How Not to Save the Planet … or Your Investment Returns

Outgoing Bank of England Governor Mark Carney may be modern central banking’s most notorious waffler when it comes to interest rates and forward guidance, but on one matter, the steel-blue-eyed gent is consistent: climate change. He has long argued banks and investors have too much skin in the fossil fuel game, and only divestment can re-orient the global economy toward greener, planet-saving initiatives. On the eve of his job switch from central bank chief to UN special envoy for climate action, he made one last attempt to green (sorry) finance: legislation, co-written with the UK Secretary of State for Work and Pensions, requiring large pension funds to “report on how they are considering climate change in their governance, strategies, risk management and targets will encourage financial flows towards addressing the threat of climate change to all our futures, and improve the health of our economy longer term.” In essence, they will have to disclose their portfolio’s carbon footprint … and a lot more. The aim here, which you are free to have your own opinions about, is what it is. Disclosure is a fine thing. The premise underlying it, however, seems suspect when you dig beneath the surface. It presumes investing in fossil fuel companies is bad for the climate. Reality, however, is a little more complex.

To see this, look no further than today’s Wall Street Journal, where Rebecca Elliott delivers a smashing look at how the largest oil and gas firms are also huge investors in carbon-reduction efforts. Their method of choice: carbon cleaning and capture. These companies aren’t just trying to reduce emissions from their own smokestacks. They are funding technology that wants to suck carbon out of the atmosphere and channel it into greenhouses, next-generation fuels and your next can of seltzer. One Texas-based oil producer is building, along with a Canadian engineering company, “a facility in the Permian Basin of Texas and New Mexico that would take up to roughly 1 million metric tons of carbon dioxide out of the atmosphere annually. That’s equivalent to the greenhouse-gas emissions from more than 200,000 cars a year, according to EPA estimates.”

As green initiatives go, carbon capture sometimes gets a bad rap—largely from potentially biased activists. But most people in the know acknowledge carbon capture is vital to meeting long-term climate targets without forcing perpetual poverty and underdevelopment on Africa and much of the less-developed southern hemisphere. Planting a trillion trees, as the helicopter-flying elite at Davos pledged to do, is all well and good. Planting what an Arizona State University engineering professor calls “mechanical trees” is probably even better, because it is more economical. It generates profits, giving people incentive to develop and spread the technology.

To say fossil fuel companies are always and everywhere not green—and at great long-term risk of failure because of their core business models—is to ignore how companies adopt technology and adapt with the times. As long as there is a financial incentive to reduce emissions, fossil fuel companies will likely be the first to jump on it, as their vested interest is strongest. Notwithstanding the UK government’s plan to ban the sale of all gasoline, diesel and hybrid cars by 2035 (or maybe 2032, if you believe today’s reports), there is still huge global demand for fossil fuels. Global air travel isn’t slowing down. Electric cars may yet rule the roost, but getting there requires an astronomical expansion of the power grid. Wind and solar, with their large environmental footprints, are at best a limited stopgap solution (see the recent controversy over unrecyclable plastic wind turbine blades clogging landfills). Beyond transportation, less-developed nations want the same opportunities for prosperity that developed Europe, Asia and America have enjoyed. They won’t get it without electricity.

If fossil fuel companies can keep producing the fuel necessary to meet global demand while profiting from cleaning up after themselves—both in real time and retroactively—is that really an investment to avoid? Is that a guaranteed money loser? Or is it progress and a net benefit to all involved—aka the basic story of free markets since Adam Smith?

Another problem this new pension regulation ignores: Nature abhors a vacuum. Let us imagine this “succeeds,” and banks and fund managers pull funding from publicly traded Energy companies. What would probably happen? A recent op-ed in Canada’s Globe and Mail has the likely answer: State-owned oil companies from other nations will step in and dominate the industry. Do you think state-owned Energy companies in Russia, Venezuela and the Persian Gulf are going to invest buckets of money into environmental technology? Highly unlikely—these companies are government funding lifelines. Their profits go to state largesse and, frequently, the support of undemocratic regimes with no accountability or regard for the rule of law. I sort of doubt Carney intends for the biggest beneficiaries of his plan to be Nicolas Maduro and Vladimir Putin, but to me, there is a fairly good chance that is how this would shake out, with a dirtier planet in the process.

I suspect the best path for investors and the planet is for everyone to spend more time thinking through the law of unintended consequences and remembering free markets have solved many other environmental problems in the past. American emissions have fallen over the past several years for a simple reason: The shale boom made natural gas cheaper than coal. Natural gas is much cleaner-burning. Shale producers took it upon themselves to develop technology allowing them to recycle and reuse water used in the hydraulic fracturing process. Even further back, technological improvements and the need to cut costs drove Big Soda to produce cans with less aluminum.

Shallow numbers like companies’ carbon footprints won’t give investors the information they need to assess whether companies they own will be profitable or, if it is important to the investor, consistent with their personal values. Environmental, Social and Governance investing—aka ESG—is much more complex than that. If it is to be more than a marketing ploy, it has to carefully examine all three aspects and understand there are tradeoffs. So the lesson here is what the lesson always is for investors whenever regulators slap new rules on financial companies: Don’t rely on the rules alone to do your due diligence for you. Get all the information you need, think critically about it, and make your own decisions. That is the real way to be an empowered investor.