ESG functions as a de facto tax on politically unfavorable sectors: not just oil and gas, but mining, steel, shipping, and more.
ESG acts as a carbon tax on the West, with the 'revenue' going to China, Russia, Saudi Arabia, and others.
I t seems like everyone these days is talking about ESG. And yet, it’s still not easy to explain what ESG is, beyond the obvious: “Environmental, Social, and Governance factors.”
ESG approaches often contradict each other, and sometimes even themselves. According to Goldman Sachs, over $100 trillion in “global assets under management have signed up to UN PRI (Principles for Responsible Investment) and are implementing ESG metrics.” For comparison, the total 2020 U.S. gross domestic product was about $21 trillion. So it’s no wonder that it’s hard to quickly summarize such a large and heterogenous field.
Instead of defining what ESG is, let’s ask what ESG does. Investors have considered non-financial factors since the beginning of investment. ESG, though, adds a novel piece: globally coordinating the consideration of non-financial factors across corporations, asset managers, and regulators, in pursuit of politically determined goals. Indeed, this intention has been obvious since ESG’s origins in a 2004 project led by the United Nations, the Swiss government, and a host of financial institutions.
We can only truly understand ESG, therefore, if we look at the bigger picture. And there we see that ESG functions as “an effective carbon tax on the consumers in places like the United States and Europe” whose revenue ends up “going to places like Russia.” That’s according to Goldman Sachs’ top commodity strategist, Jeff Currie.
Let’s unpack Currie’s two points. The first point is that ESG functions as a de facto tax on politically unfavorable sectors: not just oil and gas, but mining, steel, shipping, and more. ESG raises the cost of capital for these politically unfriendly sectors by an estimated 15 percentage points. This means it’s harder for people working in the “old economy” to access loans and investment. For example, a dairy farmer may have a harder time getting a loan due to happening to work in an ESG-unfavorable industry.
The second point is that the ESG “tax” is paid by Western citizens to foreign nations such as Russia. While the narrative around ESG spread by Michael Bloomberg and others holds that it’s simply “investing 101,” that’s hard to square with what Larry Fink has stated: that public companies’ decreased investment in oil and gas has created “the biggest capital market arbitrage.” When ESG pressures decrease public-company investment in politically unfavored opportunities, the opportunities don’t disappear. Instead, they’re largely captured by other actors less committed to ESG.
Due to the ideological presuppositions, and perhaps financial interests, of the largest ESG players, ESG pressure is mainly exerted on public companies in the West. In contrast, ESG exerts little if any impact on Chinese, Russian, and other foreign-owned companies. As a Bloomberg article explains, “National oil companies, or NOCs, are largely shielded from those [ESG] pressures. When the owners are governments, not shareholders, there aren’t dissident board members like those now sitting inside Exxon. That means state oil producers like those who populate OPEC+ can be the buyers of last resort for fossil-fuel projects cast off by the shrinking supermajors.”
This is significant because as of 2021, “For all the focus on companies like Exxon and Shell, the majors recently accounted for only 15% of the world’s supply of oil.” ESG pressure campaigns focus on a small and dwindling percentage of the world’s energy markets. The share of the oil market belonging to foreign national firms is expected to rise from just over 50 percent to 65 percent by 2050, according to Rystad Energy, at the expense of American and other Western firms.
By the way, the Biden administration’s own analysis confirms that artificially restricting American energy production results in American consumers’ paying higher prices and having to import more from other nations.
Strangely, ESG scores seem to favor this transfer of value from West to East. As a group of Utah officials noted earlier this year in a letter to S&P Global Ratings, “S&P also gave the Chinese state-owned China Petroleum & Chemical Corporation a higher ESG score than ExxonMobil and Chevron,” and Russian state-owned bank Sberbank a higher score than JP Morgan.
Meanwhile, in the West, according to Goldman Sachs, “sectors like shipping, oil and gas, cement, steel, are all investing 40% less of their cash flow than they have done in their long-term history.” Long-term underinvestment means long-term underproduction, which in turn translates into structurally higher consumer prices. In the words of Goldman’s Michelle Della Vigna, ESG “creates affordability problems which could generate political backlash. That is the risk — political instability and the consumer effectively suffering from this cost inflation.” Della Vigna is not alone: Blackstone’s Steve Schwarzmann warned last year that ESG-induced shortages would lead to “real unrest” across the world.
Even BlackRock senior investment strategist Kurt Reiman recently referred to underinvestment in “key commodities that Russia and Ukraine export,” though he did not attribute it to ESG.
A related problem is the economic and national-security risk of depending more and more on volatile, unreliable foreign supply chains while choking off American production. The European Union is further along the ESG path than the U.S., and Europe’s recent history with Russia illustrates how nations can attempt to wield commodity and supply-chain dependencies as a weapon.
When pressed, ESG advocates fall back on the expressed intention of ESG: to correct for negative externalities supposedly not satisfactorily addressed by traditional corporate governance. Yet this defense of ESG doesn’t work when Western production is supplanted by foreign-owned firms with markedly worse environmental and human-rights records.
The usual difficulty with central planning remains: unintended consequences. According to Della Vigna, coal production is up this year because of ESG-induced underinvestment in natural gas, resulting in higher emissions than would have occurred using natural gas. Who could have predicted that world energy and commodity prices would spike, Vladmir Putin would decide to invade Ukraine, and Europe would turn to coal to make up for lost Russian natural gas? No one. That’s the point: engineering global finance towards long-term political outcomes is destined to confront unforeseen difficulties and political backlash.
The question now is this: How long will it take markets to capture the opportunities that still exist in ESG-unfavored sectors? This process has already begun, with ESG starting to face market headwinds for the first time. And if Goldman’s analysis is correct, we could be at the beginning of a “commodities super-cycle” that will punish ESG-weighted portfolios and favor anti-ESG investors. Increasing political interest in countering ESG through state assets and pensions may contribute to this trend as well.
There are two main obstacles to the de-ESG scenario. The first is that years of ESG have caused long-term trends that will be hard to unravel. For example, due in part to ESG, the number of petroleum-engineering graduates has declined 83 percent since 2017. As an industry insider has warned, “the brain drain in the industry will create a real and much larger crisis in the mid-to-late 2020s.” Second, the U.S. federal government, and numerous state pensions, have been making a concerted effort to support ESG. In this sense the next decade will come down to a familiar contest: between bottom-up markets and top-down control.