Written By: Elizabeth Carey
Independent Investment Adviser

Elizabeth Carey says investors must be clear-eyed about developments beyond the landscape of western capital markets. Policy makers leading COP26 negotiations must engage pragmatically with countries and regimes where ESG values do not yet measure up to western market aspirations

Anyone working with the LGPS probably feels steeped in RI, ESG, “Impact Investing”, TCFD, Scope 1, 2 & 3 emissions, UN PRIs and SDGs¹ and the exclusion vs. engagement debate along with myriad of ESG indices from various vendors. We could be forgiven for thinking that the rest of the world sees things similarly, especially now that the Biden-led US has re-joined the Paris Climate Agreement and will be rolling out its green agenda. With the UK hosting COP26 this Autumn, a real prospect exists to agree some meaningful targets². Such an outcome requires us to remove our ESG-tinted glasses when we confront events unfolding beyond the edges of the Western capital markets.

Vostok Oil and the Northern Passage
The story of Vostok Oil illustrates how large swathes of global industry remain far removed from the shift towards ESG and RI that practitioners in the Western capital markets are promoting through capital allocation decisions. Vostok leads a peloton of Russian State-controlled industry players, undertaking a colossal investment (estimated at RUB 10 trillion or over $130 billion) in infrastructure and capital equipment to expand Arctic oil and gas production. Through this development, Russia intends to transform the 5,770km Northern Passage into a competitive shipping route between Europe and Asia. Vostok Oil will allow the Russian energy company Rosneft to deliver 30 million tonnes of oil via the Northern Passage by 2024. Shipping volume is expected to increase fourfold: initially focused on transporting oil and gas from Arctic and Siberian fields, shipping can extend to LNG, coal and other minerals and eventually bring tourism to Siberia. In short, Vostok Oil resembles a New Deal style project undertaken by US President FDR in the 1930s rather than a commercial venture. The Russian Government expects the Vostok Oil project to generate around 400,000 new jobs. It will require 15 new towns to be built in Siberia, a region that has historically lacked economic development.

Strategic national objectives
Where a sector like oil and gas lies at the heart of a national economy, it seems unlikely that Task Force on Climate-related Disclosures (TCFD) metrics or other ESG / RI considerations – as they are understood in the UK pension industry – will provide compelling motivations for state-controlled companies to make material changes in their business models. Strategically important companies like Rosneft, Gazprom, Equinor, Saudi Aramco or even the Chinese National Oil Company serve their state owner-masters by delivering hard currency, creating political leverage through trading dependency, and securing fuel for national populations, all of which strengthen the current regime. Strategic national objectives rather than return on invested capital or share price performance drive investment decisions.

Despite not adhering to Western capital efficiency measures, State controlled energy companies have no trouble attracting external debt and equity capital. In late 2020, Rosneft sold a 10% stake in Vostok Oil to a subsidiary of the privately held commodities trading house Trafigura Group for around €7.3 billion. This €73 billion implied value of Vostok Oil was higher than Rosneft’s equity market capitalisation of €54 billion³. The Trafigura stake gives Rosneft ready access to commodities markets for Vostok’s future Arctic hydrocarbons output.

Fossil fuel extraction
Neither falling oil prices nor investor pressure, nor even TCFD requirements will lead strategic national operators to reduce investment in, and extraction of, fossil fuels – in sharp contrast to claims made by BP, Shell, Chevron, Total and lately even Exxon. Even Norway’s state oil company Equinor continues to drill in Arctic oil fields just west of the Vostok Oil project, despite Norway’s claim to be one of the first countries to submit an enhanced emissions reduction target under the Paris Climate Agreement.

Far from ignoring ESG, state-controlled energy companies increasingly use ESG to cast a more acceptable veneer over their activities, perhaps to distract from what is really happening. Rosneft recently published its Carbon Management Plan for 2035. The slick ESG pages of its website talk about research into renewables and show pictures of trees newly planted. Gazprom, the Russia natural gas producer that is building the Nordstream2 gas pipeline to Germany, likewise features impressive environmental and social responsibility pages on its website. Operators like Rosneft and Gazprom appear to be harnessing Western focus on ESG to build a façade for state-sponsored industrial plans that blend Soviet-style cross-sector planning with wild West capitalism reminiscent of 1990s Russia.

From the perspective of the UK pension sector, the Vostok Oil project hits E, S and G for all the wrong reasons. Their actions are a reminder that steeping ourselves in the nomenclature of TCFD, ESG and RI, plus shifting investment portfolios towards companies with better ESG metrics – while good things to do – are unlikely to change behaviour where change is most needed. An Arctic oil exclusion criteria may make LGPS investors feel better, but it is unlikely to impact the two companies most actively doing it because of their limited free floats (Rosneft’s 21%, Equinor’s 33%). This is a case of living in separate worlds.

An uncomfortable dilemma
Vostok Oil highlights an uncomfortable dilemma. On one hand, helping an autocratic Russian regime build out a shorter route between Asia and Europe might actually help to reduce the CO2 footprint of the global shipping industry and reduce other social risks, namely piracy. If done properly, it could be positive for the environment if Russia and neighbouring countries could agree that only a limited number of ships using the latest generation of pollution minimising engines could enter the Northern Passage. In effect, Russia, Canada, Norway, the US and Greenland/Denmark could agree to allow only ships that meet the highest, and constantly rising, environmental standards to enter the Northern Passage, thereby raising the “E” bar for the industry as a whole.

On the other hand, the Northern Passage could easily bring congestion and a concentration of maritime pollution to an environmentally sensitive region that is already disproportionately suffering the consequences of global warming. Scientists have established that temperatures are rising faster in the Arctic and Antarctic than average across the World. Russia’s rapidly melting permafrost has led to fires on the Siberian tundra. Burning bogs transform a naturally occurring carbon sink into a greenhouse gas producer, which has a double-whammy effect on global warming.

The need for realpolitik responses
We who believe in RI and ESG principles must develop more realpolitik responses to developments like Vostok Oil and Russia’s broader plans for the Arctic. Making real progress on combatting climate change requires engaging with leaders of regimes that don’t subscribe to our version of democratic values. Leaders like Putin or MBS, the Crown Prince of Saudi Arabia, along with their close circles of friends, must come to realise that their own longer-term flourishing runs parallel to, and not counter to, taking concrete actions to meet the Paris Agreement targets to limit global warming. Institutional investors may need to adopt a more pragmatic mindset and realise that developments like the Northern Passage, even if undertaken with ESG principles in mind, could be very “un-G” and “un-S” because they divert state-owned assets to benefit those in power.

Reducing global demand for fossil fuels must be a national-strategic priority for the UK and all governments that seriously wish to restrict global warming to 1.5°C. The ultimate solution requires accelerating the shift towards electrification using renewables, and making the global oil price fall even faster via a lower demand curve. Although this will take decades, petroleum-dependent regimes should be encouraged to eliminate unnecessary greenhouse gas (GHG) emissions (i.e., flaring), accelerate development of carbon recycling and capture technology, and ultimately diversify their economies away from fossil fuel extraction and production. Equinor is already building up its renewables portfolio to replace its declining hydrocarbon reserves. Saudi Aramco invests in carbon capture and recycling, while also promoting mangrove tree planting, which its researchers claim are far more efficient CO2 sinks than terrestrial forests. We should try to pull state-owned oil companies faster towards a world beyond petroleum, for example by forming new joint ventures that harness their engineering and technological prowess to advance greener renewable energy generation, CO2 capture and storage, and appropriate transmission grids.

In some cases, those involved in investing LGPS assets may need to choose between E, S and G. Despite our views of Russian activities in the Crimea, Georgia, the Ukraine, or the poisoning of the Skripals and Alexei Navalny, the West could nonetheless decide to work constructively with Russia and China to use the Northern Passage shipping route to reduce shipping carbon and pollution, but do so in a way that delivers a net environmental gain.

COP26 will require joined-up cooperation across industry, government and regulators to create opportunities that motivate hydrocarbon-dependent regimes to make strategic choices more in line with Paris Climate Agreement goals. LGPS officers, councillors, advisers, MHCLG and UK pension regulators must similarly learn to look beyond the investment landscape of Western capital markets and lend their support to leaders making difficult choices as they chart a path towards success at COP 26. If the boundaries of RI and ESG are drawn too narrowly, we may find ourselves in an echo-chamber of like-minded parties who grow increasingly detached from developments in the real world. As the Vostok Oil example shows, rather than depriving state-sponsored enterprises of capital, we would simply deprive ourselves of any possibility to exert a positive influence. We must take care not to let ESG and RI-tinted thinking become the walls of our own Potemkin Village.


The views expressed herein are those of the author and not for broader attribution.


1. The UN’s six principles of responsible investment and 17 sustainable development goals

2. Specific details on targets and goals are unfortunately beyond the scope of this article.

3. At 19 February 2021, based on the share price of its 21% listed free float. Source: Yahoo Finance


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Published: February 1, 2021
Home » Realpolitik meets responsible investment

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