Monday, March 20, 2017

A Coal Free Investment Universe: Third tranche of Coal exclusions from the Government Pension Fund Global

(Pix Coastal exposure of the Point Aconi Seam (Nova Scotia))

The Norwegian State continues to project its national environmental policies onto its investment strategies.
With effect from February 2016, the Ministry of Finance added a new product-based criterion, under which mining or power companies with 30 per cent or more of their operations associated with thermal coal may be excluded from the GPFG. With respect to this criterion, Norges Bank may exclude companies without the recommendation of the Council on Ethics. So far, Norges Bank has excluded 59 companies with reference to the coal criterion, while a further 11 have been placed under observation. (Council on Ethics for the Norwegian Government Pension Fund Global, Annual Report 2016;  pp. 7)
On 7 March 2017 Norges Bank announced its decision to exclude an additional 10 companies from the Government Pension Fund Global based on the product-based coal criterion in the guidelines for observation and exclusion.

The most immediate and perhaps interesting observations that might be extracted here touch on the growing shift in effective authority over control of investment universe matters form the Ethics Council to the Norges Bank. This shift augments  the change in procedure, effective January 2015, that shifted the Ethics Council's communication from the Foreign Ministry to the Norges Bank.   The second is the willingness to make the process more efficient (and to capture a larger set of potentially offending enterprises) by substituting bright line rules (e.g. the 30% of revenues derived from coal threshold for exclusion/observation) for principles based decision making inherent in the Ethical Guidelines. The third is this mve to bright line rules suggests a pathway through which public policy may continue to be exercised through the commercial activities of public pension fund ("The Norwegian parliament voted in May last year to order the GPFG to sell off its holdings in companies that have 30% or more of their activities in the coal business.").  The fourth is that even bright line rules are substantially interlaced with discretion--now exercised by Norges Bank. Beyond the decision to exclude or place a company under observation, the interpretation of the rules, the collection and interpretation of data, and the discretion built into communication with enterprises, provide a substantially large space within which Norges Bank might negotiate with targeted enterprises. Lastly, the framework of the Norges Bank may have spillover effect:
"Separately, the 235 billion Danish kroner ($36 billion) PKA, Hellerup, Denmark, said on its website that it had updated its criteria on coal companies to enter into dialogue with those for which 25% to 50% of their business comes from the commodity. It will also exclude companies where oil sands account for more than 50% of their business.One year ago, PKA blacklisted 31 coal companies and entered into dialogue with 23 companies for which 50% to 90% of business comes from coal." (here)
 The Press Release and Grounds for decision–Product based coal exclusions (7 March 2017) follow.

In its Press Release, the Norges Bank noted:

The exclusions follow Norges Bank Investment Management’s third round of analysis of companies that may be affected by this criterion. The exclusions comprise all companies’ unlisted subsidiaries that issue bonds. The exception is green bonds, or subsidiaries that are deemed to have significant renewable energy activity.

In accordance with the guidelines, companies may be placed under observation where there is doubt as to whether the conditions for exclusion have been met, or as to future developments, or where observation is deemed appropriate for other reasons. Norges Bank has for this reason decided to place an additional two companies under observation.

In total, Norges Bank has so far excluded 69 companies and placed 13 companies under observation based on the product-based coal criterion.

Norges Bank’s Executive Board made the observation and exclusion decisions based on recommendations from Norges Bank Investment Management. The Executive Board has found that the recommendations satisfy the criterion, and that the companies can be placed under observation or excluded from the fund (see § 2, subsection 2, of the Guidelines for observation and exclusion from the Government Pension Fund Global).

Read the grounds for decision (PDF)

Companies excluded



CEZ AS Czech Republic
Eneva SA Brazil
Great River Energy United States
HK Electric Investments & HK Electric Investments Hong Kong
Huadian Energy Co Ltd China
Korea Electric Power Corp South Korea
Malakoff Corp Bhd Malaysia
Otter Tail Corp United States
PGE Polska Grupa Energetyczna SA Poland
SDIC Power Holdings Co Ltd China

Companies put on observation



NorthWestern Corp
United States
Portland General Electric Company
United States

The first and second tranches of coal company exclusions may be accessed HERE.


Grounds for decision–Product based coal exclusions
7 March 2017


The Ministry of Finance introduced a product related criterion under the Guidelines for observation and exclusion from the Government Pension Fund effective 1 February 2016. Where thermal coal is a significant part of a company’s business activities, the company may be excluded from the fund.
The criterion states that coal power companies and mining companies who themselves, or through other operations they control, base 30 percent or more of their activities on coal, and/or derive 30 percent of their revenues from coal, may be excluded from the GPFG. Coal in this case refers to thermal coal.
In the process of considering recommendations for exclusion or observation of companies that breach the thresholds above, emphasis should also be given to the forward looking product/fuel mix transition as well as the degree to which the company utilizes renewable energy in itsactivities.
In April and December 2016 Norges Bank made public the first and second round of exclusions  and observations based on the product related coal criterion. We said we would continue our research to identify companies that may be excluded according to the product based coal criterion. In this document we present the results from the third round.

Terms and definitions
While the criterion provides guidance on which metrics and factors should be considered during the operationalization of the criterion, there are certain specifics which need to be defined and measured to ensure a transparent, consistent analysis and related implementation. Some of the key terms and their related definitions can be seen as follows:
Table 1 Terms and definitions

Term: Operational definition
--Revenue: The sales of the organization, also referred to as turnover.
--Activities: Business activities of the organization, typically natural groupings of revenue in segments.
--Fuel mix: The elements of fuel stock that go into power generation. These elements can be fossil fuels like coal and oil or renewables like solar and wind.
--Generation: The actual energy produced in a period, typically measured in GwH/MwH.
Capacity mix: The measurement of the capacity to generate power and is typically measured in MW.
--Thermal coal: Coal that is used for energy generation
--Metallurgical coal: Also called “met coal” or “coking coal”. This is coal that is predominantly used in the steel and metallurgical industries.
--Renewables: Energy from a source that is not depleted when used, such as wind or solar power.
--Power company: A company that has generation of energy as part of its activities (threshold dependent).
--Mining company: A company that has mining as part of its activities (threshold dependent).
--Green bonds: Bonds that are used to fund projects that have a positive environmental
and/or climate benefit

30 percent or more of revenue from thermal coal 
The threshold related to 30 percent or more of revenue is typically more applicable to the thermal coal extraction business than the power industry. The reason for this is that companies  in this sector often report revenue values split by extraction related to thermal and met coal which makes measurement against the criteria more transparent.

30 percent or more of their activities on thermal coal
This threshold entails an assessment of what a company bases its business on and is more relevant to companies in the power industry than to mining companies. As an example, companies deriving 30 percent or more of their revenue from self-generated energy production can be identified. The mix of fuel sources used in these companies’ energy production can then be assessed. If 30 percent or more of a company’s aggregate self-generated energy production measured in energy units is based on coal, it will be covered by the criterion.
The selection criteria described above may mean that the way a company chooses to organize its activities could play an important role in whether the company is covered by the criterion or  not. For example, integrated power companies with significant distribution or network operation activities may not be covered, even if coal accounts for a significant share of their energy production in isolation. At the same time, companies deriving less than 30 percent of their revenue from coal-based energy production may be covered by the threshold referred to in the previous paragraph.
The criterion focuses on thermal coal. This means that renewable energy cannot be offset against energy production from thermal coal when assessing the thresholds in isolation. As a result, the criterion could, for example, capture companies deriving 30 percent of their revenue from coal-based energy production and 70 percent from renewable energy. To address this, the criterion further states that importance should be attached to forward looking assessments including the share of business activities based on renewable energy sources.

We have collected data from numerous sources that cover both revenue as well as the amount of coal that is used in the fuel mix. Data related to the levels of granularity required to facilitate the operational analysis and implementation of the criterion is a particular challenge. There is a lack of centralized, or even company reported information, of the various levels required for analysis. Where a company does report related information, this is frequently at an aggregated level which means deriving representative values is challenging. As such, we engaged multiple, reputable data sources and vendors to assist us in this analysis. Through this process, one often sees that while the general level of data points between vendors is reasonable, the actual data points can vary significantly. Reporting across different time periods and measurements is an additional challenge. All of the data sources used are centrally stored. Examples of data sources that have been used are as follows:
Revenue data: Data is sourced from market data vendors, company financial statements, internal analysis, selected investment banks and our external managers.

Fuel mix data: Data is sourced from market data vendors, company SRI reports, internal analysis, non-governmental organizations (NGOs), selected investment banks and our external managers.
Green bonds

The guidelines for observation and exclusion address the issue of green bonds specifically. They state that recommendations and decisions on exclusion of companies based on the coal criterion shall not include a company's green bonds where such are recognized through inclusion in specific indices for green bonds or are verified by a recognized third party. All bonds issued by the proposed exclusions have been screened against the universe of green bond s in the Barcap MSCI Green bond index.

Company dialogue

Quantitative and qualitative data related to a company’s granular business activities, fuel types and fuel mixes is often difficult to obtain. In certain cases, it does not exist as public information and as such communication with the company provides the best and only source of relevant current and forward looking information. Certainly forward looking plans related to fuel mix transitions and the development of renewables capacity is best suited to be provided by the company. To support this information gathering, letters were sent to the companies.
Companies excluded
Based on the application of the criterion and the data analysis described above, as well as replies from companies, companies listed in table 2 will be excluded from the Government Pension Fund Global.
The third round has led to the exclusion of 10 companies.

Companies put on observation
The guidelines for observation and exclusion states that “observation may be decided when there is doubt as to whether the conditions for exclusion are met or as to future developments, or where observation is deemed appropriate for other reasons.” For the product related coal criterion, observation applies to companies that are above the relevant thresholds but where there is information related to stated plans, initiatives or other material factors that are likely to bring the company below said thresholds in the foreseeable future.
Examples of plans, initiatives and other material factors include:
-Material corporate actions such as divestment/spinoffs or planned acquisition of generation capacity,
-Publicly stated plans to close, add or alter capacity, such as mothballing of plants, addition of new non-coal or conversion of existing coal capacity.
-Events such as drought for large hydro-power utility companies or critical failure/fire/shut-down of existing capacity resulting in the need for backup coal to run above normal levels.
Based on the application of the criterion and the data analysis described above, as well as replies from companies, companies listed in table 3 will be put on observation. Companies put on observation will be afforded extra scrutiny and attention to monitor their progression according to plan.

No comments: