If you are running an energy company involved in the production of fossil fuels, you’d be tempted to make Rodney Dangerfield your mascot. You just don’t get no respect. ESG investors launch one divestment campaign against you after another and your sector is either excluded from ESG funds (the fastest-growing corner of the fund market) or severely underrepresented.
I have said it before, and I will say it again: Divestment campaigns don’t work. In fact, they are counterproductive.
I advocate in favour of engaging with energy companies and rewarding them for improving their efforts to become more sustainable businesses. In practice, this boils down to an ESG momentum strategy where you invest in companies that have a proven track record of improving their ESG credentials over time.
Strangely enough, ESG momentum investing, a well-known approach to ESG investing is often practiced by ESG funds in other sectors but ignored in the energy sector. A study by Lauren Cohen, Umit Gurun, and Quoc Nguyen looked at innovation and patents in the field of green technology as one marker for companies investing in a more sustainable future.
They found that ESG investors tend to flock towards companies with more green patents in every sector, except mining and energy. Environmental ratings also improve for companies with more investments in green innovation and more green patents in every sector, except mining and energy (which begs the question whether ESG investors invest more in these innovative companies because of their better ratings, but that is not the point here).
In the mining and energy sectors, investing in a green future and being innovative in this space simply had no influence on their perception by investors. And that’s a big shame because the quality of their innovation wasn’t bad at all. Quite the opposite. The green patents of energy firms have on average 9.1% more citations by other engineers and academics and are 12.4% more likely to become blockbuster patents, i.e. patents in the top 5% of most cited patents. And they are doing a lot of innovative work as evidenced by the sheer number of patents they get.
For investors, this means that there is a clear inefficiency in ESG investing today. Most ESG investors and most market participants seem to underestimate the efforts of mining and energy companies to become more sustainable. The flip side of this is that they are more likely to overestimate the risks of investing in mining and energy companies. By adopting an ESG momentum approach for mining and energy companies, investors can identify these “underestimated” companies that “don’t get no respect”. It’s a way of finding undervalued companies, ESG style.
Number of green patents held by US firms in 2017
Source: Cohen et al. (2020).