Triple-A ratings should be put under the ESG spotlight
Western Australia shows that a heavy reliance on environmentally intensive natural resources is at odds with the highest credit ratings
Moody’s upgraded the state of Western Australia to Aaa last week, returning its triple-A rating after almost a decade. The state also holds a triple-A rating from S&P.
But despite its improving financials, the state still relies heavily on a concentrated and non-net zero compatible source of income: natural resources. This stellar rating should be carefully thought through.
Mining, for instance, contributes 46% of Western Australia’s gross domestic product, according to the state. And such a reliance on a volatile — and environmentally harmful — income base is at odds with a triple-A rating, which would suggest Western Australia is among the crème de la crème of credits.
A triple-A rating means that the likelihood of a borrower failing to repay its debt is close to zero. And although Western Australia is backstopped by another triple-A rated credit — the equally as environmentally dubious Australian sovereign — its revenue stream is heavily dependent on the price and demand for natural commodities.
Furthermore, environmental NGO Jubilee Australia this week filed a law suit against two Australian government agencies — Export Finance Australia, the country’s export credit agency, and the Northern Australia Infrastructure Facility — for failing to fully disclose the climate impact of their fossil fuel funding. The suit was filed just one day after the sovereign appointed the structuring advisers for its green debut.
This is not the first time the sovereign has been taken to court because of inadequate climate disclosures. Three years ago, retail government bond investor Katta O'Donnell filed a similar legal claim against the sovereign. That court case is still ongoing.
Taking rating action on a governmental borrower for such an overreliance is nothing new. Moody’s itself downgraded Canada’s province of Alberta by one notch to Aa2 from Aa1 in late 2019 because of the sub-sovereign’s dependence on fossil fuel energy and revenue. A further downgrade to Aa3 followed a year later, with a return to Aa2 coming earlier this year.
The Canadian province offers a cautionary tale for Western Australia: Alberta’s concentrated dependence on natural resource revenues is “a structural weakness,” Moody’s said when it first downgraded Alberta in December 2019.
So what makes the Aussie sub-sovereign any different? Both share a heavy reliance on natural resources, a highly concentrated population, and the backing of a triple-A rated sovereign.
As the zero carbon transition gains pace and nations around the world work to cut down on their emissions, resources like Western Australia’s abundant liquid natural gas and iron ore reserves could — and should — become stranded assets.
But for now, the state is still heavily reliant on the income it receives for exploiting its abundant natural resources.
The sub-sovereign produces 56% of Australia’s liquid natural gas exports and 12% of the entire global exported supply. Meanwhile, the local government last week dismissed appeals to halt the extension of Woodside’s liquid natural gas site in the north of the state.
These resource intensive projects — despite their horrific environmental impacts — play a crucial role in helping Western Australia balance its books. In its last financial year, Western Australia had a forecasted A$4.2bn ($2.9bn) budget surplus, A$2.4bn higher than it expected in its mid-year review — largely driven by a strong increase in iron ore prices. Furthermore, this is the state’s sixth consecutive surplus.
And thanks to this string of surpluses, Western Australia has cut its debt burden significantly, falling from 156.7% in 2020 to 83.3% this year, Moody’s said, helping to drive last week’s upgrade. And the rating agency anticipates that this number will hover around 87% over the next four years.
But these revenue streams are finite — and will more than likely dry up as net zero progresses. Yes, Western Australia does have some of the largest global deposits of mineral crucial to the carbon transition, like lithium, but these are still highly volatile commodities.
Western Australian sales of spodumene, the raw mineral refined into lithium, hit a record high of A$16.3bn last year, more than twice the previous record, according to local government data. But this pales in comparison to the A$126bn of iron ore sales and A$51bn of liquid national gas production.
And even then, although lithium sales are at record highs, the price is still highly dependent on supply and demand. Lithium prices fell earlier this year, Western Australia notes, as demand for electric vehicles dropped off in China.
That said, Western Australia has taken steps to mitigate the impact of climate change on the state. For instance, it launched a green bond programme earlier this year — something Alberta is yet to do.
However, although Western Australia has committed to greening its debt market access, the borrower’s sustainability framework makes no mention of mining or natural resource-related projects. Instead, the state has picked three low carbon areas to focus on: transport infrastructure, reducing electricity generation emissions and water supply management.
But a green bond is not a panacea as long as the state is still reliant on a volatile and environmentally harmful source of funding: Western Australia's concentrated dependence is at odds with its recent return to triple-A, despite its improving financials.