Hermes EOS: Mitigating ESG risks in Brazil’s resources sector

The work being done by Brazilian companies on environmental issues and disaster preparedness.

A major corruption scandal involving government officials and one of the world’s largest companies – state-controlled energy company Petroleo Brasileiro (Petrobras) – engulfed Brazil in 2014 and 2015.

Since the allegations surfaced, Petrobras has been under pressure to get its house in order and has taken significant steps to improve its governance and compliance in an attempt to restore investor confidence.

The company has appointed independent directors to its board to replace the previous government ministers, something we had long been pressing for in our engagement because we felt that the board had neither been fulfilling its oversight function nor challenging management. The appointees included an independent chair, the first non-government official to lead the board in 12 years, marking a sharp contrast in the composition of the board to that of the past.

Together with other shareholders, we were heavily involved in the selection of two minority shareholder representatives and were pleased that Petrobras published their names ahead of its AGM. We subsequently supported their successful election. The new composition of the board and the relative ease with which we were able to nominate and ratify the minority shareholder representative director candidates indicate a meaningful shift in board composition and quality at Petrobras and a significant step towards its depoliticisation. Furthermore, a chief compliance officer was appointed.

Public policy efforts
At the same time, pressure for good governance is increasing in the public policy sphere. The fifth version of Brazil’s Corporate Governance Code has just been published after a period of consultation in which we expressed our strong support for the one-share one-vote principle. To accommodate conflicting interests in the Brazilian market, the voluntary code grants companies more flexibility regarding the principle, under special circumstances and for a limited period. However, we continue to press Brazilian companies to avoid deviations from one-share one-vote.

Meanwhile, Brazil’s market regulator CVM has been debating enforcement of the country’s Corporate Governance Code via a comply- or-explain clause, suggesting that companies failing to adhere to the code will have to sufficiently explain their reasons for non-compliance. In addition, the BM&F Bovespa stock exchange has published a voluntary code for state-controlled companies.Dam constructions
The construction of the Belo Monte dam on the Xingu river in northern Brazil has been controversial. The consortium building the Belo Monte dam – Norte Energia – for example, had been accused by several Brazilian and international NGOs, such as the Inter-American Commission on Human Rights, of failing to obtain free, prior and informed consent from the indigenous tribes affected by that construction. Although Norte Energia significantly invested in the mitigation of environmental and social risks, communication with the stakeholders was not effective.

With new dams proposed for Tapajós river in the North of Brazil – again to provide Brazil’s growing population with clean energy – we visited Eletrobras, the company involved, to see whether any lessons had been learned from Belo Monte.

Although any construction projects undertaken will always have some impact on the environment or communities on the ground, we urge companies to minimise that impact and the associated risks by putting in place appropriate mitigation measures.

In the past, projects have had a severe impact on their locations, for example by requiring big reservoirs, flooding of a significant area and a large number of workers. More recent projects have managed this more carefully. Equipment was typically transported to the construction site on purpose-built roads. Now, to minimise impact, the materials are moved to the site by river barges whenever possible. And unlike in the past, workers will not live in purpose-built towns in the area but at buildings on the construction site, preferably in the area to be flooded post-construction when the reservoir is formed, thereby affecting a much smaller amount of land. Furthermore, although the construction schedule for the dams in the Tapajós river depends on many factors – such as a period of consultation by the government – Eletrobras has already been engaging intensively with local communities on the developments. A preliminary environmental impact assessment has been submitted to the authorities and was met with criticism from some NGOs.

Eletrobras acknowledged that it could improve its communications with stakeholders. After it made enhancements to its 2014 sustainability report, particularly in terms of environmental and social indicators, it plans to follow the Global Reporting Initiative 4 guidelines in its 2015 sustainability report.

After expressing concern about disclosure and reporting in previous engagements, we were pleased to see the progress made.

Disaster preparedness
Overall, a lot of work has been undertaken by Brazilian companies on environmental issues and disaster preparedness.

We were assured that Petrobras has taken extra measures to make its disaster response more effective, as a result of the lessons learned from two big accidents it incurred in 2000, BP’s 2010 Macondo spill in the Gulf of Mexico and the increased complexity of its new deep water fields. In addition to its large in-house capabilities, upgrading and investing in safety measures to mitigate the risk of oil spills, Petrobras joined the Oil Spill Response and Subsea Well Response projects, which have invested in intervention equipment that can be deployed around the world. This includes four capping stacks – the equipment that ultimately stopped the Macondo spill – three containment toolkits and a stock of dispersants. Petrobras’ own structure is equally robust, with a 500-strong response team based in 25 cities, equipped with barriers and dispersants ready to be dispatched during any accidents. In addition, it has 40 oil spill response vessels to cover its offshore platforms. Given the scale of its oil and gas production and deep water construction vessels in Brazil, these measures are crucial. The company has not had any major spills since 2000 and incurred 32 small spills, amounting to 437 barrels, in 2014.We were pleased with Petrobras’ various initiatives aimed at reducing flaring, greenhouse gas and other atmospheric emissions and at increasing energy efficiency. Petrobras has also improved the quality of its reporting of environmental indicators, which has been an important item on our engagement agenda with the company. It has started a detailed mapping of climate change scenarios across the various regions of Brazil. As the work is in its early stages, we agreed to monitor progress, particularly the adaptation and mitigation actions that may result from it, and to convey to the board the need to ensure there are enough resources allocated to the project, given its budget constraints.

As companies have to make cuts in the wake of falling commodity prices, we continue to seek to ensure that their environmental and social risk management is not compromised.

Jaime Gornsztejn is Associate Director, Engagement, at Hermes EOS.

The views and opinions contained herein are those of Jaime Gornsztejn, Hermes EOS, and may not necessarily represent views expressed or reflected in other Hermes communications, strategies or products.