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ESG Trends in the Base Metal and Diversified Mining Industries: BMO Equity Research Report

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In this special episode from BMO’s IN Tune Podcast, host Camilla Sutton is joined by Doug Morrow to discuss the key findings from the department’s recent launch of ESG coverage for the base metals and diversified mining industries.

IN Tune features Equity Research analysts from BMO Capital Markets and explores key emerging themes, trends, and important issues to our institutional clients globally.

In this episode:

  • How investors can apply the findings in their investment process

  • The amount of financial and human resources that mining companies are investing in to improve their ESG performance

  • How it’s difficult to identify an industry that won't be affected by the energy transition, at least in some way


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BMO Equity Research Podcast disclosure

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Camilla Sutton:

How does the mining industry think about ESG? And how is the sector doing in terms of making progress across environmental, social, and governance issues? Today, I'm thrilled that we're joined by Doug Morrow, Director, ESG at BMO Capital Markets for a deep dive into the ESG landscape in mining. I'm Camilla Sutton, MD in Equity Research. Doug, I'm really looking forward to the journey you're going to take us on today. And obviously, very glad to welcome you back to our IN Tune podcast. So, let's get started. Doug, you created a lot of buzz on your recent ESG and mining report, “Beneath the Surface: Exploring ESG Trends and Progress in the Base Metal and Diversified Mining Industries”. Can you talk to us a little bit about the report and how it all came together?

Doug Morrow:

Sure. Thanks very much Camilla. So, as part of our strategy, we're rolling out, just in terms of background, ESG coverage on all 900 or so stocks that we cover as a research team. And with the 25 companies that were included in this report on base metals and diversifieds, we're now at about 300 tear sheets across our full coverage, which is to say that clients can access our research platform, and in addition to complete fundamental analysis, they can also now get an ESG Tear Sheet for these 300 companies that shows how companies are performing on relevant ESG KPIs for their industry, and noteworthy practices that management teams have implemented to manage their ESG risks and opportunities. So, I just wanted to put that out as background. Now, as for the mining report, this was the 15th report that we've done, and I would say, by far, it took the most planning and preparation of any that we've done so far, partly because we were working with five covering analysts, so the mining analysts, to get this report out the door, and also partly because mining is just such a high-impact industry with tons of ESG disclosure, and really no shortage of material ESG issues. So, you know, we had several back-and-forth meetings with mining analysts, beginning back in, in Q2 of this year, where we finalized you know, which issues to look at, which indicators to look at, taking into account some of the established frameworks such as SASB, TCFD, ICMM, et cetera. And we also sprinkled in our own intuition about where, you know, the market is going and what the buy side is looking for. So, it took a lot of time, it took weeks even, simply to decide which denominator to use to normalize company performance in some of these metrics, for example, greenhouse gas intensity. And now in terms of the process, once we had that framework in place, the analysts and their teams populated the tear sheets, and then redacted copies were sent to all the management teams for comments and sign off. So yeah, my team pulled all the findings together and led the write-up of the final note, which was published on October 14. So that's kind of an overview of how it all came together.

Camilla Sutton:

It's quite the process. Doug, why don't you walk us now through the core findings?

Doug Morrow:

Sure, there are a lot of them. I mean, mining is really just such a fascinating industry from an ESG perspective, there's just so much going on, so much data to work with. I would say the industry, you know, has faced enormous ESG scrutiny over the years, from investors, regulators, community groups, indigenous groups, customers, the list just goes on and on. And I think this reflects the high impact nature of the industry, as well as some of the recent missteps that we've seen in the industry, for example, the Brumadinho dam collapse back in 2019, and the Jukan Gorge cave destruction in 2020. But I think certainly one of the key findings from our note is it's just a tremendous amount of financial and human resources that mining companies are investing to improve their ESG performance. I believe that companies that screen well on ESG are likely to deliver superior returns over the long term in any industry, but I think this is particularly the case in mining, where we've seen better ESG performers enjoy a lower cost of capital, better relationships with stakeholders, even potentially reduced permitting timeframes, and just tighter, more efficient and well-run businesses. So that's kind of a high level overview, but in terms of specific findings on key issues, let me just quickly touch on three. The first is just mining companies are investing heavily in improving minerals, traceability, and responsible supply chains. So these are definitely going to be two phrases that you hear a lot more of going forward and key issues for the industry in my view going forward. So minerals traceability, this is about following the trail of minerals along the supply chain by tracking the chain of custody along all steps in a supply chain, including miners, transporters, exporters, processors, and manufacturers. And I think what's interesting is that, as in other industries, customers increasingly want to know what is in their products, how they were made, and metals and mining is no different. So lots of companies in our coverage are doing work to improve the transparency of their products, but some practices really caught my eye; for example, BHP with its recent carbon neutral copper transaction, Rio Tinto’s START responsible aluminum initiative, the pilot work that Teck Resources is doing with Blockchain to develop product passports. These are all you know, I think, very, very noteworthy practices. A related question that the industry is grappling with is simply whether consumers will pay a premium for sustainable metals, for example, low-emission copper, low-emission zinc, etc. Now, one of the companies we spoke with said that this premium already exists in the market for zinc, but it's razor thin. Now, it could be that sustainable metals, as we say in the report, end up becoming the market standard, and that commodities without this designation, trade at a discount. But the real issue here is measurement. We just don't yet have a definitive market stamp of approval to demonstrate these qualities, but progress is being made. A second issue. I think, Camilla that's really critical here is, is obviously climate change and emission reductions, we looked at 25 companies, as I said, at the beginning, 17 of these companies have set a greenhouse gas reduction target. But when you look under the hood, there are really big differences. First, only seven of these companies express a commitment to tackle their Scope 3 emissions. So, these are Anglo, BHP, Glencore, Rio, South32, Teck, and Vale, so many of the larger, heavier resource companies in the coverage. Now recall that, Scope 3 emissions are those that are outside a company's direct control, including emissions from, for example, a company's suppliers, and emissions associated with the use of a company's products. There are diverging views on Scope 3 in the investor world, but I think it's fair to say that many investors are engaging their portfolio companies, including mining companies to measure and take accountability for these emissions, in addition to the more conventional Scope 1 and 2 sources. I would also say that among these seven that have expressed their commitment to tackle Scope 3, really only two, Glencore and Vale, have what I would consider a measurable Scope 3 target, for example, a specified percentage reduction over a defined time period. But still, I think that all seven of these companies are really demonstrating industry leadership by making a commitment to tackle Scope 3, and then another thought here is simply that in terms of Scope 1 and 2, we found that some companies are using intensity-based targets, others are using absolute targets. And I think the companies that scan as having the most ambitious approach to their Scope 1 and 2 are Central Asia Metals, First Quantum, Freeport, Glencore, Rio Tinto, and South32, all of these companies are targeting a 50% reduction in their emissions by 2030, or 2035, in the case of Glencore and South32. And then just quickly, a final theme here that I wanted to touch on is diversity, equity, and inclusion. Now, the mining industry has historically struggled with improvements in DE&I, due to several factors, including legal barriers, as surprising as many of us might find it, there are some countries where women are prohibited from working underground, believe it or not. So, we found that the industry as a whole, despite some of these legal barriers, and other factors, has made headway in improving diversity in recent years, at almost every company in our coverage, among these 25, the percentage of women in the workforce has trended up over the last three years, and the most significant increases came at Antofagasta, where today 17% of the workforce consists of women that's up from 10%, a few years ago, and BHP where the percentage has increased from .26 to 32. So yeah, that's kind of some high-level thoughts and some of the core issues.

Camilla Sutton:

There's so much in what you just said, that surprises me and has me thinking about other questions. But maybe I could sum it up easily with asking you the question, what surprised you the most as you did the work and wrote this report?

Doug Morrow:

Yeah, it's true. There really was a lot, a lot to go on. And a lot of things stood out for me for sure. But when I really reflected on what surprised me the most, I would say it was probably the use of ESG paylinks. So, this is shorthand that we use at BMO for mechanisms that link executive comp with progress against corporate ESG goals. Now, these mechanisms have become quite topical in the ESG world, and they've been around for many years, but when they first came out, when I took a look at them, there was a real lack of clarity about how they worked. For example, you know, what's precisely being measured here and how much compensation is being affected, etc. Many of the paylinks in the early days were short on these details. But I have to say I was really, really impressed by the transparency that I saw with the ESG paylinks in the mining industry. Most companies that have set them up, not all but most, clearly lay out how they work. For example, as I said before, what percentage of comp is affected? Precisely which ESG metric is being tied in, et cetera. And the most ambitious pay link, if you want to put it that way is in place at Rio Tinto. So 35% of the short-term incentive plan at Rio Tinto is driven by safety, specifically fatalities and injury rates, and then a mix of social and climate measures on top of that. And something else that I found, perhaps not surprising, but interesting is that in many cases, at these companies, a single fatality will nullify the entire contribution of the ESG paylink for the executive team. So, I think it's really evident that mining companies are putting substantial emphasis on workplace safety.

Camilla Sutton:

Such an important piece. So, talk to us then a little bit from an investor point of view. How do investors operationalize these findings?

Doug Morrow:

Well, I think they can apply the findings from this note in a few ways. I think from a portfolio construction point of view, I think the work that we've done in this note can help investors identify top performers on specific themes. For example, climate change, water management, biodiversity, stakeholder engagement, etc. And this really lays the foundation for investors to take a thematic approach for ESG integration, for example, tilting their mining allocation towards companies with a superior water strategy or climate strategy, etc. And in our conversations with investors, we find that many are moving away from composite third-party scores to more nuanced approaches. And I think this really aligns with the theme-specific assessments that we take in our ESG analysis at BMO. And then the second way would be through engagement. So, active ownership is really a crucial part of an overarching ESG strategy for investors. And what this note does, is clearly shows what best practice looks like on all of these issues and themes. And not only in conventional areas, such as greenhouse gas reduction targets, but in emerging areas too, like Biodiversity Management, the ESG experience of board directors, etc. So, I think this note can really help investors with their engagement strategies, because they can cross reference existing practices with what others in the industry are doing, and then use their influence as shareholders to push for adoption. So, I do believe this report will have a long shelf life as a source of ESG best practices in the base metals and diversified mining industries.

Camilla Sutton:

So, looking ahead then, where do you think ESG will go from here in the mining industry?

Doug Morrow:

Well, I think it's going to become more embedded in the way that mining companies, you know, do business and think about their business strategy, because, as we talked about earlier, they're just such clear and tangible business benefits associated with ESG in this industry, in terms of the lower cost of capital, the tie-in with a social licence to operate, which is just absolutely crucial to nourish in the mining industry, because it's such a high impact industry. Realistically, I do think it's possible that we will see a slowdown in some companies’ spending on ESG initiatives, just due to the uncertain financial climate that we're moving into, but I do expect this will normalize over time. And the positive side to that is that there's more and more data coming out about how senior executive teams increasingly see ESG as a value-creating exercise, not just as a, you know, one dimensional cost center. And I think this is going to unlock all kinds of new possibilities for exploring progressive ESG practices in the mining industry in the future.

Camilla Sutton:

So, Doug, we focus a lot on mining in this particular podcast. But I think it's interesting, because you have written across so many sectors, in fact, 15 reports you said at the beginning of the podcast, is there a theme that is common across all sectors? And maybe is there one that is unique for each sector?

Doug Morrow:

Yes, absolutely. So, I'd say it's a combination of the two for sure. I mean, in some industries, you know, water management, for example, matters a lot more in some than others. But there are some commonalities. So, one for sure is climate. And it's interesting because obviously some industries will have different levels of exposure to, you know, physical climate impacts, as well as transition risks, as you know, as the world moves through energy transition, but I'm hard pressed to think of an industry that won't be affected in some way, by energy transition, or the shift to a net zero economy. So, I think climate is consistently showing up as a key ESG theme, and in virtually every industry we've tackled so far. Second, diversity, equity, and inclusion. So we've had several companies tell us even in highly energy-intensive industries that the ESG issue they get asked most about is diversity. You know, not every company, but we've definitely had several companies tell us that with questions from investors on what are they doing to promote diversity within their ranks, goals that they've set, etc. So, this is also of universal importance, in my opinion. And then the final one is governance. So, you know, in my view, G issues are typically universal, and in all 15 of the industries that we've looked at so far, and launched on, we've taken a look at what we call ESG governance. So this means, you know, how boards are overseeing ESG, which committees are responsible, is the CEO involved, the use of paylinks, as we talked about earlier, as well as just how they set up their structure to manage all this, all these issues. So that's another example of a universal theme.

Camilla Sutton:

Any that stand out that are different sector to sector?

Doug Morrow:

Well, I think water would be an example. You know, typically, this is not a issue of importance, relatively speaking for banks, or insurance companies, or financials, but it's absolutely crucial, for example, in the food industry, so that would be an example of how we tailored our ESG tear sheets when we launched on to food sectors to look at water.

Camilla Sutton:

One last question for you. You recently launched a new report on climate change in US REITs. Can you walk us through just some of what's critically important for investors to understand with that work?

Doug Morrow:

Yeah, absolutely. What makes it unique is in my view is it was a real collaboration, we worked with two teams at BMO, the BMO Climate Institute, as well as the BMO Data and Analytics team. And we also partnered with a third party called Climate Engine. And I would say that my team, the ESG team, as well as the US REIT team, so John, Juan, and Ari, based out of the US, in some ways, we had the easy part, we simply had to take up, you know, collate all the findings and write it all up. But there's a ton of scientific expertise and data engineering that went in behind the scenes to that report. So, to put it bluntly, what we did here is the reason it's important for investors is simply that the physical impacts of climate change, as, as I think we can all agree, are intensifying around the world, and what we did in this note was take a look at how the US, the 70 US REITs in our coverage could potentially be affected by flood, wildfire, and wind risk, taking into account different climate scenarios. And I think what's interesting, again, is just the connection between ESG and business here, because we're finding that REITs are facing very, very significant increases in their property insurance costs at the time of reset. There's also the potential for lost revenue, as well as higher operating and energy expenses. And another reason I believe this is particularly important for investors is that many REITs right now describe to their investors the proportion of their portfolio that falls into, for example, a 100-year flood zone, but what we found is that many REITs, who do this are using FEMA maps, flood maps in the US, and there's a growing body of evidence showing that these maps, although widely accessible, are based on data that are incomplete and out of date. So, when you overlay a much more precise methodology, such as the one we do, did in this note, you get differentiated analysis. I think these are some of the reasons why this report is going to stimulate a lot of conversations with our clients and the market at large.

Doug A. Morrow ESG Strategist

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