The growth of environmental, social and governance (ESG) investment has been aided by the changing regulatory landscape. In Europe, this is best illustrated by the European Green Deal, a comprehensive package of measures launched by the European Union in June 2021 to transform the EU into a modern, resource-efficient and competitive economy.
When it comes to decarbonisation, the UK and Europe are leading the way. The UK has its own vision linking energy security and the ‘net zero’ goal of replacing the country's reliance on imported fossil fuels with cheaper, less polluting domestic energy sources.
The United States has similar plans, with its Inflation Reduction Act (IRA). Elsewhere in the world, Saudi Arabia and the United Arab Emirates are aiming to become world leaders in sustainable development.
The dark side of ESG
Despite the colossal efforts mentioned above, it must be said that global emissions have risen from 25 billion tonnes in 2000 to 37 billion tonnes in 2022. And three countries – the US, China and India – account for more than 50% of the planet's total CO2 emissions, making their participation essential in the fight against climate change.
Another major ESG investment concern is the potential for negative externalities. For example, an investment in renewable energies may seem intrinsically positive. However, if the production of these technologies involves exploitative labour practices or environmental degradation in the extraction of the necessary metals, the ethical position becomes blurred.
In addition, the decarbonisation process has forced under-investment in new sources of hydrocarbon exploitation and exploration.
The result: underproduction, which has contributed to the rise in crude oil prices in 2022-23. Decarbonisation is therefore inflationary and increases the risk of an energy crisis for countries that mainly import their energy.
After years of effort devoted to the energy transition, the global economy remains highly dependent on fossil fuels.
ESG ratings are also a conundrum. Different ESG rating agencies may assess the same company very differently, due to varying methodologies and subjective interpretations. This inconsistency is a major challenge for investors who rely on these ratings to make informed decisions, often leading to confusion and scepticism about the reliability of ESG assessments.
Green fatigue
These hurdles are compounded by the practice of greenwashing, where companies feel encouraged to present their products or strategies as environmentally friendly to attract investment. Greenwashing is a deceptive practice which can lead investors to unwittingly support companies that contribute little to environmental sustainability or social well-being.
There is also growing ESG fatigue, with climate-sceptic tweets reaching a record high in 2023, and companies such as Coca-Cola changing their language on exercise reports to exclude the term ESG for fear of retribution from certain lobbies.
Despite the growing popularity of ESG funds and exchanged-traded funds (ETFs), there have been instances of underperformance relative to their non-ESG counterparts due to sector bias but also to the higher expense ratios of ESG funds and ETFs. We note that investment flows into funds stagnated in 2023 but with a significant dichotomy between Europe (inflows) and the US (outflows).
The economic context could continue to weigh on performance and investment in ESG strategies. Most clean energy and climate change business models are capital-intensive and heavily dependent on public subsidies. Rising interest rates, exploding debt and public deficits in most G7 countries are challenging the business models of so-called green companies.
This year's US elections represent a turning point for clean energy financing. While the chances of a reversal of president Joe Biden's IRA climate bill are slim, a victory for Donald Trump could mean US withdrawal from the Paris Agreement.
Potential long-term winners
So, what should investors do? Several sectors and raw materials seem well positioned to benefit from the energy transition. Contradictory as it may seem, there can be no green revolution without the extraction and use of metals and natural resources.
Consequently, the biggest opportunities are likely to come from commodities with the highest supply risk coefficients, such as those needed for electric vehicle batteries: lithium, nickel, cobalt, copper and graphite.
Copper is a cornerstone of the transition to clean energy. Its high conductivity makes it indispensable in electric vehicles, renewable energy systems (solar and wind) and energy-efficient building materials. As the world moves towards greener technologies, demand for copper is set to double by 2050 (compared to 2022 levels).
Uranium, the key element in nuclear power, presents a very promising ESG investment opportunity. At a time when the world is striving to reduce carbon emissions, nuclear power is an obvious choice, as it is the densest and most efficient source of energy and has a low carbon footprint. Not to mention that it has by far the highest capacity factor, meaning that it produces reliable energy 93% of the time (compared with 23% for solar power).
Nuclear also has the smallest land footprint to produce a megawatt of electricity, with just over one square mile per 1,000 megawatts (compared with 75 times more for solar and 360 times more for wind).
A few months ago, participants at COP28 pledged to triple the use of nuclear power over the next decade, with China and India already having 32 nuclear power plants under construction. This renewed interest in nuclear power sent uranium prices soaring in 2023, reaching levels not seen since 2007.
As for solar power, it is emblematic of the benefits and risks of renewable energies and their relationship with political support. Over the next 10 years, free cash flow should become positive and increase significantly for companies such as First Solar. But beware: most of this free cash flow will come from tax credits, making continued political support a sine qua non.
Charles-Henry Monchau is chief investment officer of Syz Group. The views expressed above should not be taken as investment advice.