In early February, BP, the London-based oil major that for decades prioritized sustainable, climate-friendly energy initiatives, announced it would dial down aggressive renewables and emission-reduction targets in order to refocus on oil and gas production. The following week, BP stock jumped 20% — a significant snub to ESG messaging.
The trend toward ESG investing, which attempts to quantify and prioritize environmental, social and governance issues, has come under increasing pressure. The concept, introduced in 2004, became a crucial metric for many major investing outfits. Those include the $10 trillion asset manager BlackRock and the $1.2 trillion Government Pension Fund of Norway, among many, many others.
But a loose set of standards and definitions for how to quantify and compare the ESG performance of various companies, across wildly divergent industries, has left the discipline vulnerable to criticism and attack on multiple fronts.
Recently, such criticism has ranged from blaming the failure of SIVB Financial Group's Silicon Valley Bank on overly ESG-directed operations, to a 19-state alliance of governors, launched by Florida Gov. Ron DeSantis, aimed at preventing state pension funds from investing in firms that prioritize ESG principles.
At the beginning of March, the Senate approved a House measure that would prevent retirement plans from considering ESG factors in their investments. President Biden vetoed the bill — notably his first presidential veto — on March 20.
Alongside this anti-ESG political offensive, regulators have also been taking a bite out of the rapid buildup in assets marketed under the ESG label. In Europe alone, Bloomberg reports new regulations pried the ESG labels off $140 billion in managed assets in the latter half of 2022.
BP Seeks Orderly Transition
Amid all this turbulence, possibly one of the most important cuts in the ESG knife fight has come from a company long seen as a leading proponent. U.K.-based BP moved to become a clean-energy ally more than two decades ago — before the arrival of the ESG label. BP PLC rebranded its acronym to Beyond Petroleum, positioning itself as a trendsetter in an otherwise recalcitrant oil industry.
But current CEO Bernard Looney let investors know during the company's fourth-quarter earnings release that BP's trendsetting had reached a limit.
The UK energy giant set its oil and gas production guidance at a 40% reduction vs. 2019 levels by 2030. In February, they eased that target to a 25% decrease. That means BP would produce around 2.3 million barrels of oil equivalent per day by 2025, trimming that to 2 million barrels of oil equivalent per day by 2030.
In addition, BP trimmed its carbon emission reduction targets. The company now aims for a 20%-30% emissions drop by 2030 compared to 2019 levels. That's down from its previous goal of 35%-40%.
"We need continuing near-term investment into today's energy system — which depends on oil and gas — to meet today's demands and to make sure the transition is an orderly one," Looney said at the time.
BP 'Had To Do Something'
For the ESG community, it was an abrupt shift in an important company's messaging. However, while abrupt, it was not surprising to many analysts who watched BP lag well behind U.S. energy company stock performances. BP's decision to dial back climate targets, and the stock price bounce that followed, raise questions about the value investors place on environmental investing.
"The decision for BP to do this is not surprising," Third Bridge analyst Peter McNally said in an interview. "You could see this coming because upstream oil and gas returns are just so much better than renewable energy."
Sanjai Bhagat, professor of finance at the University of Colorado, told IBD that his research shows investor returns are significantly more negative for funds that focus on ESG. He said that, up to this point, oil and gas exploration simply result in better returns than renewable energy efforts.
"The evidence suggests strongly that investor returns have been significantly negative for funds that focus on ESG issues," Bhagat said.
BP Attempts To Even The Odds
BP stock has lagged behind Exxon Mobil and Chevron in recent years. Before BP made its strategy shift, shares of the U.K. major rebounded about 136% from October 2020 lows. Meanwhile, Exxon Mobil stock powered up around 260% over the same period. Chevron gained 144%
In general, U.S.-based oil producer stock prices run at roughly 10 times earnings. European peers trade at about five times earnings.
There is a long list of reasons for this, not the least of which is access to comparatively low-cost shale oil in the U.S. But BP realized it had to change tack, says Abhi Rajendran, director of research & advisory at Energy Intelligence.
"At the end of the day you're judged on your valuation, you're stock performance, your financial performance and your returns profile," Rajendran told IBD. "Pretty much across the board they were underperforming."
In the week after Looney announced BP would scale back its carbon reduction goals, BP shares shot up 15.5%. That was its biggest weekly advance since rebounding from its pandemic low. During the same week, CVX added 1.5%. XOM jumped 6.5%, as West Texas Intermediate oil prices rose almost 9% during the week.
Renewables And ESG Investing
BP's stock price has since come back to where it was before the announcement. But the move underscores that BP and other Europe-based supermajors including Shell and TotalEnergies have for years been under higher pressure than U.S. counterparts to move quickly toward ESG-related targets. Those include more renewable energy operations, targets for reduced emissions, and cutbacks in fossil-fuel production.
Notably, oil executives and investors worldwide are watching a suit filed against Shell in February by environmental activist group ClientEarth. The group contends the company is not moving fast enough to reduce its fossil fuel stance. That failure, the plaintiffs say, risks lowering the future value of the company.
The 100 Best ESG Companies
The strategy was modeled on that of tiny hedge fund Engine No. 1 which, in early 2021, succeeded in replacing two Exxon Mobil board members using a similar argument.
Currently, half of BP's top 10 institutional investors are members of Climate Action 100+, according to Refinitiv Eikon data. Climate Action 100+ is an investors' collective reportedly managing $68 trillion in assets and committed to driving companies to net-zero emissions goals.
The ESG Correction
Meanwhile, U.S. regulators are set to dial-up the resistance to "greenwashing" tactics used by companies and funds. Greenwashing is the luring of investors by assigning ESG attributes to non-ESG, business-as-usual practices.
To discourage the ploy among investment funds, new U.S. rules propose that funds would need to invest 80% of their funds appropriately in order to earn the until-now unpoliced ESG title.
The US SIF — the Forum For Sustainable and Responsible Investment — reports that tighter rules on methodology trimmed assets qualifying for the ESG label to about $8.4 trillion last year. That was less than half the $17.1 trillion level just two years ago.
Some call the decline, in both the U.S. and Europe, the "ESG correction." Ultimately, however, most see the correction as a positive.
"The days of using ESG as a marketing trick to gather assets are over," University of Colorado's Baghat said.
The Pressure Of Underperformance
For its part, BP still holds ambitious fossil-fuel reduction targets. They're just not as ambitious as they once were.
CEO Looney has said the goal is to increase alternative energy investments to around 50% of total capital spending by 2030. BP executives also told investors the company will invest aggressively in "transition growth engines."
The company is continuing its biofuel investments along with onshore wind and solar projects. But its leadership said returns from the company's renewable energy investments have been disappointing.
Bhagat said BP's decision to focus on oil and gas is a clear "reflection of pressure that came about by underperformance."
"It doesn't take a rocket scientist," Bhagat said. "All you had to do was go back to your basics."
Saudi Aramco: ESG Vs. More Oil
Similar to BP, Shell appeared to also signal the company would shift more of its focus back to oil and gas production, easing its focus on ESG criteria. However, CEO Wael Sawan made clear to investors on Feb. 2 that Shell is looking to diversify its energy portfolio.
"We're looking at how do we create value for our shareholders today," Sawan said. "But also how do we create the value opportunities for 2040 when the energy trend — when the energy system will be fundamentally different."
"I'm still convinced you're going to need oil and you're going to need gas and you're going to need a lot more renewables," he added.
The Financial Times reported on Feb. 27 that Sawan and other Shell executives were impressed by BP's share price jump after it dialed back carbon reduction goals. The group led by ClientEarth was unimpressed, and moved quickly to file their suit.
Saudi Aramco CEO Amin Nasser on Feb. 12 said ESG is "clearly a rising trend" in capital spending considerations, Energy Intelligence reported.
However, Nasser added that ESG policies are "implemented with an automatic bias against any and all conventional energy projects, (and) the resulting underinvestment will have serious implications for the global economy, for energy affordability, and for energy security."
BP: Investors Maintain Oil And Gas Despite ESG
Large-scale lenders in the Net-Zero Banking Alliance are committed to aligning lending and investments behind the goal of achieving net-zero emissions by 2050. Those bankers provided more financing to fossil fuel projects in 2021 than for low-carbon energy companies, Bloomberg reported on Feb. 28. But the variances were not as wide as one might expect.
JPMorgan Chase financed $56.9 billion in fossil fuel projects vs. $42.3 billion in low-carbon energy efforts, according to Bloomberg's data. Citigroup reported $43.9 billion in fossil fuel investments against $33.4 billion in clean energy. Meanwhile, Bank of America financed more clean energy projects ($35.8 billion vs. $32 billion). Morgan Stanley invested 8% more money in fossil fuel activity compared to low carbon businesses.
Bhagat says that energy company CEOs certainly watched BP's post-announcement share-price leap. As a result, some may come to the conclusion they can stop, or at least cut back on, touting ESG efforts.
"They might not publicly state that, or not even acknowledge that, but you know they are looking at the same market share price reaction," he said
Meanwhile, Third Bridge's McNally said investors still value ESG ratings. However, he added investors "really care" about capital allocation.
"Aggressively investing money without any incremental return is still something that shareholders are nervous about," he said. "Investors are still comfortable with certain parts of the renewable value chain, but not all."
Rajendran says "I don't see (ESG) going away," but he expects the practice to face more scrutiny, stressing the "governance" aspect of ESG cannot be "ignored for environmental and social causes."
Please follow Kit Norton on Twitter @KitNorton for more coverage.
