Freakonomics – 546. Are E.S.G. Investors Actually Helping the Environment?

Intro

In this episode of Freakonomics, the hosts explore the world of E.S.G. (Environmental, Social, and Governance) investing and its impact on the environment. They discuss whether E.S.G. investors are actually helping the environment or if their strategies are counterproductive. The episode also delves into the Norwegian sovereign wealth fund, the role of brown firms in the energy sector, and the potential consequences of divesting from these firms. Additionally, the hosts examine the effectiveness of E.S.G. ratings, the importance of engaging with brown firms, and the case of ExxonMobil’s transformation through activist engagement. The episode concludes with a discussion on the future of E.S.G. investing and the need for a more sectoral approach.

Main Takeaways

E.S.G. Investing and Environmental Impact

• E.S.G. investing aims to allocate resources in a way that makes money while also improving the world.
• Investors who focus solely on the E.S.G. rating of a company or investment fund may be making a fundamental mistake.
• Norway’s sovereign wealth fund, fueled by oil and gas resources, invests in a conservative and diversified manner.
• The fund proposed selling off oil and gas stocks but ultimately decided to sell only pure upstream oil and gas producers.
• E.S.G. investors tend to prioritize the environmental impact (E) over the social (S) and governance (G) dimensions.

The Role of Brown and Green Firms

• A small number of firms are responsible for the majority of environmental impact.
• Brown firms, active in energy, agriculture, and transportation, have a significant environmental footprint.
• Green firms, such as service companies like Spotify and Goldman Sachs, have less to change environmentally.
• Brown firms may react to E.S.G. investors by becoming more brown, which can be counterproductive.
• Divesting from brown firms in the energy sector may hinder the development of green technology.

The Effectiveness of E.S.G. Investing

• E.S.G. investing is driven by mood affiliation and a desire to believe that investments are not doing evil.
• ESG ratings provided by firms like MSCI, Sustainalytics, and Bloomberg may not be very useful.
• Engaging with brown firms to help make them greener may be more effective than divesting from them.
• Transparency on companies’ impacts allows for consideration of their externalities affecting the long-term business model.
• Engine Number One and Chris James are activist firms pushing brown firms to become greener.

The Case of ExxonMobil and Activist Engagement

• Engine Number One successfully engaged with ExxonMobil to change its environmental impact.
• ExxonMobil’s underperformance was attributed to governance issues and lack of energy expertise on the board.
• The activist campaign against ExxonMobil focused on governance changes and aligning incentives with value creation.
• ExxonMobil has pivoted towards creating value in the energy transition and decarbonizing its operations.
• Engagement with brown firms can drive value creation and make them more sustainable.

The Future of E.S.G. Investing

• Punishing brown firms to an extreme extent may lead to the elimination of crucial sectors in society.
• A more sectoral approach is needed to effectively differentiate between green and brown firms.
• Investing in brown firms that are making efforts to become greener may be more beneficial than divesting from them.
• ESG investing has already increased the cost of capital for brown firms compared to green firms.
• The future of E.S.G. investing lies in sustainable investing flows and engagement targeting brown firms’ incentives.

Summary

E.S.G. Investing and Environmental Impact

E.S.G. investing aims to allocate resources in a way that generates profits while also improving the world. However, focusing solely on the E.S.G. rating of a company or investment fund may not be the most effective approach. The Norwegian sovereign wealth fund, fueled by oil and gas resources, follows a conservative and diversified investment strategy. While the fund proposed selling off oil and gas stocks, it ultimately chose to sell only pure upstream oil and gas producers. E.S.G. investors tend to prioritize the environmental impact (E) over the social (S) and governance (G) dimensions.

The Role of Brown and Green Firms

A small number of firms are responsible for the majority of environmental impact. Brown firms, active in energy, agriculture, and transportation, have a significant environmental footprint. On the other hand, green firms, such as service companies like Spotify and Goldman Sachs, have less to change environmentally and may not be the best candidates for developing green technology. Divesting from brown firms in the energy sector may hinder the overall progress towards a greener future.

The Effectiveness of E.S.G. Investing

E.S.G. investing is often driven by mood affiliation and a desire to believe that investments are not contributing to harm. However, E.S.G. ratings provided by firms like MSCI, Sustainalytics, and Bloomberg may not be very useful. Engaging with brown firms to help make them greener may be a more effective approach than divesting from them. Transparency on companies’ impacts allows for consideration of their externalities affecting the long-term business model. Activist firms like Engine Number One and Chris James are leading the way in pushing brown firms to become greener.

The Case of ExxonMobil and Activist Engagement

The successful engagement with ExxonMobil by Engine Number One highlights the potential for activist investors to drive value creation and make companies more sustainable. ExxonMobil’s underperformance was attributed to governance issues and a lack of energy expertise on the board. The activist campaign focused on governance changes, aligning incentives with value creation, and pushing for a transition towards a greener energy future. The transformation of ExxonMobil demonstrates the positive impact that engagement with brown firms can have in driving sustainability.

The Future of E.S.G. Investing

Punishing brown firms to an extreme extent may lead to the elimination of crucial sectors in society. A more sectoral approach is needed to effectively differentiate between green and brown firms and provide appropriate incentives for change. Investing in brown firms that are actively making efforts to become greener may be more beneficial than divesting from them. E.S.G. investing has already increased the cost of capital for brown firms compared to green firms, and the size of the E.S.G. movement is growing. The future of E.S.G. investing lies in sustainable investing flows and engagement targeting brown firms’ incentives to drive positive change.

Conclusion

E.S.G. investing has gained significant attention and investment, but its impact on the environment may not be as straightforward as believed. Focusing solely on E.S.G. ratings and divesting from brown firms may not be the most effective strategy. Engaging with brown firms to help them become greener and more sustainable can drive greater positive change. The future of E.S.G. investing lies in sectoral approaches, sustainable investing flows, and targeted engagement with brown firms. By considering the long-term business models and externalities of companies, investors can contribute to a more sustainable future while still supporting crucial sectors of the economy.