Covid-19 business transformations: False hope for ESG as growth trumps ethics
Lockdowns have benefited the environment in the short term, but ESG fig leaves are flourishing
In the mid-2000s, I remember telling clients that, by pushing up the oil price through wars in the Middle East, George W. Bush, a fellow Texan whom I for one have never misunderestimated, had contributed as much to accelerating the climate transition as the Kyoto Process had. I stand by that view. The wars of the 2000s, coupled with new demand from China, dealt a major shock to oil prices, which led to the development of new political coalitions in many countries in support of not just reducing reliance on foreign oil, but reducing reliance on any oil by embracing new clean energy technologies.[1]
While lockdowns, and recessions in general, are good for the environment because they reduce emissions, de jure and de facto loosening of regulations post-lockdown may counteract that. Recessions are generally bad for companies’ performance on Environmental, Social and Governance (ESG) measures, and this recession will be particularly difficult because of the scale of lockdowns. Importantly, lockdown does not appear to have catalysed any new political coalitions in support of environmental, or broader ESG, goals as the shocks of the 2000s did.
Figure 1: Nitrous Oxide emissions in China before and after lockdown as seen from the European Space Agency’s Sentinel satellites — the same satellites that Tellimer use to support our clients with remote sensing
Figure 2: NOX levels plummeted in Europe during lockdown (top chart) but have since begun to rise as lockdowns ease (bottom)
Figure 3: In contrast with Europe and China, Africa’s and South America’s much lower levels of industrialisation mean that the fall in NOX is only really noticeable in a few major cities. The contrast between Argentina and Brazil shows the impact of a weaker policy response in Brazil. I’ve chosen April for Africa and May for South America because, judging by NOX data, South American lockdowns were implemented more slowly
The short-term shock of Covid-19 lock downs has led to major reductions in both oil demand and pollution levels, as the images of nitrous oxide levels show, that dwarf the shock of the mid-2000s. However, the medium-term implications are more mixed. Air travel, whether for business or leisure, will come back, although it will take time to recover. Although cities around the world are working hard to keep people walking and cycling as they return to work, the reality is that pollution from urban mobility may indeed be even higher post-lockdown than pre-Covid as commuters favour cars to avoid public transportation, which will be either crowded and unhygienic or running at very low capacity due to social distancing. Indeed, analysis by Bloomberg shows that a subway carriage that typically carries 131 passengers (and even more when squeezed together during rush hour) could only carry nine passengers under two-metre social distancing — a reduction of 93% — and a recent survey of London transport users shows that 63% of riders will not return to public transport unless social distancing is in place.
Whether driven by artificially limited capacity due to social distancing or travellers choosing to avoid public transportation, public transportation will account for a smaller share of journeys during the corona-crisis. Public transport strikes provide a useful proxy to understand the impact of reduced public transport usage. As is the case today, those who can work from home do so during public transport strikes and the minimal transit services that are still available during a strike provide a useful proxy for expected reductions in public transport usage post-lockdown. Unsurprisingly, empirical evidence shows that local air pollution rises significantly during such strikes.[2]
It’s easy to conflate reductions in pollution with improvements in ESG. However, air pollution is just one aspect of environmental stewardship, which in turn is just one part of ESG performance. While we all would like to think about corporations as ethical actors — after all, they are legal people — the reality is that, while corporations are made up of ethical people, the basic structure of a corporation is to delivery profitability within legal and regulatory boundaries. As such, corporations will embrace ESG to the extent that it supports profitability (eg to improve positioning with customers or to reduce the cost of capital by tapping ESG investors) or when required to do. Thus, we can see corporate ESG, especially in developing markets, as driven by a combination of private investor demand, customer demand (eg in the garment industry), government regulation, and conditionality from multilaterals and other development institutions.
Figure 4: A framework for corporate ESG performance
Weak economic growth and joblessness during and after the pandemic will be serious challenges to government credibility and political stability in many countries. In this low growth environment, many governments will formally loosen regulations, or at least turn a blind eye and weaken their enforcement, in the hope of accelerating the recovery. Research on previous recessions suggests that environmental issues take a back seat in the face of more immediate concerns like rising unemployment.[3] Indeed, a literature review looking at the impact of the last recession on climate change found that: “[hopes] that the recovery process following a recession should emphasize restructuring the economy towards a green one appears more wishful thinking than a fact in the absence of leadership and buy-in from the public.”[4] While the bulk of academic research has focused on environmental factors, one can expect that issues like the treatment of workers, let alone the treatment of minority shareholders, will be similar de-emphasised.
When faced with low growth, investors may prefer financial returns to social ones, either dropping ESG requirements entirely or becoming more inclined to accept a fig leaf policy in place of robust ESG performance. Public investors have an additional incentive to turn a blind eye: Enhanced Chinese soft power, fuelled by the perception that China has both handled the corona-crisis better than the West and remained internationally engaged, and increased competition from Chinese development finance, may even lead multilaterals to relax their ESG requirements in order to preserve market share, arguing that the potential damage from disengagement is a greater evil than accepting ESG weaknesses in any particular project.
This has at least two implications for investors:
- Investors should not assume that the fact that emissions are falling during lockdown means that ESG performance is improving, a fallacy that I’ve heard from a number of investors; and
- Investors who are serious about ESG need to recognise that they may, increasingly, be on their own. They will need to rely on their own ESG diligence and may be forced to choose from a narrowing share of opportunities, especially in emerging markets.
The environmental improvements seen during lockdown have led some investors to raise cleantech as a possible investment focus. While solar is likely to be a winner, especially in emerging markets, it would be a mistake to think that the cleantech sector as a whole will benefit.
On the one hand, many cleantech businesses typically rely on subsidies that are likely to disappear. This will be particularly the case in developing countries, where financial support is likely to come from donors, whose budgets are shrinking and whose priorities are changing (for more details, look out for my colleague Vahaj Ahmed’s series on the future for clean energy tech in emerging markets, which kicked off with a report on Vietnam).
On the other hand, small-scale energy tech in emerging markets, particularly rooftop solar, can be profitable on a standalone basis. The risk here will be whether households post-Covid-19 will be able to afford power at all. Solar rooftops are a perfect example of how a switch to subscription business models will help drive the recovery post-Covid-19.
