Militant ESG in Oil will trigger consequences elsewhere

Blain’s Morning Porridge – June 1 2021: Militant ESG in Oil will trigger consequences elsewhere

“It was a murmuration of commodities dealers… ”

This morning: ESG tightened its grip on markets in a succession of wins over oil majors. Is that a good or bad thing? Probably better shareholders decide a company’s green objectives than them being set by bureaucrats, but there will be consequences.

Markets are about psychology. If you can set a trend, then everyone will jump on board. This morning, I’m reading $2 bln per day has flowed into sustainable funds this year, according to Morningstar. ESG (Environment, Social and Governance) investing has seized the institutional market’s focus and attention. Corporates are responding in the time-honoured way – peppering annual reports with copious mentions of sustainability, diversity awareness, corporate social responsibility, and how ESG “powers” everything decision they take.

There is a risk the act of being seen to be ESG compliant becomes more important than actually doing anything tangible to improve the planet, better the lives of fellow human being, or ensure companies are well run.

Last week saw extraordinary events in Oil as successful climate change protest shook the industry to its very core. The fight wasn’t won by placard-waving grungies, or tree huggers wailing “Kumbuya” outside corporate front doors. This time the knockout blows came from ESG and CRS wielding suits in the boardroom and in court. They won. Big Oil lost. It’s a moment when the world shifted… If it’s happening in oil – it’s going to happen elsewhere.

The world is taking notice….

Exxon had to give seats to a tiny activist investor which won support from other holders concerned about the wobbly oil giant’s “strategic direction” in terms of reducing emissions. Chevron submitted to investor demands that it takes climate change seriously. Shell was ordered to slash emissions by cutting production by millions of barrels per day, on the basis of “unlawful endangerment” after being dragged to court by Friends of the Earth’s Dutch chapter. Total faced a similar challenge in France, but scraped by.

Are these Good or Bad things?

Boards being held accountable by investors is nothing new. Courts ensuring companies act honestly and do no harm is fundamental to corporate governance – the ultimate sanction. What changed last week was confirmation ESG principals are right up there in terms of how companies must act.

I find myself somewhat conflicted here – I get the science, I understand it and, owning a house by the sea, I’m motivated to avoid climate change and rising sea levels. (I can guarantee that will spawn a host of climate denial comments on Zerohedge…)

I also take the view imposing regulations (and all other varieties of bureaucracy) are distorting – and ultimately spawn a host of ways for corporates to arbitrage and avoid them. I saw it most clearly in in financial institution capital – where we dreamt up a million ways to “optimise” bank capital and arbitrage capital weightings, spawning a host of instruments and behaviours that ultimately became crisis triggers.

Shareholders taking direct action to discipline recalcitrant boards failing to act climate change is vastly preferable to companies claiming environmental compliance, by greenwashing and virtue signalling claims they meet pages and pages of regulation.

I am developing a strong suspicion the ESG Industry – which is what it now is – has become a facilitator for corporates looking to virtue signal and hide behind regulations and environmental gobbledygook. Frankly I don’t understand how a company launching a green bond makes that firm any better or excuses previous years of polluting activity. I am entirely unimpressed by Government ministers bragging about the UK’s green Gilts programme – bid deal, lots of soundbites, empty gesture.

I’m much more impressed by the tiny activist hedge fund Engine No1 knocking sense into Exxon’s prehistoric board to enforce climate change action by putting 2 board members in place – it was widely supported by institutional shareholders.

But… who is to say the carbon emission reduction policies one set of activists push companies down are better than the alternatives? Who guards the guards? Many folk think Electric Vehicles are a solution – without considering the long term carbon costs of producing batteries and cars, or the problems recycling lithium. Successful entrepreneurs like Elon Musk have not so much set a new green agenda, but dragged the market down their chosen paths to environmental betterment.

Who is next?

The activists are already targeting financial institutions. An Australian coal mine project has stalled because it can’t find insurance because of ESG concerns. The UK metallurgical coal mine I was trying to fund has stalled in government dither over the climate signals its approval might send. Banks and funds are being targeted by sophisticated organised protests. “Blackrock – Your assets on fire!” is a campaign that’s working, forcing one the largest investors to pay attention. Chris Hohn’s Children’’s Investment Fund, and climate activist, is demanding banks stop funding fossil fuels.

The international Energy Agency is also in on the act – demanding energy companies stop all new oil and gas projects this year. British banks have been described as equivalent to a top 10 carbon polluter based on their financing of fossil fuels. Ahead of the COP26 climate change conference in Glasgow this November, environmental groups intend to target bank boards and compliance with demands they cease further fossil funding.

It’s a message banks, regulators and politicians have no alternative but to listen to – and that becomes a distortion. Successful companies are successful because they are well governed and understand what makes them work – they know themselves. Imagine what happens when self-appointed climate-Nazis take over?

The power of ESG has grown exponentially is recent years. It now sets a “climate change trumps the invisible hand of markets” agenda. It has the potential to become another massive distortion moment. I’d much rather see good corporate governance in terms of companies doing the right things, rather than pandering to ESG notions and feeding the ravenous ESG panjandrum of conferences, courses, experts and consultants.

ESG principals are good. The ESG Industry? Perhaps… less so. As we all know market distortions trigger multiple primary and secondary unforeseen consequences – not all of them happy. Consequences… consequences…

One of the issues I was talking to clients about last week was what does the slew of oil decisions mean for markets?

Oil producers– under assault from activist investors and from the threat of climate goal lawsuits – have been forced to pay attention and be seen to act. If they scale back on capacity or production to meet climate activist demands – the potential is to push the price of oil higher until declining demand from oil finds a new equilibrium. That could take decades – meaning severe energy price distortion upwards in the short term, generating inflation and slowing growth – but that’s ok say climate change grungies, happy to see cities starve so a polar bear can catch fish. Higher long-term oil price distortions also favour producers with somewhat laxer social compliance values than US oil majors. Tehran will be delighted.

There is a strong body of opinion that dramatically scaling back fossil fuels via shareholders and the courts will encourage the development of new renewable power sources – but that means a massive build out of resources, which will generate further emissions, and take years of higher oil based energy to achieve.

Could last weeks’ court actions also impact the global economy? The US was looking good a few years ago as it became clear it was energy self-reliant, and could even export gas.. If these resources are now under threat, how vulnerable does that leave the US economy to other nations less squeamish about where their hydrocarbon feedstocks and energy comes from?

Lots to think about…

Finally, it’s a happy 30^th Birthday to Bridport Securities, founded by my great chum Alex Bridport, market legend and good all round bloke – who has just got himself designated an “international athlete” so he can drive his vintage car all round Italy on the Mille Miglia!

Five Things to Read This Morning

FT – Bill Gross – The real bond kings and queens sit on the Federal Reserve throne

FT – US junk bond market loses steam on mounting inflation jitters

Finance Monthly – Spacs; another deflating bubble

Bloomberg – The Covid Trauma Has Changed Economics – Maybe Forever?

WSJ – Reopening Bets Pay Off Big For Stock Pickers

Out of time, and back to the day job

Bill Blain

Shard Capital