SINCE 2016 the value of investments in financial products that claim to meet environmental, social and governance standards (ESG) went from $23,000,000 to $35,000,000. Bloomberg Intelligence, a research firm, estimates it could exceed $50 billion by 2025. ESG funds typically tell their clients that they are doing their part to fight climate change when they invest in publicly traded companies. Most individual investors take these claims seriously and buy these funds in good faith.
Such faith is not always well placed. A lack of rigorous measurement means greenwashing is widespread and false claims go unchallenged. Many funds claim that there is no trade-off between maximizing profits and green investment, which seems unlikely as long as the externalities created by polluting companies are legal and untaxed. And ESG funds often seek to achieve their goals simply by excluding stocks of companies in polluting industries from their portfolios and instead stacking them in expensive tech stocks, from Alphabet to Zoom.
As we report this week, the increase in ESG investment and the stigma faced by publicly traded energy companies has an unintended side effect. The dirty assets of the western world are heading for the shadows. Public companies, including European oil majors like Shell, and major listed mining groups, are selling their most polluting assets to please ESG investors and achieve their carbon reduction goals. But these oil wells and coal mines are not closed.
Instead, they are bought by private companies and funds that have other sources of capital and stay out of the spotlight. No wonder: Owning dirty assets may require thick skin, but it’s likely to pay off. Private equity firms have acquired $60 billion in fossil fuel assets in the past two years alone, from shale fields to pipelines. Their appetite could grow as unrest around Ukraine pushes oil prices back above $90 a barrel.
This move towards private ownership is part of a larger global trend. More opaque institutions seize dirty assets. Public oil giants like Saudi Aramco don’t have to worry too much about what ethical investors think. Neither do the state-owned companies and banks that own or finance a vast archipelago of coal-fired power projects across Asia.
Shading is problematic for two main reasons. First, claims made by listed companies (and ESG financial) that they contribute to decarbonizing the planet are debatable. Selling a polluting asset does not reduce emissions at all, if it continues to pump oil or extract coal. Second, as dirty assets move into private hands, it becomes harder to tell whether their owners plan to reduce production over time or increase it. All that has been created is an arbitration system, in which dirty assets change hands to inappropriate applause.
What to do? First, impose more carbon taxes or carbon prices. These tools are the best means of aligning the pursuit of profit with the imperative of reducing emissions, and thus unleashing the power of markets to reallocate capital quickly and efficiently. And they can apply to the entire economy, not just to particular industries or forms of legal ownership. Long rejected as politically impractical, they are gradually being introduced, at least in places. Nearly half of all energy-related carbon emissions in g20 economies are covered by a carbon price, compared to 37% in 2018, according to the OECD, a club mostly made up of wealthy countries. However, coverage still needs to expand and the carbon price needs to be higher to reduce emissions more effectively.
The other answer belongs to institutional investors, such as pension funds, endowments and insurers. Some are the proud recipients of virtuous ESG funds whose portfolio companies are dumping dirty assets, and simultaneously the partners of private equity funds eagerly buying them. If institutional investors really want to be green, they should consider the total carbon footprint of their portfolios. The task of measuring these footprints and avoiding double counting is onerous but crucial.
Finally, investors should challenge the idea that the best way to get polluters to pollute less is to dump their stocks. Such dumping is supposed to increase the cost of capital for polluters, and therefore prevent them from further investment. But that doesn’t work if there is an abundance of alternative private money ready to buy up those shares, which there is. Larry Fink, the boss of BlackRock, the world’s largest asset manager, suggested a different approach. Sincere green investors – and there are many of them – should hold onto their dirty stocks and work with managers to reduce emissions. He is right. To be truly green, investment strategies need to be less black and white. ■
For more coverage on climate change, sign up for The Climate Issue, our bi-monthly newsletter, or visit our climate change hub
This article appeared in the Leaders section of the print edition under the headline “A dirty secret”