Due to the complexity associated with most environmental, social/safety, and governance issues in the natural resource space, we do not employ screens when evaluating the ESG capabilities of individual companies and management teams or the potential implications of ESG-related matters on future commodity fundamentals. Instead, we incorporate ESG considerations into our investment/risk management process as a key pillar of our vetting process.
Our focus is on identifying upstream commodity producers that can create economic value across a commodity price cycle. While asset quality and management’s capital allocation acumen are critical variables in the value creation calculus, we have witnessed numerous instances where investors have suffered permanent capital impairment from failures related to ESG. As a result, ESG assessment is binary, similar to the way we view sovereign risk. Haircutting future cash flows or increasing discount rates does not compensate owners sufficiently for the potential downside created by a less than rigorous approach to environmental compliance, operational safety and prudent local and corporate governance practices.
In evaluating ESG-related issues, our due diligence process includes site visits, meetings with management and operating teams, and discussions with service providers, government officials, competitors, local business leaders, environmental groups and other stakeholders. If we conclude that ESG-related issues are not being managed properly, or that above-ground risks are simply too great, that company is eliminated from the investment process. For companies that pass our risk assessment process, ESG remains a critical part of our on-going due diligence.
ESG-related missteps will cause either a sale of a position or an increase in engagement with the Board and management team.