Sustainable investment — accounting for corporate performance on environmental, social and governance (ESG) metrics — has seen spectacular growth. Companies’ carbon footprints are under particularly close scrutiny.
Under pressure from ESG-focused investors, large multinationals like BP (the British energy major) and BHP (the Anglo-Australian miner) are now selling off some of their fossil-intensive assets.
In June, BP sold its petrochemicals unit for $5 billion to INEOS, a privately-owned British company. BHP recently confirmed that it will sell its thermal coal business.
Orsted, the Danish power company widely hailed for its transformation from oil and gas production into renewable energy, back in 2017 sold its upstream oil and gas business. Yes, also to INEOS.
These are no isolated exceptions: a string of coal-fired power plant in Europe has already changed ownership, and many other incumbents across the energy, industrial and mining sectors are actively exploring divestment options.
Corporate divestitures are welcomed by the ESG investment community as good news; it helps divesting companies retain 'investability' in the eyes of increasingly green-minded international capital markets.
But what is the climate benefit of such a corporate divestiture, really? Of course, it reduces the seller’s carbon footprint and thereby helps achieve company-level climate targets. That’s great.
Yet the carbon continues to be emitted under new ownership that, for different reasons, may care less about its perceived greenness. Often the buyers instead are privately-held companies that are not as directly in the public eye or perhaps based in countries with only modest climate ambition. That’s less great.
The issue is akin to the distinction between the production and consumption of carbon emissions.
Britain has successfully cut production of carbon at home — but imports more carbon from abroad, which does not count against its commitments under the Paris Climate Agreement.
Large listed incumbents are cutting their carbon footprints by selling dirty assets — but the carbon just resurfaces elsewhere with a new name on the tin, and is largely ignored again by ESG investors.
The only thing that matters is the global carbon tally; which country and which company emit the carbon is ultimately irrelevant for climate change.
So what to do?
Successfully aligning corporate strategy with the Paris Agreement and a net zero ambition makes portfolio churn inevitable for many large fossil-intensive players.
Selling high-carbon assets is attractive because it can achieve a quick win in improving a company’s ESG investment score and demonstrating increased strategic alignment with the Paris Agreement.
At a minimum, such transactions should come with a theory of change: why, from the perspective of societal value, is the carbon-heavy asset in better hands with the new owner? Is the new owner also committed to Paris? Will the operation or lifetime of the business be altered by the deal?
A private-equity buyer might employ a strategy that leads to the fossil-intensive business winding down faster than it would have under the old owner. Or then again it might not.
Other buyers may in future be able to run a more climate-efficient operation, for example, thanks to a superior capability to capture, utilize and store carbon (CCUS).
So far, there is too little debate and too little transparency about whether and how divestiture can improve the environmental performance of a business.
There is also little systematic evidence on the issue. A recent academic study of US corporations found that, on average, moving from public to private ownership has no significant impact on a firm’s environmental performance. If so, ESG-driven corporate divestitures achieve no overall gain for the planet.
In short, investors and the wider public should look more closely at where divested fossil assets end up, and the climate implications — if any — thereof.
Given the cards they have been dealt, management teams at BHP, BP and other incumbents cannot be blamed for following the temptation to divest. As the case of Orsted suggests, a low-carbon transformation can be appealing to employees and lucrative for shareholders.
So far, a lot of attention is being paid to sellers being able to use the money raised by asset sales to finance new investment into renewables and other potentially zero-carbon businesses. Yet this is only half the story.
Environmental stewardship needs a genuinely global and systemic perspective, not one that is artificially restricted to a select set of companies that are listed on the stock market.
Robert Ritz is Assistant Director of the Energy Policy Research Group (EPRG) at the University of Cambridge, Senior Research Associate in Economics & Policy at Cambridge Judge Business School and a Fellow in Economics at Peterhouse.