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Reliance Industries is among the world’s most transformative businesses.
The conglomerate’s status as one of India’s biggest fossil fuel producers still drives much of its earnings, but increasingly its focus is on eco-friendlier sources of energy.
And its telecoms subsidiary, Jio, is already a disruptive force, helping digital businesses and poorer Indians by slashing the costs of mobile and broadband internet.
Yet it’s a company that many ESG (environmental, social and governance) rating agencies love to hate. And, as we’ve heard directly from Reliance, risk-dominated perspectives have a damaging effect on how existing and prospective shareholders engage with the firm.
When determining their scores, the rating agencies often focus on problems they find with a company’s activities. In the case of Reliance, they have flagged controversies including missing emissions targets, a workplace fire and fines for alleged regulatory breaches. As a result:
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Sustainalytics rates Reliance as ‘high risk’
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S&P Global scores it a relatively weak 22 out of 100
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MSCI gives it ‘BBB’, representing ‘average’
These scores miss the company’s potential to be a positive social and economic force, improving hundreds of millions of lives.
A backwards-looking, risk-based approach can restrict market participants’ understanding of a firm’s real-world impact. Moreover, it can cause them to see ESG engagement solely as a risk mitigation exercise to point out flaws and preserve their clients’ capital.
At Baillie Gifford, we think ESG analysis and engagement can encourage responsible behaviour and meaningful change. And we think it should be about preserving potential returns. When clients give us money, they want to see that capital grow.
Our ESG engagement strategy identifies areas where we push companies to improve and mitigate risks with negative consequences. However, it spends just as much time finding ways to fight our holdings’ corners and encouraging them to take potentially beneficial risks.
By focusing on what might go right over the long term rather than what might go wrong in the short term, our engagements with company management are more likely to be constructive and ultimately productive for all involved.
Ambitious aims
There’s good reason to be optimistic about Reliance. In a literal manifestation of the adage “data is the new oil”, the company has ploughed billions of dollars from its core oil and gas business into data and is now expanding into green energy.
In 2016, Reliance rolled out a new mobile network in India that led data prices to collapse from an unaffordable $3 per gigabyte to less than eight cents today. Domestic calls became free.
This yanked India into the 21st century, as even the poorest Indians could finally get online. A new crop of digital businesses took off, and the country now claims to have the world’s third-largest startup ecosystem after the US and China.
Reliance aims to become one of the world’s largest green energy companies. It is spending $10bn over the next three years to generate 100KW of renewable energy by 2030.
Part of the plan is to create a fully integrated solar panels business to rival Chinese leaders, including LONGi and Trina Solar. It is also developing a complementary battery storage solution to deliver reliable, uninterrupted supply to electric grids so they don’t need to fall back on fossil fuels or other energy sources at night-time.
In addition, the company is investing in green hydrogen by creating electrolysers and fuel cells. These could provide a way to heat homes and power planes, among other uses, via renewably generated energy. Reliance’s incredible goal is to cut the cost of green hydrogen by about three quarters to $1/kg within a decade.
This forward-looking investment in renewables and data is not easily captured by ESG risk-based scoring. But it is critical to the company’s prospects and its contribution to society and the environment.
Accounts, disclosures and risk
As I’ve already mentioned, Reliance is far from perfect.
But we don’t believe that the accidents and other retrospective controversies flagged by the rating agencies suggest a wider malaise. Rather they represent the kind of growing pains that many fast-expanding enterprises experience – although they must still be addressed and learned from.
Undeniably, the company is a major source of carbon emissions. But the fossil fuels it produces play a critical role in India’s wider economy, helping to lift living standards and fund the clean energy transition to come. Reliance aims to be carbon neutral by 2035, and its giga factory bets could result in itself and others radically reducing their emissions over the long term.
There are, however, three sustainability challenges that are worth exploring further:
- Reliance’s accounting policies raise concerns
For instance, it depreciates Jio’s assets differently from how other companies do, including local rival Bharti Airtel. There’s also unease over how it redirects some costs onto its balance sheet – a process known as capitalisation. Subtracting the costs from its profits would be more transparent. - Reliance has raised further governance issues by stripping some granular detail out of its earnings
For example, it used to disclose separate figures for its refining of petroleum products and its production of petrochemical substances, such as plastics and rubber.
However, it now groups both under a single ‘Oil to Chemicals’ banner in its quarterly results.
Likewise, it no longer separates earnings from its various retail divisions to the same degree. These moves make it harder for analysts to determine how specific divisions have handled recent events or to compare their performance to other companies in the same sector. - Reliance is taking a high-risk approach to its green energy business
For example, it is pursuing sodium-ion batteries even though lithium-ion technology is more established.
We take a nuanced view in our response to these challenges.
Accounting policies matter for long-term investors like ourselves. We and the wider market need to have confidence in how Reliance reports its numbers. We have raised the issue in conversations with management and intend to press the point. We think the company is moving in the right direction, but it has much more work to do.
On disclosures, we support the company in deciding what it thinks is important to share with long-term investors. Shorter-term shareholders and sell-side analysts often request copious amounts of information to get their quarterly numbers right. But this sort of week-to-week or month-to-month data is less useful when you take a decade-long view.
In fact, too much disclosure involving meaningless metrics can be counterproductive. Earnings calls get crowded out by related questions and there is a real danger that management loses focus on decisions that could have the most positive lasting impact. So we push for disclosures where they matter, but we also back Reliance in not giving in to demands for data that just feeds quarterly models.
Finally, regarding technology risks, we think Reliance is making the right choices.
Its decision to become fully integrated from sand to solar panels makes sense if it is ever to compete as an equal with China’s champions, even though it may be the riskier path.
And its bet on sodium-ion batteries could well pay off as lithium, nickel and other metals needed for conventional batteries become scarce.
We are also comforted by Reliance’s track record of achieving great technological feats at scale.
They include building at speed the world’s largest oil refining complex at Jamnagar in North-West India. Challenges included dealing with a major cyclone partway through construction. And at one point, the worksite was larger than London.
Jio’s decision to go with Samsung as its sole 4G network provider is also notable. Many telecoms firms go with a mix of two vendors to reduce the danger of a fault taking their service offline. But by opting for one, Jio was able to roll out a nationwide service more quickly.
Samsung was also a relative minnow in the network infrastructure market when it was picked in 2013. That might have made it seem a risky choice. But it proved to be a highly engaged partner – more so, perhaps, than the larger players Nokia and Ericsson would have been.
Admittedly, past successes do not guarantee Reliance’s new bets will pay off. But they do provide a level of comfort.
Evolving ESG engagement
So, our approach to ESG at Reliance is to push hard for change where it matters for the long term.
In this case, that means encouraging the company to take big bets on paradigm-changing technologies.
We also fight the firm’s corner. This involves persuading others to see the value in capital expenditure that could take years to pay off and cause the firm’s stock to be more volatile in the short term.
This approach applies to other investments we make on behalf of our clients. When ESG engagements become entirely focused on risks and the downside, you miss the opportunity to help companies prosper and tackle some of the world's biggest challenges.
So, we tell management that we are providing them with patient capital and will support them in making tough choices for sustainability and long-term growth.
By doing so, we believe we can help Reliance and others be leaders in terms of transforming the world and delivering strong returns to our clients.
Risk factors
The views expressed should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.
This communication was produced and approved in 2022 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.
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