Introduction
The London Metal Exchange (LME) has announced various initiatives in the past year. The most recent is its plan to establish a low-carbon aluminium platform1. Before that, the LME announced the application of the OECD2 Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas (OECD Guidance), as part of its responsible sourcing requirements, to all brands listed for “good delivery” on the LME. The LME is following in the footsteps of the London Bullion Market Association (LBMA), which also adopted the OECD Guidance on 15 December 20103 in respect of ‘London Good Delivery’ of precious metals.Is there a sustained trend towards sustainable commodities? Will the COVID-19 pandemic derail such progress, or accelerate it? We explore these themes in this note.
For a more detailed version of this note, please see the attachment below.
What is driving the trend towards sustainable commodities?
Society needs commodities. This is irrespective of whether the economy is green or not. There are many reasons for such need, for example, nickel for the production of electric vehicle batteries, or LNG to transition away from other fossil fuels. The question is whether it is possible to source, supply or use commodities in a more sustainable manner. Our discussion on ‘sustainable commodities’ is centred on this question.
The commodities sector has many existing initiatives towards some form of sustainable sourcing or production, often led by industry bodies made up of key producers. For example, in respect of sustainable palm oil, there are standards such as the Roundtable on Sustainable Palm Oil and Rainforest Alliance Sustainable Agricultural Standard, among others.
There will be many drivers that are specific to a sector, company or individual business in explaining the variable progress in adopting ESG principles across the different commodities. However, at the international level, the push towards the adoption of greater ESG practices is likely to be driven by three main developments:
(a) the Paris Agreement, which obliges its 195 signatories to reduce the risk and impacts of climate change with an objective of the overall amount of global emissions peaking by 2030 at the latest;
(b) the United Nations Principles for Responsible Investment (UN PRI), which has led to an increase in asset owners and professional investors adopting ESG objectives and policy commitments; and
(c) the United Nations Sustainable Development Goals (SDGs), a set of aspirational sustainable objectives, many with targets that have to be achieved by 2030, agreed to by all member states of the United Nations.
What are the impacts of these drivers?
The two factors worth highlighting here are time and scale.
Time
The (i) ambition to reach peak emissions by no later than 2030 under the Paris Agreement, (ii) achievement of the SDGs, many of which have a deadline of 2030, and (iii) increasing awareness of the need to incorporate ESG considerations into investment strategies, have been powering progress in ESG practices. However, with the economic fallout from the COVID-19 pandemic, some wonder if it is still possible to prioritise the sustainability agenda at this point. Compounding the issue is whether the market is willing to pay a premium for more sustainably produced commodities. There is, presently, scant evidence to support such a conclusion.
Many argue that there is merit in capitalising on the COVID-19 pandemic as an opportunity to build a cleaner and greener future. Fundamental changes to various industries, such as energy and tourism, can be made by strategically allocating government support and spending. The COVID-19 pandemic could thus accelerate further advancement of sustainability initiatives, by focusing investments on creating a ‘triple bottom line’ of people (social), planet (environmental), and profit (financial)4.
Scale
There is growing scale in ESG actions being undertaken by multiple stakeholders. ESG reporting and disclosures are increasingly becoming commonplace worldwide. Investment managers are removing investments in certain assets from their portfolio that do not fit with their ESG objectives or targets5 6. Many financial institutions have ceased funding certain projects considered against the lender’s ESG principles (e.g. coal projects)7. In addition, an increasing range of financial products, such as green or sustainable loans, are being offered, with incentives (e.g. lower borrowing costs) when certain ESG objectives are achieved. These loans create incentives for behaviour and performance measured against ESG metrics and have already been taken up by many commodity sector participants.
To be clear, the actions undertaken by financial institutions are mostly driven by investor pressure and their own ESG initiatives; not by mandatory regulation. However, financial institutions see such regulation as inevitable and very much in the pipeline.
The EU New Green Deal is currently one of the most ambitious sustainability initiatives in the world, and aims to transform the whole of the EU into a low carbon economy through regulation. It aims to achieve this with targets that include a minimum 40 per cent cut in greenhouse gas emissions by 2030, a share of at least 32 per cent renewables in final energy consumption and at least 32.5 per cent in energy savings. In order to protect EU industries from the impact of competition from outside the EU, in particular in respect of energy intensive industries, the initiative includes carbon border-adjustment measures that may impact sectors such as cement, fertilisers, steel, non-ferrous metals, chemicals, pulp and paper, glass and imported electricity8. These measures may manifest in the form of carbon taxes on imports into the EU from countries that do not share the EU’s climate ambitions.
Possible impact on commodity market participants
There is likely to be (i) increasing demand from investors and businesses for supply chain transparency and (ii) development of sustainable commodity products, whether in base metals, precious metals or LNG. Where exchanges or organisations have mandated various ESG standards, investigations have been conducted against those who breach them9.
These initiatives are impacting market participants and triggering changes in behaviour. For example, Chinese cobalt producer, Huayou Cobalt recently announced that it will no longer purchase artisanal cobalt sourced in the Democratic Republic of Congo until relevant standards are recognised and supported by the industry. This follows on from the addition of its subsidiary, Zhejiang Quzhou Huayou Cobalt New Materials, by LME to its list of brands approved for good delivery in 2019.
Similar to the case of LME, supply chain concerns could invite other exchanges that list commodity products to consider similar practices on sourcing. Agricultural products, like rubber and palm oil, are obvious examples of commodities about which end users and large corporate purchasers have supply chain concerns, but for which the relevant exchanges have yet to impose any sustainable supply standards.
Companies that are owned by ESG-conscious businesses or by investors who subscribe to the UN PRI or other equivalent objectives and standards, will require supply chain transparency and information about the carbon cost of the production of commodities. For example, Pavilion Energy’s recent LNG tender required bidders to quantify greenhouse gas emissions associated with each LNG cargo produced, transported and imported into Singapore, and, additionally, included an option for bidders to propose the delivery of carbon credits to offset the actual greenhouse gas emissions from the supply of LNG sold under the terms of the tender10.
Lessons learnt from the financial sector allow parallels to be drawn with sustainable commodity products. Therefore, like the financial sector, questions about the ‘greenness’ of commodity products labelled in certain ways will arise sooner or later. This will raise the bar for disclosure, transparency and reporting. However, for the reasons outlined earlier, it is likely that the growth of sustainable commodity products, and thereafter the improvement in the quality of such products, will only continue. As such, it seems inevitable that ‘sustainable commodities’ will be the new reality.
- London Metal Exchange plans “low-carbon” aluminium trading’, The Financial Times (5 June 2020).
- Organisation for Economic Co-operation and Development.
- This was subsequently supplemented with the OECD Gold Supplement in July 2012.
- www.wisconsin.edu.
- www.theguardian.com.
- www.reuters.com.
- By way of example, Barclays Bank has announced that it will “not support project finance transactions for the development of greenfield thermal coal mines or to enable the construction or material expansion of coal-fired power stations, anywhere in the world … [and will] also not provide general corporate financing that is specified as being for new or expanded coal mining or coal-fired power plant development.” See Barclays PLC Environmental Social Governance Report 2019.
- The EU emissions trading scheme’s carbon leakage list for Phase 4 (2021-30) identifies 63 sectors and sub-sectors covering about 94 per cent of industrial emissions.
- ‘Metals authority probes Perth Mint over gold sourcing claims’, The Financial Times (15 June 2020).
- www.bloomberg.com.
Client Alert 2020-412
