ESG & carbon credits: the indulgences of a zero-sum world

At some point in the past couple decades, the corporate world drew inspiration from the Middle Ages, and decided it was time to bring back indulgences. 

Indulgences, if you’ve forgotten your Roman Catholic theology, are a way to reduce the amount of temporal punishment you undergo for your sins. In other words, you could pay money and spend less time in limbo. At first this penance was paid in forms of prayer or charity or good works, but if you’ve forgotten your Roman Catholic history, this began to mean financial donations. By the time of the Reformation, you could basically just pay off your vices through consistent donations to the overflowing and corpulent Papal treasury. 

Simply put: pay enough, and you’re all good.

Lately, the investing world has been running amok with a new concept called ESG which is (to describe it in the most simplistic terms possible) a scoring factor to judge corporations by their environmental, social, and governance goodness.

Sounds nice, right? 

Funds and ETFs are popping up faster than caffeinated prairie dogs in West Texas. These funds are massive. They’ve grown fast. Around 15 years ago, they did not exist. Today, they have a market cap of over $16 trillion. Handily, nearly all of these funds have 2-3x more expensive management fees as your standard vanilla ETF.

But the devil is in the details.

  • 87% of ESG funds that popped up in 2020 are actually just rebranded normal funds, which added words like “sustainable”, “green”, or “climate” to their name. Of all the ESG funds that rebranded in 2020, none changed their stock holdings before the rebrand.
  • Many of these funds hold Exxon, Nike, JP Morgan, and Amazon as their top holdings…none of which are exactly known for environmental or social benefits.
  • Not a single ETF or fund analyzes deforestation risk — or factors in climate risk — despite marketing their offering as a “green” ethical option. 

Turns out, like any other abstract scoring factor, ESG scores can be gamed. And, much like the papal indulgences of the 14th century, you can just buy yourself good ESG credits.

Let’s look at these ESG funds.

You’d think that the SPDR S&P 500 Fossil Fuel Free Reserves Free ETF would be…I don’t know…fossil fuel free? 

No. The SPDR S&P 500 Fossil Fuel Free Reserves Free ETF is actually composed of 5.3% fossil fuel producers, including coal plants and oil companies. When reached for comment by MarketWatch, the head of SPDR Research stated that “Eliminating all firms that interact with carbon would result in a heavily concentrated portfolio that may not be suitable for all investors. As a result, there is a small exposure to firms that may interact with carbon, but do not have proven reserves…” So basically, the qualifier through which this ETF invests in companies has nothing to do with actual sustainability. They just make sure the company isn’t actively stockpiling physical stores of fossil fuels. You know, like just about every company doesn’t do.

You’d think that the Vanguard Environmental and Social Governance ETF would avoid controversial holdings, right?

No. Vanguard’s ESG fund holds Transunion & Equifax (remember the data breaches and class action lawsuits?) Morgan Stanley & Blackrock (largest owners of residential property/debt in the US, they’re always in the news) and chemical companies like Clorox & Vulcan (which have paid millions in environment related fines just in the past few years).

It turns out, you can just pay your way into the good graces of the ESG world. Purchasing a few carbon credits or putting a diverse hire onto the board suddenly turns your personal corporate hellscape into an angelic social paradise, and gets you a slice of that tasty $16 trillion of ESG monies.

Which brings us to carbon credits.

Companies like to flash their carbon neutrality. You’ve seen it everywhere. Everyone and their sister is going carbon neutral by 2025. 622 of the world’s 2000 largest companies have signed net-zero pledges.

On a personal level, I’m a big fan of green energy. If I can figure a practical way to take our entire lifestyle off-grid, and build my own bank of solar panels/passive radiant heat/personal nuclear reactor, I’ll do it. 

But these guys are not building solar panels. They’re not building wind farms. They’re not replacing their asphalted parking lots with oak forests. They get their power from coal- and oil-fired plants like everyone else. So how does a massive corporation go carbon-neutral? Carbon credits. They just pay someone else (who does have a solar farm) cash for carbon credits. 

And somehow, they reap billions in federal tax credits while also still consuming megawatts of smoke-belching coal power and qualifying for ESG investments.

Net-zero pledges, much like ESG scores, can also be gamed. Walmart, for example, is the world’s largest company by revenue. It’s headquartered about 20 minutes from my house, and as a beneficiary of many regional lifestyle perks from Walmart profits, I’m proud to say that Walmart has pledged to reach zero emissions by 2040.

However, numbers can be massaged like clay into whatever sculpture you want. They will easily reach this goal. Not because they’re especially green, but because they just decided to not factor in Scope 3 emissions (indirect supply chain emissions)…which make up 95% of Walmart’s total emissions.

Both Shell and Saudi Aramco, which are literally oil companies, are both committed to reach net zero by 2050. How companies that literally only exist because of oil can reasonably manage to reach net zero is beyond my (admittedly low) intelligence. 

Now that I mentioned Saudi Aramco, let’s loop back around to ESG.

Turns out, if you buy into the average ESG fund, you will have a higher exposure to Saudi Arabia than if you bought a traditional non-ESG fund.

(Here’s an article from the Wall Street Journal called Why Your Good Governance Fund Is Full Of Saudi Bonds

That’s right, the company which is 95% owned by a monarchy…which murders journalists in foreign countries, forbade women to drive until 2018, amputates hands in robbery cases, and sentences people to 10 years in jail for homebrewing, somehow skirts a direct ESG score because its “parent company” is state-owned, and “states are graded differently than companies”. 

So what’s the real problem?

The real problem here is not individual holdings, or third-party ratings, or individual companies, or corruption, or ESG scores, or carbon credits.

The real problem is why this is happening.

See, I’m all for avoiding investing in companies you don’t believe in. I don’t buy stocks in a handful of companies because they do questionable things (Raytheon?) or I simply don’t like ‘em (Comcast?)

What I’m not for is creating false structures that operate on a zero-sum approach to ethics. As if you can just do a bad thing and then balance your badness with a sprinkle of goodness.

You can’t vandalize a storefront and then donate an extra few bucks to charity…it doesn’t really work like that.

Hasn’t Nike been under fire for sweatshops scattered across Southeast Asia? It’s fine, though, because they’ve atoned for their sins via modern indulgences, bought carbon credits, and sculpted an entirely artificial ESG profile…and are one of the top 10 highest held ESG stocks. They’ve bought themselves a good name, and billions of dollars in market value along with it.

The real problem? 

It seems people (individual investors) are more interested in owning the label rather than enacting actual change. The real problem is that individual investors don’t actually care, as long as it feels nice.

One might even say they are buying indulgences for themselves.

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