With Energy Up, ESG Is Under Fire

With Energy Up, ESG Is Under Fire

ESG critics are using short-term market disruptions as an opportunity to question the investment thesis, overlooking a central premise to ESG investing: it's about long term performance.
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The S&P 500 Index has fallen 15% this year (as of May 16), as markets continue to face a perfect storm of uncertainty. Russia’s invasion of Ukraine, Covid lockdowns in China, global supply chain disruptions, surging inflation, and pending Fed rate hikes all threaten to tip the economy into recession. 

Energy (In)dependence

Meanwhile, WTI crude oil prices have surged 48% this year as of May 16 to more than $100 per barrel. While plummeting demand for oil at the start of the pandemic sent benchmark oil prices to below zero, surging demand amid more relaxed Covid restrictions has quickly sent prices higher.  On the supply side, many believe that Russia’s war in Ukraine and the Biden Administration’s decision to restrict Russian oil imports have fueled the spike in prices. And politicians critical of the current president have pointed to his overall climate agenda, suggesting restrictions on domestic production led to reliance on foreign oil and the U.S. losing its “energy independence.”

And yet, U.S. oil exports grew each month from September through December 2021, making the U.S. an average net exporter of 162,000 barrels per day, according to Energy Information Administration (EIA) data. But the political finger-pointing on oil prices tends to disregard the real complexities, including how OPEC’s supply controls abroad can still affect domestic prices, regardless of our energy independence status. 

Blame The “Activist” Investors

Meanwhile, many of the same politicians have also suggested that Biden’s agenda and activist investors have dissuaded U.S. producers from increasing output, which might in turn increase domestic supply enough to ease prices. But U.S. producers chose to stockpile permits at the start of the new administration. Ironically, the move to limit supply was certainly not to appease activist investors, but instead fossil fuels investors for the sake of stock returns. And, it worked. By intentionally limiting supply, combined with more recent global oil market stress, the S&P 500 Index energy sector has risen 51% this year as of May 16, despite the overall decline in the stock market.

It’s About Long-Term Risk

Given ESG approaches often, in part, screen certain traditional energy out of broad index exposure, critics of ESG investing have used this moment of energy outperformance as evidence of inherent flaws in ESG investing. The BlackRock iShares MSCI USA ESG ETF, which screens out controversial sectors and companies with low ESG scores, for example, is underperforming the index by almost 400 basis points year to date. For now, energy companies are playing a larger role in broad market returns. 

But the ESG critics tend to overlook a central premise to ESG investing: For many investors, short-term shocks from unprecedented market conditions should not necessarily change longer-term views related to climate risk and other material risks related to traditional energy.

Clearly, the short-term win for energy investors is not based on fundamental energy company performance, but the effects of prices amid overall oil market chaos. In assessing longer-term risk, this moment could arguably force countries to more deeply assess and act on fossil fuel dependency not just relative to other countries but altogether. Certainly, further regulation to curb fossil fuel usage, including a carbon tax, could also add to the sector’s long-term risks.

Many signs therefore point to fossil fuels continuing to face long-term structural decline. And who could therefore avoid the longer-term effects on stock prices? ESG investors.


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