ESG and energy shortages – have we hit a wall? 

Prior to the Russia-Ukraine crisis, the world appeared to be on the path of wholesale green reform, and much of the investment community accepted that the IEA roadmap to Net Zero by 2050 was a fait accompli. In fact, research shows that the global oil intensity of GDP peaked in the 1970s and has been on a constant downward trajectory ever since. However, the recent geopolitical crises have raised questions on the path ahead.  

Among the concerns being raised by policymakers and investors are energy security and geopolitical risk; food security and instability; greenwashing and climate colonialism. Is this a crossroads moment or a U-turn in the evolution of ESG? At Sentio, we would argue that this ‘global crisis’ should not be wasted and should rather be used to question previous tactical errors in the implementation of policy.  

We have long argued in the past that ignoring the real interplay of ESG risk and market forces will merely lead to window dressing and eventually practical policy reversal. Case in point: investors who have recently been underperforming due to their underweight in oil and energy, have paused or abandoned their ESG underweights. For example, according to BofA research, 6% of European ESG funds now own Shell vs. 0% a year ago, and the trend is similar for other global energy majors.

Ignoring the real interplay of ESG risk and market forces will merely lead to window dressing and eventually practical policy reversal

Furthermore, a new law designating gas and nuclear now as ‘sustainable’ was approved in the EU. In fact, the debate has gone further and affected other areas of ESG beyond the ‘E’; for example, where defense companies were previously excluded from ESG portfolios, there is now a rethink of ‘good defence spending to keep the bad guys at bay’.  

The fear is that if we don’t have symmetric views on ESG, we merely change the payoff profile for offenders so that they will benefit even more through economics. The hypocrisy of policymakers also doesn’t help the cause of ESG investment cases. If one looks at maritime research, one can see that the top dozen container ships create more sulphur oxide than 19 million diesel cars (yes, that’s correct)! If we act symmetrically (unemotionally) across industries, we are likely to have better longer-term outcomes.  

Sentio’s view is that ESG (especially environmental) policies will become blunt tools for change unless we adapt the system to take account of economic forces and dynamic markets. If we continue with this obsession with measurement and box-ticking, we will have a constant reversal of ESG transformation when we have crises, because we ignore the basic premise of markets: risk and reward.  

We need to stop acting along the lines of good and bad or inclusion and exclusion. It means we need to identify and ‘engineer’ the ESG risk into portfolios so that it’s not about excluding oil majors but loading their risk premia so that we adequately price the risk-reward ratio for investors and funders.  

Engineering risk into portfolios requires an understanding of pricing risk, this is where the weakness lies in current policymaking and investment strategy. We believe that incorporating the above will lead to better ESG outcomes while aligning investment returns with clients’ requirements.