Right-leaning U.S. states are leading an effort to discredit Environmental, Social, and Governance (ESG) investments, despite the fossil fuel industry reporting record profits. This ABI Insight offers analysis into the war against ESG with recommendations for moving forward with ESG and a thoughtful energy transition.
Fossil Fuel-Producing Regions Are Fighting ESG Reporting, Despite Record Profits
In recent months, “anti-ESG” has entered the lexicon of global political and culture wars, spurred on by Republican-led U.S. states. In Florida, Governor Ron DeSantis and the State Board of Administration recently barred the state’s US$200 billion pension fund from considering Environmental, Social, and Governance (ESG) factors in its investment decisions. A day later, the Texas comptroller issued a list of 10 financial firms and nearly 350 investment funds, including BlackRock, Credit Suisse, UBS, and others that it deemed as proponents of ESG and “boycotters” of the fossil fuel industry, demanding that Texas state pension funds divest from the list. BlackRock’s response to the Texas announcement highlighted that it “does not boycott fossil fuels — investing over $100 billion in Texas energy companies” on behalf of clients. Meanwhile, Oklahoma signed the Energy Discrimination Elimination Act of 2022, requiring Oklahoma to divest in any financial company that boycotts the energy industry. Louisiana, West Virginia, and other states are also working on legislation addressing anti-climate change bills and an “anti-ESG” movement. Even the creator of the “Dilbert” cartoon published in more than 55 countries is joining in the fight against ESG.
While it doesn’t take an advanced degree to understand that money and political power are driving the latest war against ESG, it could be risky for states and regional governments to completely ban investment analysis of environmental risks (e.g., toxic spills), social risks (e.g., workplace diversity and fair labor practices), and governance (e.g., potential corruption). Opponents of the recent anti-ESG, pro-fossil fuel legislation also question this type of overt government interference in a free-market economy and society. Further, by banning a multitude of large financial institutions, states could reduce competition for underwriting municipal bond deals and thus increase the costs of municipal bonds. In the United States, bonds pay for schools, large public arenas, water treatment plants, essential infrastructure like sidewalks and lighting, and more.
Making the anti-ESG rhetoric even more of a head scratcher, the fossil fuel industry is reaping record-high profits at the same time politicians are ranting against ESG. In mid-June 2022, Forbes reported that the S&P Energy sector had returned 61% year-to-date compared to a decline of -18% in the S&P 500 index, with Exxon generating a return of nearly 68% (these results led U.S. President Biden to quip that “Exxon made more money than God last year” during an event in Los Angeles). In second quarter earnings announcements for 2022, BP posted a 14-year high record profit of US$8.5 billion, while Exxon’s US$17.9 billion in net income was its largest quarterly profit ever. BP, Exxon, Chevron, Shell, and TotalEnergies together recorded blockbuster results, making US$55 billion for the quarter. United Nations Secretary General António Guterres reported that profits of all the major energy companies were close to US$100 billion in the first quarter of the year.
What Is ESG? Companies Are Using ESG Practices to Increase Company Value
So, what is all the anti-ESG fuss about? ESG-related business practices look across several non-financial factors of a company. For the environment, ESG might assess carbon emissions, air and water pollution, waste management, renewable energy initiatives, and water usage. For social impact, ESG programs consider employee gender and diversity, fair labor practices, human rights at global locations, data security, and customer satisfaction. For governance, ESG guidelines can monitor executive pay, lobbying, diversity of board members, large-impact lawsuits, and potential corruption.
To illustrate ESG practices more clearly, an automotive Original Equipment Manufacturer (OEM) considering climate and “E”-related ESG risks might establish science-based targets for reducing the company’s carbon emissions, while investing in software and technologies for eco-design and engineering (e.g., light-weighting or using recycled materials), supply chain transparency, and efficient use of materials, water, and energy during manufacturing. Due to current labor shortages, the company may also establish a Diversity, Equity, and Inclusion (DEI) group to help the firm appeal to a larger, more inclusive audience. The company wants to recruit across a broader employee base, while making the company more attractive to women with more creative and flexible working policies and hours. To keep up with changes in customer demographics and the industry, governance policies recommend hiring more employees and board members with diverse cultural backgrounds and stronger technology-based skillsets. In all, the automaker assesses that ESG-driven practices are increasing the value of the business. ESG monitoring helps reduce energy, water use, and waste. ESG taps into a wider talent pool. ESG-related Request for Proposal (RFP) criteria are critical to supply chain partners, while providing guidelines for responsible mining of raw materials. ESG helps mitigate risks for corruption across the company and for suppliers. And finally, being a company known for sustainability and inclusion helps attract a wider range of customers and technology-savvy talent, especially from younger generations, contributing to better products and increased brand value.
Decouple ESG from Politics, Continue to Improve ESG Measurement, Optimize Energy Industry Talent, and Embrace Energy Companies for Helping to Lead the Energy Transition
The future is moving toward a more inclusive, sustainable economy, and the global capital markets agree. Bloomberg Intelligence estimates that ESG-related assets are set to exceed US$50 trillion by 2025, representing more than one-third of the total US$140 trillion assets under management, and according to McKinsey & Co., more than 90% of S&P 500 companies publish ESG reports. In 2021, a Russell Investments survey of asset managers found that 82% of U.S.-based asset managers incorporate ESG data into their investment process, while the result is nearly 100% for the United Kingdom and Europe. Moreover, as of September 2022, more than 380 companies had joined the RE100, a global initiative consisting of influential businesses that have pledged 100% renewable energy electricity use, including Walmart, Apple, Samsung, Facebook, Microsoft, Google, Goldman Sachs, 3M, Target, Starbucks, Nike, Coca-Cola, JPMorgan Chase, McKinsey & Co., General Motors, and more. While the anti-ESG movement might imply these types of decisions are “woke” and politically motivated, the annual reports of the companies relay a different message. ESG considerations are generally made after all other business objectives are met to meet the needs of various stakeholders, and decisions to switch to renewable electricity, for example, are economically driven and based on facts, science, and risk management data. Climate risk is investment risk. Therefore, it seems counterproductive and futile for politicians to blast the financial industry for assessing a multitude of investment risks, including ESG risks, and to direct divisive rhetoric toward business executives for making decisions that build a more resilient economy benefiting more people. With deeper analysis, anti-ESG rhetoric seems designed to protect the money and power of a few. ESG needs to be decoupled from politics.
While there is much room for improving ESG-related data, criteria, and reporting, many companies are taking real and actionable steps to address their environmental impact and societal contributions, proving that profitability and ESG are not mutually exclusive. ESG investments as a concept would not exist without financial returns. Often, though, the disconnect about ESG correlating to financial returns results from an industry bias toward short-termism, or short-term thinking. ESG investments tend to generate returns on a long-term horizon, while incentives for most Chief Executive Officers (CEOs) and asset managers occur on a quarterly or annual basis. Furthermore, ESG does not need to be in direct opposition to the fossil fuel industry. Level heads can prevail when it comes to the energy transition. Energy companies and sustainability professionals should be partnering to harvest energy industry talent and diversifying energy sources to greener portfolios, while helping to ensure the long-term survivability of energy companies. Texas and Oklahoma, for example, have large portfolios in solar and wind for adding renewable energy to the grid and producing green hydrogen; diversifying the total energy mix will help support and diversify regional and local economies. With everyone working together, further investments can be made in renewable energy expansion, grid infrastructure improvements, and technologies to reduce the environmental impact of fossil fuels (e.g., reducing methane leaks and scaling up carbon capture usage and storage), while also maintaining energy security for countries around the world. In reasonable response to the current energy crisis (from the post-COVID-19 surge of demand and isolation of Russia and its energy resources), countries across Europe and other regions have already extended the immediate use of coal, oil, gas, and nuclear power options to ensure proper heating and energy supply throughout the winter.
Finally, climate collaboration might be a long way off, as the latest war on ESG is a complex mixture of grievance politics, fossil fuel protectionism, anti-inclusion efforts, and anti-stakeholder capitalism. Although politicians turning back the hands of time to an era when companies pursue profits above all else at the expense of the environment, employees, and society is not very likely to happen. ESG analysis and ESG investing are baked into the system. Let the free markets choose. If investors want to place their money with ESG-driven companies considering a triple bottom line of their people and the planet, in addition to profits, then let ESG investing continue to improve its methodologies. If investors want to invest in Strive Asset Management’s anti-ESG Exchange-Traded Fund (ETF), DRLL, to urge more drilling and fracking, then that option is available, too. As for the anti-ESG war, from analysis across a wide spectrum of industries, ESG is hardwired into the reporting of most major companies, and the real reason why carbon emissions are tracked, diversity programs are enacted, and sound governance policies are put into place is because ESG is good for the bottom line and good for business.