Sustainability and Materiality in the Natural Resources Sector

Sustainability and Materiality in the Natural Resources Sector

ABOUT SUSTAINALYTICS Sustainalytics is an international and independent sustainability research and services provider. Our global perspective is underpinned by nearly 20 years of experience in the responsible investment and traditional socially responsible investment markets. Recently the firm was selected Best ESG Research House by IPE/TBLI. Sustainalytics has more than 50 analysts assessing environmental, social and governance performance, and has research methodologies for more than 40 different industries. Internationally the firm operates as Sustainalytics, and as Jantzi-Sustainalytics in North America. Headquartered in Amsterdam, Sustainalytics also has local offices in Boston, Frankfurt, Madrid and Toronto. The information here in has been obtained from sources that Sustainalytics believes to be reliable; however Sustainalytics does not guarantee its accuracy or completeness. Copyright 2011 Sustainalytics. All rights reserved. No portion of this material may be reproduced without the expressed written consent of Sustainalytics. For further information contact: Sustainalytics P.O.Box 22703 1100 DE Amsterdam The Netherlands Tel. +31 20 205 00 00 Fax +31 20 205 0099 info@sustainalytics.com www.sustainalytics.com

EXECUTIVE SUMMARY That corporate competitiveness is linked to the management of both environmental and social impacts is becoming more widely accepted; and based on our analysis, this holds true for companies in the mining, oil and gas and forestry products sectors. However, not all corporate responsibility initiatives are linked to improved competitiveness. Our research identifies the specific environment and social performance areas that have the greatest potential to create or destroy business value. METHODOLOGY In this study we identified eight business drivers common to companies in the natural resources sectors and nine categories of environmental performance. We then worked to answer two important questions with respect to each possible point of intersection between these two areas of business operation: 1) how material is the correlation between the management of the environmental or social performance area and the business driver and, 2) how strongly does the evidence support the link. STEP1: DETERMINING ENVIRONMENTAL AND SOCIAL IMPACT AREAS In order to maintain an evaluation framework that accurately reflects impact and international standards and norms in the 42 industries that Sustainalytics tracks, we regularly incorporate information from a number of sources including our global reviews of best practices and controversies within each of the relevant industries; interviews with industry stakeholders, governments, NGOs, industry associations and financial institutions; and reviews of the international standards developed by organizations such as the Global Reporting Initiative (GRI), the Carbon Disclosure Project (CDP), the Extractive Industries Transparency Initiative (EITI), and the International Labour Organization. For the purpose of this report we identified five broad categories of social performance: Contractors & Supply Chain, Customers, Society & Community, Employee Relations, and Philanthropy; and we identified four broad categories of environmental performance: Contractors & Supply Chain, Operations, Climate Change, and Environmental Products. STEP 2: DETERMINING INDUSTRY SPECIFIC BUSINESS DRIVERS Measures of competitiveness at the firm level comprise indicators of financial performance, such as the development of revenue, the reduction of costs, as well the ability to access capital, which are influenced by a firm s ability to manage various business drivers. 1 P age

The figure above outlines the framework we use to connect competitiveness to the underlying drivers of company performance. It is ultimately through their impacts on traditional business drivers that the management of environmental and social impacts can influence firm competitiveness. In order to identify the industry specific business drivers for the natural resource sectors we engaged with company representatives and mainstream financial analysts who cover the oil and gas, mining and forestry sectors. We specifically asked them which business drivers they look at when evaluating firm value and direction. In this process we identified eight drivers, which are listed below, that are relevant to the natural resources sector as a whole. Each driver can be categorized as either internal (drivers over which companies have control) or external (drivers over which companies have less direct control). While the industries within the natural resource sectors share the same general business drivers, how each driver is defined is somewhat industry dependent. 2 P age

STEP 3: EVALUATING THE LINKAGES BETWEEN ENVIRONMENTAL AND SOCIAL FACTORS AND COMPETITIVENESS Lastly we cross-linked these eight drivers of business performance with the nine most important dimensions of environmental and social performance in order to investigate which aspects of a natural resources company s environmental and social performance are most likely to lead to business value and competitiveness. Our approach to investigating these questions included a review of existing literature, case studies and examples, and drawing insight from our work with major financial institutions and corporations in the field of corporate sustainability. Our review of existing literature included an analysis of more than 50 reports from credible sources that address the link between managing environmental and social performance and corporate economic performance. Every report was either relevant to or specifically about one or several natural resources sectors. This body of research is vast and diverse and includes: Descriptions of the links between sustainability issues and business performance Empirical correlation studies of business performance and particular aspects of sustainability performance Empirical studies of market returns of particular portfolios of companies Scenario-based assessments of how companies within a sector are poised to gain or lose from sustainability-related issues, in a relative sense Compendiums of case studies showing how individual companies have gained or lost from sustainability issues Guidelines to help companies make the business case in their own organizations A report had to meet a number of criteria in order to be included in the review. Those included came from a number of sources, representing views from a wide range of organizations including investment banks, business associations, non-governmental organizations, consultancies, rating agencies, academics and intergovernmental organizations. Each report was examined in relation to each sector (forestry, mining and oil and gas) with respect to the intersections between each business driver and each environmental and social performance area. We aggregated the results and scored each intersection along two dimensions: 1) the strength of the link and 2) how strongly the evidence supported the link. The findings from this process were tested through interviews with industry analysts and company representatives. 3 P age

KEY CONCLUSIONS POSITIVE IMPACT Overall, corporate responsibility performance has a positive impact on business success and a strategic focus on sustainable performance is aligned with mainstream business purpose. When an organization s most significant environmental and social issues are addressed, business value is created. The business case can be developed without having to exclusively rely on direct or tangible measures of business success. LINKAGES STRONGLY DEPENDENT ON STAKEHOLDER EXPECTATIONS Sustainability concerns and evolving stakeholder expectations are having a greater impact on the business environment than ever before. In all cases, links are strong or weak depending on stakeholder and government expectations. It is prudent to acknowledge the degree to which expectations from both of these groups are evolving and have evolved over the last five years. In addition, the business case is likely to strengthen in coming years, as stakeholder expectations continue to increase. MULTIPLE MEASURES The business case is strongest when multiple drivers of business success are considered. Some of the strongest linkages that were identified in our analysis cannot be captured in a simple payback or return on investment calculation. Links that support reputation are difficult to monetize. Links that mitigate risk are hard to quantify. It is interesting to note that the environmental and social areas that generate the most business value do so through their impact on multiple business drivers. A more holistic view of business success is required one that considers both financial results and underlying financial drivers. KEY BUSINESS DRIVERS Of the eight measures of business success that we identified for the natural resources sector, reputation is the measure that appears to be the most affected by corporate responsibility performance. This is not surprising as it reflects the findings from broader business case studies. Other powerful conduits to competitiveness that are affected by sustainability performance included operational efficiency, the role of the political and regulatory environment, access to natural resources and access to labour. FIGURE 1 - BUSINESS DRIVERS RANKED IN ORDER OF MOST AFFECTED BY CORPORATE RESPONSIBILITY 4 P age

In the natural resources sectors, competitiveness from corporate responsibility is generated through traditional business drivers such as reputation, operational efficiency, access to natural resources and access to labour. KEY AREAS LINKED TO COMPETITIVENESS For each report, we classified each of the intersections between business drivers and areas of a company s environmental and social performance into one of three categories, indicating the strength as strong, moderate, weak or negligible. For each report we also assessed the evidence supporting the existence of the link as either strong or weak. After assessing the level of materiality and the strength of evidence in the respective reports, we calculated the average score per point of intersection (linkage) and assigned an overall colour and a coloured traffic light. For each sector, the result was the identification of which environmental and social categories have the greatest potential to create business value. Our research reveals five environmental/social categories that are strongly linked to competitiveness in the oil and gas sector, four links in the mining sector and two links in forestry. 5 P age

SECTOR RESULTS OIL AND GAS The oil and gas sector faces significant exposure to environmental and social issues. Environmentally, oil and gas operations result in significant emissions to air, land and water and require substantial commitments for reclamation post-operations. Failure to mitigate these impacts can lead to increased costs in the short term, and more stringent regulations and reputational damage over the long-term. The sector must also concern itself with possible future climate change legislation and alternative energy mandates. Companies that prepare to embrace alternative energy and cleantech technologies are well positioned to capitalize on a potentially immense opportunity. Energy companies must also be cognizant of the importance of maintaining community support for their operations. One study by UN Special Representative John Ruggie estimated that one company may have experienced USD 6.5 billion value erosion over a two-year period from stakeholder-related risks, amounting to a double-digit percent of its annual profits. Companies with operations in emerging markets should be additionally concerned with human rights and the risks associated with operating in areas of political instability. Companies with operations in high-risk countries can suffer reputational damage that can in turn affect share value. Also linked to competitiveness are employee relations. It is of particular concern given the sector s historic difficulty in attracting and retaining skilled labour. 6 P age

MINING The mining sector faces significant exposure to both environmental and social issues. The strongest links exist between community relations and access to resources and reputation. Without proper engagement with local communities and aboriginal groups, there is a strong potential that opposition may impede a miner s ability to maintain business operations. Miners operating in conflict zones or countries with poor human rights records are particularly exposed. Within the environmental dimension two issues, tailings management and water consumption, are of notable importance. As the sector has relatively low direct GHG emissions, climate change was revealed to be less tightly linked to competitiveness, but is of emerging concern pending regulatory outcomes. Finally, as for many sectors, employee health and safety and labour relations are linked to competitiveness as addressing environmental and social issues has the potential to improve recruitment and retention. This is particularly relevant for mining because it is a sector in which skilled labour shortages are of concern in several regions. PAPER AND FOREST PRODUCTS The forestry sector is exposed to two environmental and social issues that have strong potential to affect competitiveness. On the social side, paper and forest companies that engage and consult with local communities and stakeholders are better positioned to earn their social licence to operate. Engagement helps to ensure a speedy permitting process and access to the forests. It also minimizes media and NGO attention and reputational risk. 7 P age

On the environmental side, new technologies and innovations related to non traditional forest products (e.g. biofuels) have strong potential to impact revenues and are touted by many as the golden ticket for a sector in hardship. There is also an increasing demand for forest products that have been certified to sustainable forest management standards, such as by the Forest Stewardship Council (FSC). CONCLUSION In our analysis we identified a number of strong, often underappreciated, links that influence business drivers and impact competiveness. A deeper understanding of these links should be leveraged by industry professionals to create shareholder value and should be incorporated into investment managers engagement or investment decision-making processes to reduce risk and influence returns. For each industry there are both environmental and social areas linked to competitiveness. The specific linkages are unique to each industry. 8 P age

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