitment to provide $8 billion in capital by 2015 to its alternative energy ventures attracted many SRI managers. Over the past four years, it has already invested $4 billion in this area, which includes biofuels, wind, solar and carbon capture. Much credit is also given to BP's 'best in class' approach to ESG issues and willingness to engage with the SRI community.

Good policies and a decent record on climate change, human rights, diversity and governance made BP one of Walden's larger oil holdings, says Smith. Walden held on after BP's deadly Texas City refinery accident in 2005 and its Prudhoe Bay spill on Alaska's North Slope in 2006 because the company committed to improving safety.

BP also shared its best practices for safety process improvements with other companies, says Todd Cort, CEO of Two Tomorrows (North America) Incorporated in San Francisco, part of the global sustainability consulting firm Two Tomorrows Group Limited. In March, BP again emerged as the leader in his firm's annual Tomorrow's Value Rating (TVR) – which assesses sustainability-related strategy, governance, engagement, value chain and innovation – of the world's largest oil and gas companies.

Cort notes, though, that the margin between the sector's top seven members is narrowing and they have all retreated from their previously high commitment and leadership roles in corporate responsibility and sustainability. He discussed this problem in his article published in the March issue of trade journal Petroleum Review.

BP's slipping commitment to safety concerned Walden. When BP was slammed with a record fine late last year of more than $87 million from OSHA for the Texas City incident, "it was the precipitating factor that pushed us over the edge… It was a real sign they had not changed their policies or practices and did not implement the Baker recommendations," says Smith. He is referring to a report of 10 safety recommendations produced by an independent safety panel led by former US Secretary of State James A Baker III and commissioned by BP at the urging of the US Chemical Safety Board. Walden sold off BP in February.

'Best in class in a dirty industry' is how Matthew Patsky, CEO and senior portfolio manager with Trillium Asset Management Corporation in Boston, long viewed BP. He estimates that more than half his SRI firm's clients want to be invested in traditional energy companies – something he says he has not personally owned in about 20 years – to get exposure to the broader markets.

In January, though, he and his team debated whether to replace BP given its pullback on commitments to greenhouse gas reduction and climate change legislation. They held on because they were not comfortable yet with any potential replacement. Just after the spill, Trillium sold off most of its BP shares but still holds some under client direction.

MMA Praxis Mutual Funds, a faith-based family of funds headquartered in Goshen, Indiana, had tough, challenging conversations with BP, a long-time holding, after the company's 2005 and 2006 incidents and believed the company was taking steps in the right direction, says Mark Regier, director of Stewardship Investing. Now it is not so sure BP is clean or green.

"The jury is definitely out now. We have lots of questions about how far up their failures go," says Regier. For now, MMA Praxis is continuing to hold BP in its International Fund and Intermediate Income Fund. It also remains available for purchase by managers. "Not investing in a company does nothing for the world. One has to be engaged."

"If BP wishes to remain committed to the values it has expressed in the past, then I would find it unfortunate – given the important role it has played in improving policies in the industry over the years – if there were not social investors ready to engage the company and address current problems so that BP might return to a leadership role in corporate social responsibility," he says.

Regier realises it will take a long time to get answers. "When the house is on fire, it is hard to have a good conversation about how it started," he says. He hopes to see BP improve its communication channels, which many believe have declined under CEO Tony Hayward's leadership. Hayward is to step down from this post effective 1 October.

Regier recalls BP's good communication efforts with the SRI community under its previous management regime while developing its BTC oil export pipeline from the Caspian Sea to Turkey's Mediterranean coast. "They began by asking how to go about developing a socially responsible pipeline that people would want in their community, who they should talk to, and if we saw holes or better ways of doing it," he says.

BP's most recent sustainability review, nearly 40 pages with interactive links to additional data, gives little hint of the company's backpedalling on sustainability and no warning of the possibility of a Gulf crisis that would be intensified by management's lack of accountability and transparency. But despite their limitations, no one is ready to dismiss the value of sustainability or corporate responsibility reports.

"Sustainability reports are a great tool for asking questions… and pushing greater work and performance in the whole ESG area," says Regier. A couple of questions he has for BP: Where were the governance pieces? Was the board constantly trying to save money by cutting corners?

"We are big fans of companies doing these reports and telling their story, but you cannot stop there," says Smith. He emphasises the need to also look at data from sources such as RiskMetrics/KLD, Trucost, CRD Analytics and CERES (the Coalition for Environmentally Responsible Economics) to check if they see problems with a company's ESG record. He also recommends looking at carbon disclosure reports and the material risks companies report on Form 10-K.

In addition to company reports, Freeman says Calvert's analysts review reports from the United Nations Global Compact, the ILO (the UN's International Labour Organization agency), the World Bank, NGOs (non-governmental organizations associated with the U.N.), the government and the media.

Cort is pleased that BP and the other major oil and gas companies have moved to data-based reports. But what is often missing in this sector in particular, he says, is some form of third-party validation or assurance. Investors and raters need to put a heavy estimate on the quality of the assurance statement and take a look at how a company decides what is considered material, he says.

"The Global Reporting Initiative is a great start, but companies need to get better than that. GRI would not have predicted what happened to BP or Enron," says Cort, co-author of the practioner's handbook Corporate Social Responsibility: A Guide to Good Practice published by the Institute of Environmental Management and Assessment.
 
Longer sustainability reports are not necessarily the answer. "People do not want to read 400-page documents, investment analysts for responsible funds included," he says. "The dilemma is getting the right information to the right people at the right time."

Cort believes intelligent web design can help with this and give companies a place to elaborate on how they have imbedded responsibility practices and controls at the regional and local level. Printed reports generally have a global focus. "To ask global questions about risk indicators misses the point," he says.

Evaluating companies' true ESG intentions is not easy. "We made the mistake on BP and we are pretty good at ripping apart fluff," says Patsky, who would like to see clearer standards for sustainability reporting much like we have for financial reporting.

Meanwhile, Trillium is encouraging US companies to publish more sustainability reports. It filed a resolution asking Google Incorporated to produce them on an annual basis so people do not have to paste together a year of its periodic blog reports, says Jonas Kron, Trillium's deputy director of ESG research. "I think ad hoc sustainability reporting will soon be [seen as] very quaint," he says.

Of course, BP is not the only one to blame for the Gulf spill. Key US government agencies must also be held accountable, Calvert wrote in a position statement it issued in June. Nor is the problem isolated to BP. "I think the spill could have happened to any one of the oil and gas companies which are pushing the boundary of exploration in deep water," says Cort.

Calvert is asking companies with deepwater exploration and production operations to conduct urgent reviews of their safety procedures and spill contingency plans with regulatory agencies. And it is expanding its objectives for the remaining oil and gas companies in the enhanced engagement portion of its portfolio (Anadarko Petroleum, ConocoPhillips, ExxonMobil, Marathon Oil and Royal Dutch Shell).

Trillium remains wary of big oil but has put much of its BP money back into traditional energy to meet client demand. "The biggest slug went into smaller players in oil and natural gas with better safety records," says Patsky.

 

 

 

This article first appeared in the September 2010 issue of FA Green. For more related articles, please go to www.fa-mag.com


                                                     

 
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