What Does ESG Actually Mean?
An investigation into one of the hottest trends in finance.
ESG investing has been a hot trend over the last few years, as climate change has become a more and more important topic. From governments to companies, everyone seems to be taking steps to do their part... right?
Today we are going to dive into what ESG actually is. The truth might surprise you. Before we begin, a message from our sponsor:
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Windmills for Everyone
Earlier this week, Bloomberg reported that Germany plans to restart its coal plants to help with its energy crunch. This was a necessary step to ease the financial burden on German citizens, as next year's power continues to grow more expensive.
Energy prices are climbing because Russian gas was a huge source of German energy, but Europe sanctioned Russian energy imports after the latter invaded Ukraine. Now, this didn't hurt Russia all that much. Russia simply increased exports to India and China, and the ruble is sitting at a five-year high vs the euro:
These policies did hurt European consumers though, as their electricity bills have more than doubled since Christmas. So Germany turned to coal to lower energy prices.
While German energy costs will decline, there's one problem with this solution: coal is horrible for the environment. Actually, coal is the most harmful energy source on the planet, from the perspective of both greenhouse gas emissions and deaths from accidents and air pollution.
The trifecta of clean energy is nuclear, wind, and solar.
Nuclear is especially interesting, because it is actually cleaner, emissions-wise, than wind and solar. And the death rate (which includes the Chernobyl and Fukushima disasters, as well as mining accidents) is only a rounding error higher.
Nuclear is also interesting because 27% of Germany's power actually came from nuclear reactors in 1990. Now, 6% of Germany's power comes from nuclear. Why the reduction?
Because in the 2000s, Germany decided to phase out nuclear and double down on renewable, clean energy! Yes, this is supposed to highlight the absurdity of what happened in the 2000s.
I previously wrote a detailed breakdown of how Germany became dependent on Russian gas (worth a read if you really want to get into the weeds), but I'll summarize below for brevity.
In 1980, a new political party, the Greens, was formed in Germany. Since the party's formation, the Greens have been concerned with the immediate halt of construction and operation of all nuclear power stations. As an alternative, they have promoted a shift to non-nuclear renewable energy sources such as solar and wind power.
After the Chernobyl disaster, the Greens became more radicalized and refused to compromise on the nuclear issue. Fearing public backlash, politicians across all parties began to stress that nuclear was a “transient technology”, but not the future. After 1989, no new commercial nuclear power plants were built in Germany.
Let's keep in mind that this anti-nuclear movement was supported by fear-mongering, not facts. Germany had the safest nuclear plants in the world. The Chernobyl disaster was caused by years of abhorrent misconduct across all levels of the chain of command.
If 500 blind, drunk, 90-year-olds were speeding down the highway at night in vehicles with broken headlines and cut brake lines, and they caused a series of wrecks, would we ban cars?
We would probably make sure that blind, drunk 90-year-olds and cars with broken headlights and brake lines stayed off the road.
Germany decided to just ban the cars instead.
In 1998, the Social Democratic Party of Germany (SPD) and the Greens led the nation as a joint coalition. Gerhard Schröder, leader of the SPD, was elected as Chancellor.
In his first term, Schröder’s government decided to phase out nuclear power and instead double down on funding other renewable energies. As you can see from the chart below, it worked. Nuclear usage has been collapsing.
To the German government's credit, the adoption of other renewable energy sources did increase exponentially. But you know what else increased? Natural gas.
As you can also see in this chart, it will still be decades before other renewable forms of energy can sustain Germany's grid. This meant that Germany had to increase its usage of another energy source to offset the nuclear reduction.
Gas still produces 150x more emissions than nuclear, but it is cleaner than coal and oil. Having already committed to phasing out nuclear, Germany turned to natural gas to fulfill its energy needs. There was just one problem:
Germany produces little natural gas of its own.
However, Europe’s estranged neighbor to the east, Russia, happens to produce the second-most most natural gas in the world.
So Germany started importing a ton of gas from Russia. And Schröder approved the construction of the Nord Stream 1 pipeline between Germany and Russia, so they could import even more gas.
The result? In 2022, 55% of German gas imports came from Russia.
In the name of renewable energy, Germany replaced a domestic, clean energy source that powered 27% of its grid with a much dirtier fossil fuel from Russia.
This was quite beneficial for Schröder though, as the former Chancellor currently serves on Gazprom's (the owner of the Nord Stream pipeline) board, and he just recently stepped down from the board of Rosneft.
I'm sure there were no conflicts of interest there, and Schröder just underestimated how long it would be before windmills could power Europe's biggest economy. Gas was just a "transient" fuel source, right?
20 years later, Germany is burning coal again as a result of its green movement. Very ESG. In other news, I am smoking cigarettes to lower my risk of lung cancer.
Did you know that you, as an individual investor, can now invest in cutting-edge environmental, social, and governance companies? And you don't have to do the due diligence of sorting through the quarterly filings of alternative energy and electric car companies. You can simply invest in ESG ETFs created by large asset managers.
BlackRock is the world's largest asset manager, and they offer 800 different iShares ETFs. You can filter for different ETFs on the iShares site, and guess what? Some of these funds are ESG-friendly!
BlackRock's flagship ESG fund? The iShares ESG Aware MSCI USA ETF. With $21B in net assets, this ESGU ETF has the GDP of a small nation invested in the world's leading ESG firms. Let's check out the portfolio:
Apple, Microsoft, Amazon, Alphabet (2x), Tesla, Nvidia, JPMorgan, J&J, and UnitedHeath. Ah yes, the bastions (excluding Tesla), of proper environmental, social, and governance practices. A lot of work went into building this niche portfolio.
Now let's look at BlackRock's S&P 500 portfolio, which, ya know, matches the S&P 500.
Apple, Microsoft, Amazon, Alphabet (2x), Tesla, Berkshire, J&J, United Health, and Nividia. I guess Jamie Dimon has a smaller carbon footprint than Buffett and Munger! But man, isn't it crazy that the world's biggest companies are also the most environmentally friendly?
There is one key difference between the ESG and S&P funds: the expense ratios on the ESG fund are 400% higher.
It's actually a great business model: Sell the investor on the idea that they are making environmentally-friendly investments, hope they never actually check out the portfolio allocation, and rake in extra cash from fees.
Thank you BlackRock, very cool.
This mislabeling of "ESG" companies shouldn't be a huge surprise.
While BlackRock's CEO Larry Fink has been telling investors that "climate risk is investment risk" in his annual letters, he's had no issues pouring billions into China. For those who weren't aware, China emits 2x the greenhouse gases as the United States and has lackluster "social" and "governance" records. (Though if we use China's social credit system, China probably has a 10/10 social score.)
So What Is ESG?
That's a great question, and there isn't a definitive answer. It's a vague conglomerate of buzzwords about helping the environment and treating people right, I guess. The ambiguity of ESG is a feature, not a bug.
ESG isn't about saving the environment. It isn't about saving anything at all. ESG is a catch-all label that policymakers and company leaders can manipulate however they like to shift public perception.
Slap some windmills and green borders on a PowerPoint, pay for a few trees to be planted to offset your carbon footprint, fly private jets to Glasgow every year for climate conferences, and then keep doing everything that you were going to do anyway. Because now, all of your actions are ESG!
And don't worry about the rest of us. We'll keep doing our part by drinking from paper straws.
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