ESG Investing Loses Momentum, But Not Direction

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Investors are taking a more pragmatic view of oil and gas as they weigh up the need for more near-term investment in hydrocarbon supplies with climate goals. The energy crisis has curbed some of the momentum behind environmental, social and governance (ESG) investing, notably in the US. Yet the direction of travel is clear — and some investors believe an inflection point has already been passed when it comes to ESG-related scrutiny and selectivity that will bring rapid and potentially disruptive change.

  • ESG and returns go hand-in-hand for some.

One of the world’s biggest investors, Norway’s $1.2 trillion sovereign wealth fund, recently reinforced its belief that ESG issues and returns go hand-in-hand. Norges Bank Investment Management (NBIM), which manages Norway's Government Pension Fund Global (GPFG), has set a goal that requires all companies it invests in to reach net-zero emissions by 2050 at the latest. CEO Nicolai Tangen said the fund's long-term returns would depend on how companies in the portfolio adapted to a zero-emissions society. "The fund has a clear financial interest in the goals of the Paris Agreement being reached," NBIM said. "Our analyses show that a delayed climate transition is what constitutes the greatest financial risk for the fund." The GPFG, which owns the equivalent of about 1.5% of the global equity market and counts a shareholding in Shell as one of its largest, will press businesses to reach the goal by setting "credible" interim targets and requiring cuts in both direct and indirect emissions.

The fund’s focus on decarbonization comes against a tough global economic backdrop that has raised doubts over the pace of the energy transition. The GPFG's market value fell by 14.4% in the first half of this year amid worries about rampant inflation and a global recession. Energy stocks performed well, buoyed by booming oil and gas prices, while all other sectors saw negative returns. As Tangen made clear earlier this year, as a large investor and a shareholder in big integrated oil companies “either you sell out and run away from the problems or stay [invested] in the companies and be a constructive long-term shareholder and help the transition.” But he said the fund has clear expectations. It will ask companies to develop transition plans, define time frames and milestones and provide details of annual progress. "We will look closely at … governance structures, frameworks for capital allocation, assumptions about carbon pricing and the use of climate quotas and their quality," he said.

  • There needs to be a clear distinction between ESG and net zero.

The US, however, has seen a political backlash against ESG investing this year from a number of Republican-leaning states that have threatened to cut ties with large asset managers they believe are limiting investments in the oil and gas sector. “There’s been a lot of attention on the large asset managers —BlackRock, Fidelity, Wellington State Street and so on,” Aniket Shah, global head of ESG and sustainability research at investment bank Jefferies, told the recent Offshore Northern Seas (ONS) conference in Stavanger. “They are not the people to be talking about. They are not ‘woke,’” Shah emphasized, noting that none of the top 15 global asset managers has a top-down oil and gas exclusion policy. Instead, he pointed to their clients — the asset owners, such as pension funds, endowments and foundations, that have attached strict oil and gas exclusions to around $40 trillion of capital.

Shah also underlined the need to drive a distinction between what he called the two different concepts of ESG and net zero: the former is an ESG-related evaluation when making an investment decision to maximize risk-adjusted returns; the latter refers to decarbonizing either a portfolio or the real world. “Believe me — at the largest pools of capital they have a very clear distinction around this,” he said.

  • Investors have doubts about how quickly net zero can be achieved.

Asset managers that remain invested in oil and gas “will be heavily focused on engagement, bordering on activism," Jefferies' Shah said, citing activist investors at the sharp end, like Engine No. 1, which launched a successful board coup at Exxon Mobil last year. The whole industry is doing more forceful engagement, for example, through investor initiatives like Climate Action 100+ and others with around $70 trillion of assets under management. “That’s only going to continue more and more over the next 10 years,” Shah said.

While the investor community has signed up to net-zero targets — and in Europe it’s codified by law — Shah said privately his clients have serious doubts about the pace of decarbonization. “Behind closed doors, when I’m chatting with them and advising them, they say there’s no question about the direction, but the time horizon doesn’t make sense.”

In Shah’s view, the world will not achieve net zero by 2050. He believes even more decarbonization than occurred in 2020 at the height of the Covid-19 pandemic would need to take place every year from now until 2050 to hit the target. “And that’s very clearly not happening.” Being honest about time horizons is needed “in a constructive way,” he said.

  • Energy companies will have to cannibalize to survive.

Steve Westly, founder and head of California-based venture capital firm Westly Group, and an early investor in electric vehicle maker Tesla, sees huge opportunities for oil companies that are “fleet of foot” and “see the inflection points and where things are going.” But, he argues, the industry must be willing to cannibalize successful high-margin legacy businesses as companies try to build new green ones before new entrants do so. “That is the world we’re in.”

Equinor CFO Ulrika Fearn said she recognized the need to cannibalize the business in order to maximize long-term returns. “That’s what we have to do as a company to survive," she said. "And that's about building renewable energy for the future as fast as we can, using the capability that we've got, but also creating market opportunities in low-carbon solutions.” To do that, the Norwegian state-controlled major is channeling oil and gas funding into new green businesses “as fast as we can.”

Danish utility Orsted (formerly Dong Energy), was forced to make a choice between renewables and fossil fuels back in 2017. “We were in financial difficulties. We were looking at a balance sheet with way too many different things and we were being downgraded,” said Orsted’s head of offshore Continental Europe, Rasmus Errboe. "On the one hand we had an offshore wind business that we really wanted to grow. And then we had a legacy business that was killing us.” Orsted began divesting noncore assets and speeding up on renewables. It has now cut its emissions footprint by 90% and expects to be fully carbon neutral in 2025. By 2040, this will include end-use emissions from products (Scope 3). "It has gone really well, but our view is that the challenge in front of us as a company is way more daunting than the one we have been through,” Errboe said.

ESG, Equity and Debt Markets, CO2 Emissions, Corporate Strategy
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