By Toby Belsom, Director of Investment Practices, the PRI
The recent Saudi Aramco debut bond issue raises a series of environmental, social and governance (ESG) challenges for investors. The issue featured prominently in financial media over the last month for its record-breaking demand. However, the coverage mainly focused on the size of the order book – a record for emerging market debt issuance – and less on the fundamentals of the deal.
This was a good example of the different approaches credit ratings agencies (CRAs) and bond investors might take to an issuer with elevated climate and political risk. This different approach is driven by different objectives: credit ratings will only include ESG factors if material to credit risk, whilst fixed income investors may have broader objectives, reflected in standalone ESG scores and sustainability assessments as well (see the PRI’s ESG in Credit Ratings Initiative).
At face value, Saudi Aramco’s financial strength, and its “fortress like” liquidity position, coupled with global investors’ thirst for yield seem to explain the record-breaking orderbooks. Indeed, its unique capital position resulted in high investment-grade ratings from both Fitch (A+) and Moody’s (A1). Both rating agencies also commented that, as a standalone business, its high production, vast reserves, low production costs and conservative financial profile would have resulted in higher ratings but for the strong links between the company and the sovereign.
Instead of being driven by a need for capital, the issue was another step in the gradual “opening up” of the Saudi economy to capital markets. This process is seen as an important part of Saudi Arabia’s Vision 2030 reform plan – and possibly a stepping stone before Saudi Aramco looks at its initial public offering (IPO) in the coming years.
There are many questions the Saudi Aramco issue – and probably the forthcoming IPO – raises for investors from an ESG perspective.
Firstly, they relate to climate change and how it is integrated in credit analysis. In the debt prospectus, the company refers to various aspects of climate-related risks and the company’s response – including topics such as climate litigation, changing regulation, new technology and hydrocarbon demand reduction.
Saudi Aramco appears to view addressing climate change concerns as an important priority. The prospectus refers to the appointment of Amin Nasser as president and chief executive in 2015 as focusing on “increasing operational excellence and integration, creating a performance-based culture and addressing climate change concerns”. The company also supported Saudi Arabia’s national “efforts to achieve the objectives set by the United Nations Framework Convention on Climate Change, the Paris Agreement”. And even if because of its low production costs, Saudi Aramco comes out well by the metrics that Carbon Tracker uses in its stranded assets analysis. Clearly, disruption in the oil industry has important implications for all major participants, especially as Saudi Aramco’s reserves stretch well beyond some analysts’ predicted peak oil demand.
Both within the prospectus and on a broader level, Saudi Aramco seems to recognise the potential for some of the material risks to the oil industry and its business posed by climate change and the energy transition. However, the questions investors might want to ask are: how will these issues affect future business models of this and similar businesses, and what can and are boards doing to address them? Have CRAs given them sufficient weight in their assessment? In this instance, this seems particularly relevant since 50 percent of the debt issue has a maturity of 20 years or beyond, a time frame when many forecasts are starting to anticipate “peak oil” demand (and some even earlier). How might investors incorporate these considerations into their own investment analysis, valuation and portfolio weightings?
If disclosure was viewed as an issue in this case, one route to potentially improving the quality of reporting across the sector would be for leading corporates, such as Saudi Aramco, to commit to reporting in line with the recommendations from the Task Force on Climate-related Financial Disclosure. Saudi Aramco could make a strong statement for a leading emerging market corporate in the run-up to its proposed IPO by endorsing and committing to these recommendations. As the company goes through a process of “opening up”, ESG-focused investors might want to see this as a priority.
Saudi Aramco could make a strong statement for a leading emerging market corporate in the run-up to its proposed IPO by endorsing and committing to the TCFD recommendations
Secondly, this example highlights the importance of incorporating political risk into valuation and assessment, something that has been recognised by the CRAs in some of their research. For quoted businesses with such a strong connection to a sovereign, investors need to recognise the role these governments may play in determining strategy, setting expenditure, the perception of the quoted entity and their influence on determining the willingness to repay debt. These links have both positive and negative implications.
And finally, for investors seriously engaging on ESG issues – especially climate issues – does this “opening up” process provide the opportunity to encourage a leading issuer in the oil and gas sector to promote better climate disclosure? Investors who have signed up to programmes such as Climate Action 100+ might want to review their approach to engagement in the run up to Saudi Aramco’s possible future IPO.
There are many more questions to be raised and the PRI does not have all the answers but encourages a healthy debate around this case. Get in touch with me if you have any comments about this.
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