Auspice Capital president and CIO argues instruments provide inflation protection without the guilt of carbon exposure
The tables are turning for the energy industry.
After enduring through years of depressed oil prices – including a brief period of cratering demand last year that pushed key benchmarks into negative territory – the price of a barrel of crude has rebounded. Today it’s hovering around the $60-$70 range, with some triple-digit forecasts for 2022.
Against that backdrop, the traditional energy industry is attracting more than its fair share of fair-weather investors. It’s also getting attention from those mindful of how oil and gas prices have been a driving force in the streak of record-high inflation in recent months.
But for many others bound by climate-focused mandates or convictions, oil’s comeback poses a dilemma. While ESG-focused investors may be fundamentally against supporting activities that hurt the environment and add to the already-alarming levels of carbon in the atmosphere, that means having to stay on the sidelines of what could be a once-in-a-generation supercycle.
At least, that’s what the conventional wisdom says. But according to a new white paper from Auspice Capital, a commodity-focused alternative investment manager based in Alberta, there’s room to expand that thinking.
“People have this idea that commodities and ESG are just diametrically opposed, and we get some of that. We've always said producing commodities, particularly in the mining and extraction business, is inherently an invasive process,” Auspice Capital President and CIO Tim Pickering, told Wealth Professional. “But the question is, how do you go about gaining that commodity exposure as an investor?”
While a lot has been written about the role of equities and debt in promoting ESG, the same can’t be said for futures. According to the white paper from Auspice, neither the Organization for Economic Cooperation and Development (OECD) nor the UN Principles for Responsible Investment (UNPRI) provides comprehensive guidance specifically related to commodity futures. So after Auspice “scoured the earth” to find very little on the topic of ESG and futures contracts, the firm was compelled to develop its own thesis.
“Ultimately, what matters for carbon accounting is who owns the company,” Pickering said. “It's the owners of the company that provide the capital that powers this economic activity and thus creates an environmental footprint and emissions issue.”
That’s what makes investing in resource equities so ethically fraught for many investors. By having a stake in the company, they’re effectively financing and enabling an activity that leaves behind a large carbon footprint. Investors who finance the company’s activity with debt are similarly accountable.
But according to Pickering, futures contracts don’t affect the production activities of a resource company one way or the other. Rather, they’re just a way to manage exposure to risks associated with the price of a certain commodity.
“Some may say that commodity futures can be taken to delivery,” he said, referring to how some investors in futures contracts exercise their right to buy a certain amount of a particular commodity at a certain price. “But at a high level, just 5% of commodities futures contracts are taken to delivery. In the case of big participants in the in the commodity space, like CTAs, or futures-backed commodity ETFs, that's effectively zero.”
Pickering says the research has resonated significantly across the institutional investment space, and for good reason. While ESG mandates hamstring many asset managers and large institutions into a “fight or flight” ESG paradigm – either invest in energy companies and push them to change through shareholder engagement, or avoid investing in the space altogether – Auspice’s argument for commodity futures contracts opens the door to new portfolio management possibilities.
“The reality of our world right now is different investors, including large institutional investors, are saying ‘We can't have anything to do with the resource space or commodities, because it has this negative environmental and sustainability aspect to it,’” Pickering said. “That might be true for equities, but not for commodity futures because they have zero impact. So we think these investors are missing out on an incredible opportunity.”
Of course, the argument cuts both ways. Just as a futures contract doesn’t add to the carbon exposure of a portfolio, it also doesn’t neutralize any carbon exposure that an investor already may have. Someone who has a stake in the company’s equity or bonds, for example, can’t claim to counterbalance the carbon production that represents with an equivalent short position in energy futures.
But futures contracts could also be beneficial to the non-environmental pieces of an ESG-oriented portfolio. As Pickering said, the liquidity in the derivatives market provided by futures supports the development of the marketplace, particularly as they represent “strong backbones for risk management” among resource-dependent companies. The products of resource companies’ activities, he added, could ultimately be essential ingredients to a brighter future as they are used to build infrastructure and otherwise contribute to social development.
“The potential for rising commodity prices is a reality for various reasons, whether it's underinvestment in production, the developing supercycle, or efforts to build back better in the greening of the economy,” Pickering said. “A lot of people can argue these are going to be significant inflation drivers in themselves, which means investors will want to consider some commodity exposure in their portfolios.”