Several state treasurers have withdrawn billions of dollars worth of investment assets from managers over ESG concerns in recent months. The treasurers felt that firms like BlackRock were too focused on climate change to the detriment of their fiduciary responsibility.
We agree that many elements of ESG investing have been disastrous and applaud the state treasurers for their resolute actions.
Below is an open letter we sent to State Treasurers regarding this situation.
Dear State Treasurers,
For nearly a decade, countless firms have liquidated their energy investments entirely after bowing to ESG pressures. In July 2008, energy companies made up 16% of the market capitalization of the S&P 500. As recently as 2014, they were 10% of the market. Since then, widespread ESG initiatives and a bear market in oil prices have led many investors to sell their energy holdings entirely. By November 2020, energy made up 1.8% of the S&P 500 – the lowest level in history. Two years later, energy companies generated over 20% of the EBITDA of the S&P 500 but still represented less than 5% of its market capitalization – less than half the long-term average.
Taking their cues from investors, energy companies have also stopped investing in their assets. As energy demand fell, capital expenditures plummeted during COVID but have yet to rebound. Most analysts expect energy spending in 2023 will be 30-40% lower than in 2019, despite much higher energy prices. Many companies prefer to return free cash flow to shareholders through dividends and buybacks instead of reinvesting in new oil and gas drilling. Our research suggests that hostile ESG rhetoric and depressed corporate valuations are primarily responsible for these capital allocation decisions. Given how cheap E&P companies are, management can often generate a better return by buying back their stock than through the drill bit.
None of this bodes well for our energy supply. Over the past 15 years, nearly all global oil and gas production growth has come from the US shales. If we restrict capital to these vital assets, we risk turning off the sole source of traditional energy growth. Furthermore, the US has gone from being a large energy importer to a net-energy exporter. If we continue to starve the industry of capital, it is only a matter of time before we slip back to being large-scale net energy importers.
Moving away from firms that push traditional energy divestment is an essential first step. For too long, asset management companies have taken too active a role in de-facto energy policy by redirecting capital flows away from E&P companies, often with no explicit mandate. However, we would argue this is too little too late. So much capital has already been removed from the energy industry that to fix this problem, institutional investors must actively target those companies directly funneling money back into the energy business. The effects of a decade of energy divestment are hard to overcome. Today, many generalist investors and analysts have never learned anything other than to sell energy stocks. In 2022, energy equity ETFs saw net redemptions, despite being the best-performing sector in the S&P 500.
If we want to secure an abundant energy supply, we need to get capital back to the E&P industry and encourage them to deploy it. At Goehring & Rozencwajg, we have invested in the energy sector throughout the bear market and continue to do so today.
We are not blind to the issues surrounding carbon emissions. However, we believe many proposed solutions (notably wind and solar) are not viable. By moving capital away from traditional energy towards these new solutions, we risk not only impairing trillions of dollars but also not solving the underlying carbon issue. Most importantly, we believe economic incentives and the free market are the best way to generate an efficient outcome.
To read more of our research especially as it relates to the complex interchange between traditional hydrocarbon produced energy and energy produced from renewable sources, please visit our website at gorozen.com.
Sincerely,
Goehring & Rozencwajg
Natural Resource Investors