Increasing number of ESG risks shows company is not committed to a low-carbon, sustainable future, says manager.
Federated Hermes has divested from oil giant Pemex across its credit strategies, but the asset manager has pledged to continue engagement efforts on climate and social-related performance. The decision comes after Federated Hermes determined that the ESG-related risks associated with the Mexican 100%-state-owned petroleum company are now too high.
The asset manager highlighted concerns over weak governance, an unsafe workplace environment, rising emissions and a lack of response to its engagement efforts. Federated Hermes downgraded the company’s ESG score to 5, meaning that its ESG policies and behaviours are considered to be materially and negatively impacting its cashflows and credit profile.
“However, given our aim to drive sustainable wealth creation, we will continue engagement with the company as we believe in the positive impact of stewardship in the long term. In addition, if we get results from stewardship and we sense that management is genuinely committed to driving positive change, we can reconsider our currently very negative view on the company,” Federated Hermes said.
The asset manager has been engaging with Pemex since 2017, both on behalf of the International Business of Federated Hermes and as part of the broader coalition under Climate Action 100+.
A particular area of concern is that gas flaring at Pemex facilities has increased by 54% year on year, as of Q2 2021. Gas flaring refers to a gas combustion device used in industrial plants, including petroleum refineries.
The increase has been driven by a number of factors, including increased production and failures of compression equipment.
“It is concerning that a lot of the flaring is caused by seeming mismanagement of Pemex operations,” the asset manager noted.
The company’s sulphur oxide equivalent emissions also increased by 37% year on year as of Q2 2021.
Pemex is a member of the Oil and Gas Climate Initiative (OGCI), alongside other oil and gas giants such as Shell and bp. OGCI is a CEO-led initiative aiming to accelerate the oil and gas industry’s response to climate change by investing in low-carbon technological solutions.
In terms of health and safety, since 2018 there have been 16 major refinery workplace accidents at Pemex, with the number accelerating over the last few months.
In April two fires occurred at the transfer pump house of the General Lazaro Cardenas del Rio refinery and in the pipeline supplying natural gas from the Cenagas to the company’s work centres. During the former fire, 12 people sustained minor injuries.
“The increasing number of incidents caused us to question the management’s ability to conduct the company’s operations in a safe way, putting its workers and the environment at risk. This may also result in lost revenues and cash flows due to operational disruptions and repair costs,” Federated Hermes said.
Further, the asset manager noted “numerous reports” of Pemex providing inadequate Covid-19 protection to its workforce, including poor conditions on the offshore platforms and being slow to sanitise working and living spaces. In August 2020, a floating Pemex oil processing and storage facility off the coast of Campeche State had to suspend operations for six days following a Covid-19 outbreak, Federated Hermes said.
The company also showed little ambition to improve its sustainable-related performance in the longer term in its updated business plan, published in March. Further, Pemex provided few details about efforts to transition to a low-carbon world, including only “minimal and disconnected emissions reduction targets”, Federated Hermes noted.
Although asset owners and managers are increasingly willing to divest firms if they continually decline to address ESG risks, this does not necessarily lead to complete severing of the relationship. For example, Legal and General Investment Management (LGIM) has reinvested in companies demonstrating improvements inspired by engagement with the asset manager, even after divestment. American retail company Kroger introduced a comprehensive deforestation policy after LGIM divested and now provides evidence for compliance with this policy via CDP Forests, leading LGIM to reinvest.