Is your fund manager’s ESG investment policy really ethical?

The so-called ethical policies of some investors are doing more harm than good, says Merryn Somerset Webb.

Energy prices are on the rise everywhere. Here, wholesale natural gas prices have just hit record highs – up 100% in a month. In the US, petrol prices are at their highest for seven years. In China the government has begun to ration electricity. In India, coal supplies are so low (a few days’ worth) that power cuts are almost definitely on the way. It rather looks, says Gavekal research group, as if the world is “in the grip of a full-blown energy crisis”. There is lots to think about as a result. You might want to have a good look at just how diversified your portfolio is: energy crises have a history of opening the door to inflationary spirals. That’s a particular risk when combined with rising wages and rising taxation. Are you ready (see this week's magazine for how much markets hate stagflation)?

But there is something else you should do: check the environment, social and governance (ESG) criteria your fund manager uses when it chooses – and rejects – possible investments. They could be part of the problem. These last few years, it has been all the rage in the investment industry to signal concern for society by announcing that you will not invest in grubby stuff. Only last month, Harvard University said it would divest its $42bn endowment from filthy fossil fuels. It joins another 1,337 institutions globally, managing over $14trn, who have made the same commitment. 

That sounds nice. But as we are finding out, the consequences are not. The immediate causes of the energy crises in different countries vary, but drill down, says Gavekal, and they are all due to “market distortions caused by deliberate policies” – policies that in large part reflect the desire to go green. This is theoretically laudable. But we can’t go fully green anywhere near as fast as activists and governments think we should. 

Global energy use tends to rise at about 2% a year. And regardless of how fast we build renewables, we will need fossil fuels as back-up for decades to come, not least because building renewable energy capacity takes a lot of energy in itself. As Edward Chancellor notes on Breakingviews.com, it takes four to five years to recoup the energy that goes into making turbines and other renewables. That means the $16trn of green investments planned globally will mean concurrently soaring demand for oil. Want clean energy? You need dirty energy.

A shame then that investment in fossil fuel production and exploration is falling sharply and that oil majors are loath to invest in big new projects, for the simple reason that no one will back them. Over the last five years, the world has discovered about 12 billion barrels of oil a year and consumed three times as much (more on this in next week’s magazine), while global oil and gas upstream capital spending has fallen from nearly $800bn in 2013 to below $350bn this year. The result will be unpleasant – in terms of growth, in terms of living standards and in terms of the actual goal, our ability to efficiently attempt our energy transition. 

So look at your fund manager’s policies. They may be divesting from fossil fuels. They may feel good about all the ESG boxes they can tick. Their policy, they will tell you, is ESG-compliant. They’ll be right. But if that ESG policy is not practical – if helps create inflation, falling living standards and general misery – and if it turns the public against the idea of the green transition... is it also ethical? It’s a question worth asking. 

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