Ukraine and the Geopolitical Considerations for ESG

Despite the growing importance of considering ESG factors as part of an investment process, many investors remain unclear about how to incorporate such an approach in their decision making, particularly in the context of emerging global events such as the crisis in Ukraine. 

As corporate credit investors, our team’s investment process revolves around quantifiable observations of relative value and valuations that are supported by an in depth analysis of corporate credit and industry fundamentals.  Our efforts to emphasize ESG within our traditional investment process has encouraged us to consider factors that are challenging to quantify and measure.  The difficulty in measuring the impact of ESG initiatives and evaluating their materiality has resulted in serious debates within our team and the broader investment community. Everyone claims to be an ESG leader, but very few can back it up.  Navigating this environment requires an active approach supported by a rigorous research process to maximize performance while adhering to ESG objectives.

Within a sea of ambiguity, one thing has been clear – the fossil fuel sector has generally been viewed as challenging within ESG investing frameworks.  It is no secret that the extraction, refining and consumption of fossil fuels results in significant greenhouse gas emissions. Under pressure to act on climate change, many large investors, including pension plans and sovereign wealth funds, have made plans to exit investments in the oil and gas industry altogether. While these moves will certainly help to advance environmental objectives, it is worth debating if an abrupt exit is the right approach, especially considering that we continue to rely on oil and gas in practically every aspect of the global economy. We are beginning to see the impacts of a lack of investment in the energy sector as a constrained supply environment could contribute to growing inflation and negatively impact consumers, particularly those in lower-income brackets. 

The recent shocking events in Europe have important implications for the cross-border flows of fossil fuels and will result in increased debate about how Western economies consume energy products. Russia is a major producer of oil and gas and a significant amount of Russia’s energy production flows into Europe and beyond. The simple reality is that the world (and Europe in particular) remains very dependent on Russian energy exports which makes it challenging for Western governments to effectively sanction Russia’s energy production. Sanctions can create hardships for all involved, and could potentially leave millions of people in the dark, without power or heat.  

The terrible crisis in Ukraine and its spillover effects throughout Europe could spark a call for increased investments in renewables. As uncertainty surrounding energy supply causes spikes in price volatility, reliance on unfriendly foreign jurisdictions for energy products should accelerate a collective call to action. We could see European nations make increased investments in domestic sustainable energy production initiatives to wean their economies off Russian energy imports. Unfortunately, the impact from such investments won’t be felt in the short-term and could also come at a high cost to consumers. The transition to a more sustainable future will take time and could involve near-term environmental trade offs to balance social and economic considerations. We are already hearing calls to restart domestic fossil fuel driven generation in Europe to plug the gap from reliance on Russian energy products.

An argument can be made that energy sourced from jurisdictions where there are strong governance frameworks and commitments to future net-zero carbon emission goals can play an important role filling the gap as economies transition to greater reliance on renewables in the future.  Ignoring the role that energy currently plays in our economy seems like a risk, especially considering the harmful impacts of surging inflation that pressured energy supply is contributing to.

Canada can play an important role in the transition to renewables as a safe and stable supply of oil and gas products presently. Environmentalists may argue that Canada’s oil sands have significant greenhouse gas emissions; however, if the alternative is to continue to source energy from countries with increasingly significant social and governance concerns, perhaps one shouldn’t be so quick to dismiss Canadian energy production. As we transition to a greener future, perhaps greater emphasis should be placed on investing in the energy sector of stable, friendly jurisdictions to reduce reliance on foreign oil from bad geopolitical actors. Transitioning to a sustainable future in the long-term remains one of the best ways to reduce our reliance on unfriendly regimes for oil and gas. The key question is how we get there.

It’s worth debating how the energy sectors of stable jurisdictions, with strong corporate governance and strong environmental oversight, fit into an ESG investing framework. This is where an active investment approach can add value and will require a comprehensive research process that revolves around detailed discussions with management and industry players, rather than simply relying on an issuer’s slide deck or third party ESG scores. The importance of transitioning to renewables remains more important than ever, however, to maintain economic stability and avoid chaos from an abrupt exit of fossil fuels, the path to a greener future requires careful consideration and planning.

RIA Disclaimer
The views and opinions expressed in this article are solely those of the authors and do not necessarily reflect the view or position of the Responsible Investment Association (RIA). The RIA does not endorse, recommend, or guarantee any of the claims made by the authors. This article is intended as general information and not investment advice. We recommend consulting with a qualified advisor or investment professional prior to making any investment or investment-related decision.

Author

Jeremy Lucas

Vice President & Portfolio Manager

Dynamic Funds

Jeremy joined Dynamic in 2017 as a member of the Credit Team, which is responsible for managing over $6 billion in credit-related asset classes including investment grade corporate bonds, preferred shares, high yield bonds and loans, along with floating rate and credit absolute return strategies.

Jeremy has 22 years of industry experience in a variety of roles that includes energy derivatives and North American credit markets. His previous experience includes sell-side research and trading responsibilities focused on high yield bonds for a large Canadian bank where Jeremy played a key role in the development of the Canadian high yield bond market.