02 Nov ESG: Doing More Harm than Good?
The following commentary/analysis is one I wrote in my capacity as a senior fellow at “the nation’s oldest consumer protection agency,” Consumers Research, where, among other things, I compile a weekly letter for public pension-fund managers. I am sharing it here today because I thought it might be useful to some of you.
Shocking New Research: Profit Motive > Central Planning
Last week, Investors Business Daily released its fifth annual list of the “Top 100 Best ESG Companies.” Many of the names on the list were unsurprising. Microsoft, for example, a longtime ESG darling, was rated the best ESG company overall. Indeed, tech companies accounted for 11 of the top 25 spots in this year’s survey, shocking absolutely no one.
That is not, however, to say that everything in the IBD report fit the traditional ESG narrative. Some of its revelations may have come as a surprise to investors, particularly those who have not been paying close attention. Consider:
Some companies that might seem to be the antithesis of ESG actually are at the forefront of the green technology revolution to address climate concerns, new research suggests. The implication is that investors seeking to mitigate climate change need to look closely at companies that might appear to be more problem than solution.
The National Bureau of Economic Research this summer circulated research titled “The ESG-Innovation Disconnect: Evidence from Green Patenting.” Lauren Cohen of Harvard Business School authored the report, along with Umit Gurun of the University of Texas at Dallas and Quoc Nguyen of DePaul University. Many of the companies they found to be at the cutting edge of climate change mitigation are among those that ESG investors would least expect.
The professors analyzed all patents awarded to U.S. publicly traded companies since 1980. They focused only on those patents classified as “green” according to criteria laid out by the International Patent Classification system of the Organization of Economic Cooperation and Development.
They found most “recent green patenting is not driven by highly rated ESG firms — firms that are commonly favored by ESG investors and funds. It is instead driven by firms that are explicitly excluded from ESG funds’ investment universe” — fossil fuel companies especially.
For example, the professors found the following oil and gas companies to be at the forefront of green innovation: ExxonMobil (XOM), which is the 11th largest owner of green patents, Royal Dutch Shell (SHEL), the 18th largest, and BP (BP), the 27th largest. Other top green technology patent holders were ConocoPhillips (COP) (28th largest) and Chevron (CVX), (30th).
I’ll point out here that this research is not new, although its history lends it credibility. The original paper, “The ESG-Innovation Disconnect: Evidence from Green Patenting” was published in October 2020. The data were reexamined this year, and a revised version was published this past June. What this tells us, though, is that the findings remain consistent over time, which is a potent endorsement of the researchers’ conclusions:
Specifically, we find that oil, gas, and energy-producing firms – firms with lower Environmental, Social, and Governance (ESG) scores, and who are often explicitly excluded from ESG funds’ investment universe – are key innovators in the United States’ green patent landscape. These energy producers produce more, and significantly higher quality, green innovation. In many green technology spaces, they appear to be influential first-movers, not easily substitutable, and to produce ongoing foundational aspects of innovation and commercialization on which other alternative energy producers build (for instance, in carbon capture).
The good folks at IBD suggest that this is a good reason for “investors seeking to mitigate climate change” to look anew at traditional energy companies. And it is that, no doubt. But it is so much more as well.
This research is yet another nail in the proverbial coffin of ESG, further evidence that the entire scheme is based on false premises.
From an investor’s perspective, ESG has two components: a capital allocation function and a coercion/engagement function. If traditional energy companies are, indeed, a driving force behind green energy innovation, then the first of these components is destructive, while the second is, at best, unnecessary.
As traditional Socially Responsible Investment (SRI) evolved into ESG, the point of divestment from “sin” stocks evolved as well. While divestment began as a means of salving one’s conscience by avoiding investments in companies that violated firmly held religious or other moral beliefs, under the ESG framework, it quickly took on a much broader and more universal aim, to starve unfavored corporations and industries of capital: “The less we (and others like us) invest in oil and gas companies, the less likely they are to have the resources to exploit the world’s bounty and overheat the climate. By divesting from them, we are also saving the planet.” Or so the theory goes. That theory falls apart, however, if oil and gas companies are also the leading green innovators. It turns out, in such a case, that divestment is actually impeding rather than advancing the cause of de-carbonization.
With respect to the engagement function of the ESG investment strategy, in light of this research, it is difficult to see it as the means to any end other than the raw exercise of power. Fossil fuel companies were deeply invested (financially and otherwise) in developing alternative energy resources long before Larry Fink went full Leeroy Jenkins on sustainability or Engine No. 1 went after Exxon’s board of directors. Fossil Fuel companies didn’t need BlackRock or State Street of CalSTRS to tell them to invest in the future. The profit motive was enough to compel them to do that, as Adam Smith anticipated: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own self-interest. We address ourselves not to their humanity but to their self-love, and never talk to them of our own necessities, but of their advantages.”
When one adds to all of this the fact that divestment from fossil fuel companies has cost investors and pensioners considerable gains over the past couple of years, this research provides further evidence that the core promise of ESG is a lie on both ends: by depriving traditional energy companies of capital, ESG appears not to be doing good but precisely the opposite, even as its practitioners put themselves in a position not to do particularly well either.
Or to put it more simply: Even on the question of the future of “green” energy, ESG is indeed disconnected. It does more harm than good and impoverishes its practitioners on a relative basis.