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ESG provides profitable returns from smart capital allocation – analyst

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Nedbank mining equity analyst Arnold van Graan.

15th June 2022

By: Martin Creamer

Creamer Media Editor

     

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JOHANNESBURG (miningweekly.com) – Environmental, social and governance (ESG) frameworks not only help businesses and the communities in which they operate but can also generate positive returns as mining companies reduce operating expenses and receive favourable investor interest and cheaper finance.

When it comes to ESG, the cost of non-compliance with stakeholder demands could be substantial, as companies are at risk of losing their licences to operate. However, the good news is that ESG initiatives can pay for themselves and support profitability.

When implemented correctly, ESG projects not only improve stakeholder relations, but also yield considerable financial benefits almost immediately.

The right ESG projects could also attract cheaper forms of finance, making it easier to fund and allocate capital to such projects. Ultimately, these projects could boost a company’s ESG credentials, attracting investor interest and resulting in better valuations.

This is the view of Nedbank mining equity analyst Arnold van Graan, who notes further in an Op-Ed to Mining Weekly that most mines aim to reduce their carbon footprint by 30% by 2030 as part of the global decarbonisation drive, which would be achieved mainly through renewable wind and solar energy projects.

Several large solar projects have already come on stream to reduce reliance on fossil fuels and replacing diesel-generating capacity with gas or other lower-carbon alternatives has been another trend.

Although initially capital-intensive, ESG projects, he writes, yield cost savings for mines, helping offset the capital outlay amid energy being a huge cost driver that weighs heavily on the bottom line, as it accounts for 25% to 30% of direct operating costs.

Businesses also benefit from less downtime by moving away from traditional power grids often plagued by outages. As a result, most of these early-stage renewable-energy projects should generate strong returns that exceed the internal hurdle rates set by companies. These projects, therefore, do not just pay for themselves, they generate positive returns, Van Graan states.

2050 TARGET

In time, ESG strategies would mature further to meet the 2050 carbon-neutrality deadline set by many companies. This means moving even more of their energy sources away from fossil fuels towards renewable energy sources.

The size, scale and complexity of these endeavours in pursuit of net zero are expected to differ materially from the initial wind, solar and battery storage projects being rolled out to meet the 2030 targets. The capital outlay of these projects could, thus, be much higher, making it harder to generate the same level of returns seen up to now, Van Graan writes.

Yet, there would still be long-term benefits in terms of carbon emission tax reductions, which should offset the cost. In addition, technological advances and economies of scale should make these projects more efficient and aid the economics.

BROADER BENEFITS

Van Graan expresses the view that the benefits of meeting these ESG targets go beyond the metrics measured by traditional financial metrics. Mining companies realise that, collectively, sound ESG practices make for sustainable business. Communities, governments, and investors are more likely to support a mine with solid ESG initiatives in place. The benefits of this could be substantial, including higher valuations, he writes.

Investors and finance providers are beginning to understand and appreciate the link between a solid ESG implementation track record and a company’s financial viability. Just as a company with a good safety track record would inevitably have good operational and financial performance, one with solid ESG outcomes should deliver the same upside.

ESG could therefore play an increasingly important role in the broader capital allocation framework. According to Deloitte’s 2022 report that tracks ESG trends in the mining sector, companies are thinking more holistically, aligning their capital spending with ESG commitments. Companies and financiers alike need to ensure holistically that their capital is allocated to fit with their broader ESG strategy, as investing in ESG makes business sense.

REPORTING CONUNDRUM

Mining companies have for a long time been incorporating ESG into their strategies, but they have not always received full credit for these initiatives, owing to inadequate reporting. The biggest challenge mining companies face in driving ESG best practices is the lack of standard ESG reporting metrics, notes Van Graan.

Although a coalition of more than 50 companies, supported by the World Economic Forum, has created a comprehensive set of metrics that highlights the need for consistent ESG reporting, this has yet to be widely implemented and legislated. Since January 2021, only 120 companies have shown support for these metrics that enable easy comparison of companies, regardless of their sector or region.

While some mining companies are doing more in terms of ESG than is being reported, not all are on par, and there is a need to hold companies accountable, Van Graan adds.

In his view, a standard reporting system to track performance against ESG targets and requirements is needed to show where the gaps are.

He states further that the best reflection of whether a company is faring well as far as ESG is concerned is how stakeholders respond to how it operates. A mine that is not in good standing would encounter community resistance or could see governments take them to task, as we have seen in many jurisdictions in recent years,” he notes.

“ESG principles are a business imperative and should be driven from the top down, not through shareholder activism. It would benefit the sector in terms of cheaper access to finance, lower operating costs and better relationships with governments and the communities in which they operate. Sound ESG practices make for sustainable business and make business sense,” Van Graan concludes.

Edited by Creamer Media Reporter

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