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May 6, 2022updated 09 May 2022 1:55pm

How investors should engage with polluting SOEs

State-owned enterprises are responsible for more global emissions than their private sector counterparts, yet most investors shun the former. Those that do work with government companies talk about how they do it.

By Elizabeth Meager

David Nicholls of East Capital says engaging with state-owned enterprises can be highly effective at driving down global emissions. (Photo courtesy of East Capital)
  • Engaging with state-owned enterprises (SOEs) can be a long and frustrating process, but they are responsible for a large chunk of global emissions. 
  • SOE engagement is an untapped area seen as offering low-hanging fruit for those willing to put in time and effort to achieve positive impact.  
  • Where the state has a clear climate strategy, SOEs can be prepared for the transition and willing to listen to investors. Russia’s Gazprom is a case in point. 

Of the 20 biggest corporate emitters in the world, more than half are owned by governments and are headquartered in emerging markets. Many sustainability-minded investors favour buying into companies and activities already fit for the transition – in areas like wind and solar power, carbon capture and electric vehicles. But in order to avoid catastrophic global warming, the largest polluters will need to play a role too, and allocators will need to engage with state-owned enterprises (SOEs) to that end.

State ownership is particularly common in carbon-intensive industries such as energy, chemicals and industrials. This is especially acute in the power sector: SOEs represent almost two-thirds of global electricity generation capacity, and together they are responsible for more emissions than any country except China, according to Columbia University’s Center on Global Energy Policy (CGEP). 

Hence SOEs pose enormous decarbonisation potential, which is for the most part untapped, says Philippe Benoit, adjunct senior research scholar at CGEP. “There have been very little analysis and very few resources targeted at SOEs. 

“Investors and civil society want to talk about the Googles and Citibanks of the world,” he tells Capital Monitor, “but they forget there are these enormous players that are not only responsible for high levels of emissions, but [which] also tend to be big players on low-carbon alternatives.” 

SOEs: huge emitters

Indeed, listed investor-owned companies are responsible for around 32% of historic emissions, compared with SOEs’ 59%, with China accounting for a little over two-thirds of the world's SOE emissions (see chart below). The scale of real emissions reductions needed will not be possible without the public sector being involved. 

“Whether SOEs are good or bad, they’re here today and they’ll be here 20 years from now,” says Benoit, "and they tend to be in countries whose emissions are trending upwards every year, so will only become more important to the climate discourse. We just don’t have time to waste.” 

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Investors typically avoid SOEs for several reasons: they are often seen as inherently riskier than privately owned companies; they tend to be concentrated in emerging markets with unpredictable governments – often post-communist states; and can be seen prioritising government interests over those of shareholders.

And to engage with SOEs is, of course, different from doing so with private sector companies – but not necessarily less productive. In fact, in cases where the government wants to be seen as particularly supportive of climate policy, such as China, SOEs can be more receptive than the private sector, says John Lin, China portfolio manager at US fund house AllianceBernstein in Hong Kong.  

“China’s carbon-neutral drive is a top-down directive from President Xi Jinping himself, so we’ve found that when we talk to SOEs about climate targets and disclosure, they are much more likely to have a plan than a privately owned company,” he says.  

However, working with SOEs to reduce emissions – or indeed achieve other goals – demands “different avenues and interventions” than would be effective in the private sector, says Benoit, because SOEs are not driven primarily by profit. Similarly, the threat of divestment does not tend to be as effective as it would be for privately owned companies. 

Russia’s Gazprom offers an interesting case study. Between 1965 and 2017, the state-owned energy company was the third-largest emitter in the world, behind only Saudi Aramco and Chevron.  

Gazprom's climate progress

Even if one sets aside the war in Ukraine, investing in companies like Gazprom might not look great in an asset manager’s sustainability report or portfolio emissions calculation, but it can be highly effective at driving down global emissions, says David Nicholls, Russia portfolio adviser at East Capital, a Swedish emerging markets-focused fund manager with $4bn under management.

Following a coordinated investor campaign by East Capital and others, in 2020 Gazprom reduced its carbon emissions by 14% (16 million tonnes) on the previous year – around the same as Kenya’s total annual carbon dioxide emissions. 

“When we joined the engagement [in 2019], Gazprom had no targets – within a year it had set targets for its gas business, then last year introduced targets for the oil and utilities business too,” Nicholls tells Capital Monitor. “It was time-consuming, but there’s a lot of low-hanging fruit here. We’re not saying it was all us, but if we were responsible for even a tiny part of this, then the impact is still absolutely enormous, given this is one of the largest emitters in the world.” 

East Capital positions itself as a consultancy of sorts, setting out market expectations and providing best-in-class sector examples when it comes to climate plans, Nicholls says. Collaborating with other allocators is also key – East Capital works with others in the Climate Action 100+, which is backed by 615 investors with $55trn under management. Last year, the firm sent one formal letter detailing expectations, and that was followed by email correspondence and several high-level meetings. 

During the Gazprom campaign, Nicholls met with an in-house senior independent director, its head of environment, head of utilities and, separately, a methane-tracking agency. 

Since Russia’s invasion of Ukraine on 24 February, the company has suspended its engagement campaign with Gazprom. 

A considerable chunk of the world’s SOEs are based in Asia, and the Asia Corporate Governance Association (ACGA) has been working with them and investors for years on ESG-related issues.  

While in China the investor focus is largely on emissions reduction, a big issue for investors in India – and the area in which they have been most successful – is governance, says Sharmila Gopinath, ACGA’s India research director. 

Rules of SOE engagement

Generalisations are unhelpful, as there are enormous differences between markets that are home to large SOEs. A conversation with French utility EDF, for instance, is nothing like one with China National Petroleum Corporation or Gazprom.  

Hence knowing the language and being embedded in local cultures is helpful, says AllianceBernstein’s Lin. But domestic investors will not necessarily have more success than their foreign counterparts when they engage with local SOEs. Government companies might not be motivated by profit, but for the most part they still want to project a particular type of image to foreign investors and the broader global community. 

“Image is very important, particularly for the biggest SOEs, and with governments looking to sell some of these companies [such as Air India and Bharat Petroleum Corporation], there is a focus on cleaning them up a bit,” says Gopinath. In that context, input from foreign investors is very helpful in terms of what the market expects.

Increasing climate regulation helps in this regard, as investors can use it as a clear baseline of market expectations. 

Moreover, middle management tends to stick around at SOEs for longer than those at the top, so any long-term strategy will need these teams to be on board, Gopinath says.  

Long-term process

Success in engagement ultimately can depend on many factors, one being the level of government involvement: a company that is majority state-owned is naturally less affected by the wants of investors than one that is largely privately owned. It generally depends on how investor goals fit with those of the government. 

“For example, the mindset in India is very much that coal is here to stay for now, and everyone’s on board with that, including institutional investors, largely because the social issues outweigh the environmental,” says Gopinath. Coal accounts for some 75% of electricity generation in India, and it would be impossible to ensure access to affordable power for much of the country without it. 

That’s not to say investors would be wasting their time by trying to encourage a shift away from coal, but it would need to be a very long-term strategy, Gopinath adds. “There is a question as to how much the government is willing to engage [on an issue like coal] - it depends if an initiative works with its own policies or not," she says.

If institutional investors are serious about exercising influence and having a genuine impact as long-term and responsible capital allocators, engaging with SOEs should, then, surely be a core focus.

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