Axa Insurance Cuts German Utility RWE
France’s largest insurance company, Axa SA, severed ties with the German energy utility RWE in the middle of March. Headline reports note the “precedent-setting” [1] decision and the “necessary consequences” of Axa policy on coal and climate. [2]
Axa’s decision may seem prudent at face value. After all, a core pillar of a multi-disciplinary approach to tackle climate change are for insurers and capital providers to proactively include climate externalities in their credit assessments. It is true that RWE is large producer of coal and that Axa’s policy was contingent upon a two-year grace period and not an abrupt decision. Yet even the slightest scratch below the surface and this story falls apart. Axa’s unilateral policy is entirely inappropriate, and potentially counter-productive in the long term.
First, some context on RWE. In early 2020, RWE completed a major asset swap with E.ON. It is not an exaggeration to assert that the swap transformed their business. Pre-swap, RWE’s business model was based on a free cash flow maximization strategy that depended on the firm running existing thermal coal assets as efficiently as possible and with the lowest possible maintenance capital expenditure. Capital appreciation potential was limited, and growth potential was tied to European electricity demand. Any excess FCF from the core business, when it occurred, was paid out as dividends.
Via the asset swap RWE monetized its financial holdings to fund a new renewable business that immediately made the firm one of the top six renewable generators in Europe (it doubled their renewable generating capacity). Furthermore, in one move, RWE transitioned from a utility suffering from the slow adoption of renewables due to legacy assets to one of Europe’s largest renewable power developers and operators.
RWE’s renewable energy development pipeline is one of the largest in the industries at 24.7 GW, of which 3.4 GW is currently under construction. RWE has reduced their CO2 emissions by 9.6% per year since 2012. Based on its development pipeline it will cut emissions in half again by 2030. By 2040, RWE intends to be carbon neutral. It would not be stretch to assert that RWE is one of the most proactive utilities in the world in reducing their carbon footprint.
ESG materiality models are unfortunately one-dimensional, and static across time. Yet companies have unique materiality signatures that develop over time. While multi-factor models are ubiquitous (a recognition we live in a complex, interconnected world), ESG modeling has yet to incorporate such dynamism.
Axa is utilizing this single dimensional framework. Their coal policy (which RWE stands in violation of) prohibits insurance to companies producing more than 20 million tones of coal per year. Simply to communicate, sure, but grossly inadequate when considering the idiosyncratic risks of a particular business.
Compare two hypothetical utilities: Utility A produces 19 million tons of coal per year and has no plans to change. Utility B produces 100 million tons of coal per year and is looking to bring that to zero within 10 years. Axa’s policy may continue to provide insurance, in perpetuity, to a 19 million ton per year coal producers, but penalize a producer that generates a 100 million ton per year reduction in coal production. Axa has created a policy that bifurcates large vs. small coal production, not a policy that incentivizes transitional behavior.
Lise Moret, Head of Climate Strategy at Axa, is on record saying: "We need to continue to incentivize firms to not only stop capital expenditure in fossil energy but also to increase and speed up their investment plans in low-carbon renewables." Not only does RWE satisfy this condition, but we would also argue RWE may be a model for aggressive utility change.
Of course, rate of change matters. One could argue that RWE is not cutting coal production fast enough, independent of their aggressive renewable buildout. The reason RWE cannot simply flip an off switch is because of system reliability. It is the reason that their coal operations are now legally ring fenced from the company and the coal reduction plan is based on a government decision voted by law. Electricity has public good characteristics. The moment one imposes static levels of coal production across companies independent of size and motive, you then “need to administer who is allowed to use how much power” as aptly noted by RWE CFO Markus Krebber. In fact, forcing retirement on electric generation capacity without considering system stability and replacement capacity creates a risk you need more coal power plants in the future, not less.
The notion of Corporate Social Responsibility is like a Ptolemaic model as the stakeholders who implement the extra-economic decisions act as if they are the center of the universe and thus determine the geography of the interests at stake. By contrast, the idea of Sustainability is a Copernican vision, whereby society aims to satisfy the needs of the present without compromising the capacity of future generations to satisfy their own. Participants recognize that the system is affected by variables that carry more weight than their own vested interests. Akin to financial markets, we are dealing with a non-ergodic system. One should not maximize growth, but rather maximize growth that conserves survival. Policy’s addressing climate change must look to minimize atmospheric emissions while ensuring that the economic prosperity that allows for such contemplation does not collapse.
I applaud Axa’s intent, but their policies are ill-informed and likely damaging. Moreover, RWE should be applauded and aided in their ambitious transformation journey.
[1] Bloomberg, March 11th 2021.
[2] Director of Reclaim Finance.