Solving the ESG puzzle

By: Noora Mukhtar, Senior Researcher, GPCA

Why ESG is becoming a hot topic?

ESG is continuously growing which indicates how important it is becoming, creating consumer trust and developing positive relationships with investors. It is an essential aspect that companies are utilizing to gain a competitive advantage.

The global sustainability challenges that the world is facing are presenting new risks for investors that may not have been seen in the past. In addition, the economic pressure the COVID-19 pandemic has imposed on some industries has affected their exposure to ESG risks and their ability to manage them. As a result, companies face rising complexities and greater scrutiny if they are not adequately managing their ESG or climate risk. Governments across the world are mandating practices to encourage and foster better behavior, reduce risks and liability.

Another driver is the rising interest of the younger generation of investors around the world which has driven the rapid growth in ESG investment. Moreover, with the current advanced technologies, investors are able to minimize the dependence on voluntary disclosure from companies and increase the suitability and precision of data collection, analysis, and authentication. Consequently, making it easier to convey robust content and financially significant ESG insights.

Moreover, many research and recent trends have shown ESG’s appealing impact in creating higher value and shifting wealth trends, advocating that ESG is “much more than a fad or a feel-good exercise”. A study by McKinsey & Company revealed that a strong ESG proposition is linked to value creation in five essential ways: top-line growth, cost reductions, lower regulatory risk, productivity uplift, investment and asset optimization, and positive brand image.

Figure 1: ESG growth

Source: GPCA research

Figure 2: ESG main drivers

Source: McKinsey, GPCA research

What’s in it for the chemical industry?

ESG offers several opportunities for chemical companies such as:

Investments: The chemical sector is a capital-intensive industry and by aligning with ESG investors’ expectations and values, companies are recognized and avoid losing ground to greener rivals and may score higher rates and ROIs. Establishing their entity well in ESG could help them access broader sources of capital and larger pools of cash as managing authorities’ probability to trust businesses with a strong ESG proposition is higher. There are many ESG funds/ stocks and green bonds such as the Sharia-compliant green bond, in which Saudi Arabia and the United Arab Emirates hold $1.3 billion worth of green sukuk and $1.2 billion floated, respectively. FAB was the first MENA bank to issue a green bond and has financed over USD 10 Billion in sustainable projects, and it is the first GCC bank to join the Net-Zero Banking Alliance (NZBA).

Performance: Cut costs since efficient use of energy, water conservation and waste reduction can affect operating profits. The GPCA members’ estimated savings owed to their environmental performance through resource conservation exceed the $900 million threshold.
Optimization: ESG ratings allow companies to benchmark their performance to understand their areas of strength and weakness and optimize their risk management processes.
Competition: Being proactive and prepared as investors are increasingly asking for detailed objectives around an entity’s ESG strategies and monitoring their progress.
Image: Distinguish their sustainability efforts from peers in the eyes of investors and as well the community. Form social credibility and deliver a strong, dynamic message to stakeholders and appeal to more women and younger generations as both employees (boosting company’s productivity and employee motivation), and clients who demonstrate more devotion and loyalty to sustainable companies and products. According to a recent Mercer poll, employee satisfaction and appeal to talent were found to be higher in top-performing companies with strong ESG frameworks in place.
Support: In the form of reducing the risk of unfavourable governmental action threatening corporate earnings and as well gaining regulatory and legal benefits where clear ESG priorities may attract subsidies, government support and deregulation, while avoiding penalties and enforcement actions.

What should the chemical industry focus on?

The highest pressure on the chemical industry to improve ESG-related practices under each pillar is shown in table 1. There are different ESG scoring providers such as MSCI, Sustainalytics, Bloomberg, ISS, Dow Jones and S&P which have frameworks created by the financial services company specifically to inform investment decisions and benchmark against other competitors in the investor’s portfolio. According to SASB standards, ESG industry materiality topics relevant to the chemical industry is tabulated in table 2 below which highlights the highest average weight issues under each pillar:

What are the regional and global ESG-related trends in the sector?

Many of the regional industry companies are working towards establishing governance through sustainability councils for setting sustainability vision, priorities, and goals. They are working and collaborating towards supporting the circular economy through plastic recycling solutions and carbon capturing and storage. In addition, the region’s vast potential in solar, wind and green hydrogen energy allows using renewable power to run petrochemical and chemical plants.

For example, SABIC has been recognized as the Best ESG Responsible Petrochemical Company in Middle East/Africa for 2020 and has established an ESG Reporting steering committee headed by the CFO, to take charge of the ESG reporting strategy and roadmap.

Another GCC ESG trend is the local employment contribution of the chemical sector to local employment targets, where the 2020 nationalization rate in the GCC states was at 71%.

On a global level, BASF estimates 28% of its products, contribute to sustainability initiatives, and since their operations involve handling dangerous products and complex chemical reactions, safety of the workforce is also a material aspect of their ESG analysis especially following the explosion incident in Luftwigshafen in 2017. Another example is the Dow chemical company which has taken some steps to reduce its exposure to the hazardous nature of its product portfolio by discarding many of its chlorine assets, and has adapted to the shifting needs, environmental and social challenges through M&A and restructurings. As for Solvay, they have reduced hazardous industrial waste by almost 50% in the span of 2 years after the deconsolidation of the Performance Polyamides business and has entered into a corporate social responsibility framework agreement with IndustriALL Global Union to reinforce the company commitments on health and safety at work, anti-discrimination, diversity, and environmental protection. It has established a strong safety record where medical treatment accident rate (MTAR) decreased to 0.54 in 2018 down from 0.77 in 2016. Nutrien, an industry leader in producing crop nutrients and services, includes in their production and operating reports, the costs of complying with the various environmental regulations that they are subject to which are mainly focused on air emissions, wastewater discharges, land use and reclamation, groundwater quality, and solid and hazardous waste management.

Table 1: Pressure to improve ESG practices in the chemical industry

Source: ADI Analytics

Table 2: SASB ESG chemical industry materiality relevant issues

Source: SASB

Who are the leading chemical industry players in ESG?

There are four chemical companies in the Investor’s Business Daily (IBD) top 100 ESG companies which are Linde (rank 2, ESG score 76), Cabot (rank 28, ESG score 68.1), Advansix (rank 30, ESG score 67.76), and Chemours Co. (rank 65, ESG score 64.58).

Regionally, SABIC and Sipchem ESG ratings sit under the average spectrum with BBB and BB MSCI scoring respectively. They are both considered leaders in terms of carbon emissions compared to their industry peers and average in terms of corporate governance, corporate behavior and toxic emissions and waste.

What are the ESG-related challenges faced in the chemical industry?

Petrochemicals and chemicals’ key stakeholders play an important role in the industry’s green revolution. The regional industry is striving to think creatively when it comes to transition planning, however, measuring emissions along the industrial value chain remains a challenge. Accurate measurement and calculation of scope 3 emissions along the industrial supply chain and product distribution, which are among the most significant contributors to greenhouse gas emissions in the broader chemicals and petrochemicals industry, presents a challenge for the segment. From a trading perspective, the strategic position of the GCC could offer a lower-cost solution for reducing scope-3 emissions globally. This requires retrofitting and replacing ageing ships with new designs that would be compatible with future, environmentally accepted energy sources.

Other challenges faced by firms as they incorporate ESG into existing risk management frameworks, are namely governance, since ESG has a wide scope and impacts numerous risk types and business segments, framework due to lack of harmonization and different methodologies and scoring systems, access to consistent ESG data, and changing disclosures requirements.

How to go forward?

The GCC region have always been leaders and pioneers in the chemical industry. Following on this positive image, it is imperative to establish an early-mover advantage in sustainability and make the effort to integrate ESG in their business models. Otherwise, the chemical industry will find it both difficult and expensive going into the global transition to net zero emissions.

Financial companies get their ESG data either from ESG rating agencies or directly from enterprises. Therefore, engaging with the rating providers to understand their scoring system mechanism, ensuring transparency and accuracy of the gathered data, and continually following up on any update from the regulatory authorities on any ESG information is crucial.

Sustainable development in the GCC’s chemicals and petrochemicals industry – including expanding the use of renewable sources of energy and ongoing efforts to minimize harmful greenhouse gas emissions – looks set to boost the segment’s contribution to non-oil GDP revenue from 2022 onwards. This should ultimately increase the region’s resilience to external headwinds, drive value-added production and present wide-ranging investment opportunities over the coming years.