The return of coal-fired power plants is hitting the ESG rating of European companies

George Velev

European companies turning to coal as an alternative to Russian gas face hits to their environmental, social and governance ratings. And that makes them struggle to impress investors, who still look primarily at how sustainable and environmentally focused their investments are.

Despite the energy crisis following sanctions against Russia, major European investors say they will not weaken their investment principles to achieve a carbon-free economy by 2050 or sooner. Investors are increasingly using ESG ratings developed by companies such as MSCI or Sustainalytics to assess the merits of companies. Burning coal, which emits more carbon dioxide than alternatives such as oil and gas, gives companies a black spot, the Reuters agency recalls.

European countries, including Germany and Italy, are nevertheless considering a return to coal because of the crisis in Ukraine, which has cut off Russian gas flows. Some companies, such as German specialty chemicals maker Lanxess, have also said they may start using more coal.

Companies forced by cost pressures or national policy to use the fuel could catch up by finding other ways to improve their environmental credentials or by focusing on the S and G in ESG, added industry sources (Environmental, Social and Governance – environmental, social and corporate governance, note ed.).

"When your emissions go up, other things being equal, you have more trouble from a ratings perspective," explains Sylvain Vanston, executive director, climate change investment research at MSCI. "If you come up with a fantastic new environmental focus, then that can make up for it."

But so far, few companies have been able to find a universal cure to counteract the use of the highly polluting fuel. Lanxess, which has previously acknowledged the hit to its carbon footprint, declined to comment on the potential impact on its ESG rating from burning more coal.

However, they pointed out that if they took themselves out of the market, it could mean plant closures and job losses, potentially affecting the "social" aspect of their business. There are other options for companies looking to maintain their ratings. David McNeil, head of climate risk at Sustainable Fitch, said the agency looks at a company's broad ESG impact when rating it. "If an energy company issues a green bond, that's something we'll look at as well," he says.

Some companies, such as the Italian utility company Enel, have issued bonds related to sustainable development and their overall performance in this direction.

But sustainability-related bonds and green bonds, which finance specific environmental projects, have underperformed in recent months as the prospect of higher interest rates and a possible recession hit corporate debt markets broadly.

Germany's biggest power producer RWE, whose chief executive said last month that Germany should save gas in its power sector by replacing it with coal, has already issued green bonds. A spokesman for the group said RWE was still focused on expanding the use of renewables and hydrogen with a view to further accelerating the phase-out of coal - a strategy that its investors had given "broad approval".

Other companies, such as Europe's biggest mining giant Aurubis, have also said their aim remains to decarbonise their operations, despite the added short-term complication of bringing coal into the energy mix.

Investors insist they have made such a commitment. AXA Investment Managers, Allianz Global Investors and Zurich Insurance, which between them manage $1.8 trillion in assets, all said they were sticking to their plans to cut coal, despite the war in Ukraine.

"We are not changing our position and we are not changing our policy - we are staying the course," said Linda Freiner, Zurich Group's head of sustainability.

So far, Europe's energy crisis shows little sign of resolution. It remains to be seen how far companies or investors can keep their faith in the importance of long-term ESG principles such as coal shutdowns if the situation worsens.

"Coal raises the question of energy security, which in the short term conflicts with the decarbonisation problem," said Alex Simcox, head of ESG investments at asset management firm Mondrian. "If you're in Germany and Russia cuts off gas, even if you're in the Green Party, you have to accept that expanding coal capacity is a pragmatic response," he says.