ESG RIP: Review of Terrence Keeley’s "Sustainable"
Part 1: Davos, the UN and the Rise of ESG
ESG has its origins in a speech by UN secretary-general Kofi Annan at the Davos World Economic Forum in 1999. In the first of his four part review of Terrence Keeley’s Sustainable, Rupert Darwall shows how this created ESG’s dual mandate that accounts for its success – and its unsustainability as an investment strategy.
“On my previous visits, I told you of my hopes for a creative partnership between the United Nations and the private sector,” the UN secretary-general, Kofi Annan, told business and finance leaders at the World Economic Forum in Davos in January 1999. “Without your know-how and resources, many of the UN’s objectives would remain elusive,” the secretary-general continued.
This year, I want to challenge you to join me in taking our relationship to a still higher level. I propose that you, the business leaders gathered in Davos, and we, the United Nations, initiate a global compact of shared values and principles, which will give a human face to the global market.
Annan then called on business leaders to “embrace, support, and enact” a set of core values with respect to human rights, labor standards, and environmental practices.
Within two years, the Global Compact attracted about a thousand corporations. In 2004, the Global Compact’s financial-sector initiative published a report, “Who Cares Wins,” outlining recommendations on how to better integrate environmental, social, and corporate governance (ESG) issues in asset management and investment. Companies that perform better regarding ESG issues can increase shareholder value, the report asserted. The report’s 18 endorsing institutions, with over $6 trillion assets under management, declared their conviction that
a better consideration of environmental, social and governance factors will ultimately contribute to stronger and more resilient investment markets, as well as contribute to the sustainable development of societies.
Here, at the very conception of ESG, we see the dualism at the heart of ESG, which explains both its extraordinary success and its ultimate unsustainability as an investment strategy—the dualism of serving two masters simultaneously, the imperative of shareholder value, and the greater good of people and the planet (embodying a subsidiary dualism that is becoming harder to ignore).
Contemporaneous with “Who Cares Wins,” English economist David Henderson wrote The Role of Business in the Modern World, which amounts to a 200-page critique of the doctrine of Corporate Social Responsibility, which was in the process of morphing into ESG. “This prescribes sustainable development as the goal of business today, with improved profitability as a happy outcome rather than a primary goal or criterion.” In competitive markets, Henderson observed, a business’s revenue line indicates what people are prepared to pay for the benefits of its products or services. On the other side of the account, the cost to people in general—or society, if you prefer—is the value to them of what could have been produced elsewhere with the resources used by the venture, i.e., a reasonable approximation of the business’s costs. The difference between these two flows—the business’s profits—is a prima facie indicator of the good that a business is doing for people.
Henderson noted two strands of thinking about world problems—or “crises,” as they’re now called: the first relates to problems of poverty and inequality; and the second to environmental issues, the biggest one being climate change. Both are painted in dark and alarmist hues, and both are amenable to concerted programs and strategies by the international community. “ ‘Solutions’ are at hand, given wise collective decisions and actions,” Henderson wrote. “It is the combination of alarmist visions with confidently radical collectivist prescriptions for the world which characterizes global salvationism.”
Eighteen years later, nearly $8 billion a day flows into ESG-labeled investment products, and ESG stands triumphant over the worlds of business and finance. The role of finance is accorded an honored place in Article 2 of the Paris climate agreement and its objective to
strengthen the global response to the threat of climate change, in the context of sustainable development and efforts to eradicate poverty, including by … [m]aking finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development.
Enter Terrence Keeley, author of Sustainable: Moving Beyond ESG to Impact Investing. Keeley’s intent is the mirror image of Marc Antony’s funeral oration, when he came to bury Caesar, not to praise him, and then proceeded to incite the people against Caesar’s assassins. Keeley’s praise for ESG is effusive and sincere. “ESG investing could well be the biggest thing in finance since the Dutch East India company issued shares in 1602,” Keeley writes. “ESG’s success or failure could literally impact every living creature on Earth.” He supports stakeholder capitalism, which, he says, appears uniquely suited to frame and help execute “this ambitious plan” to make the global economy more sustainable and inclusive, before concluding that, over the longer run, “stakeholder capitalism and shareholder capitalism appear broadly synonymous.”
Whereas much systematic analysis of ESG and its eliding of the ESG dual mandate into a unity of alignment with its keystone claim of “doing well by doing good” is undertaken by finance and business school academics, Keeley is a practitioner. For 12 years, until June 2022, he headed BlackRock’s official institutions group, advising sovereign wealth funds, central banks, finance ministries, and public pension funds. Unlike many in finance, career success has not been bought at the cost of idealism or humanity. He writes of the privilege of working in finance and his shame about finance causing the 2008 financial crisis. Good intentions saw financial alchemists working with four government-accredited agencies—Keeley names names—that “took the world to hell and back,” he says. “What’s to prevent another government-blessed, officially sanctioned investment paradigm—that is, accredited ESG investments—from blowing up in our faces?”
Posing a question like this—and answering it with “Good intentions create unsustainable market valuations. When those valuations correct, hell can be unleashed”—could have made Keeley an awkward fit in Wall Street firms requiring corporate conformity; and it says much about BlackRock and its leadership under its CEO Larry Fink that it could accommodate a free-spirited thinker. Keeley repays that confidence. “I believe BlackRock has done more good for more people on the planet, as well as for its future generations, than any other financial services firm in history,” Keeley writes in the book’s acknowledgments.
Perhaps that loyalty accounts for one of the book’s very few unpersuasive passages. Criticizing Harvard law professor John C. Coates’s 2018 paper “The Problem of Twelve,” which highlighted the concentration of stock ownership and shareholder voting power in a handful of mega-investment managers, Keeley’s rejoinder is that how proxies controlled by BlackRock are voted and how other stewardship decisions are made is with the input of hundreds of professionals. (Last year, BlackRock announced a new proxy policy so that owners of some of its indexed investment products can select from a range of third-party voting policies.)
BlackRock’s behind-the-scenes, unrecorded engagements are often more impactful on company managements than proxy votes, Keeley says, and he praises BlackRock’s campaign to induce Korean energy utility KEPCO to drop its plan to finance coal-fired power stations in Southeast Asia and South Africa. Is this an unalloyed good? Insufficient coal-fired capacity has seen Eskom, South Africa’s power utility, spend $636 million on diesel in the first 10 months of 2022, resulting in more than 100 days of outages and leaving South Africans without electricity for up to 10 hours a day. As Keeley notes: “Coal’s reliability, affordability, abundance, navigable technology, and safety records have made it the preferred electricity source in most developing countries.”
Keeley can also be outspoken in defense of companies targeted by the Left. In a discussion of publicly quoted oil companies selling carbon-intensive assets to private companies, Keeley pushes back on “salacious stories” published by the likes of Rolling Stone impugning the Koch family. Koch provides products that consumers want and is well positioned to substitute for products like oil and fertilizer that have been historically supplied by Russian firms, Keeley says. “As they are crucial to maintaining pressure on Putin, I suggest we thank them rather than persecute them.”
Part 2: The ESG Reality: Not Doing Good, but Feeling Good
ESG investment strategies can see investors giving up financial returns for no societal gain. In the second of his four part review of Terrence Keeley’s Sustainable, Rupert Darwall explores the implications of investment theory for ESG artificially constraining investment opportunities; the risks of regulators worsening an already inflated ESG bubble; and the distortions that arise from the widespread adoption of sustainability as an investment concept lacking an objective definition.
Terrence Keeley’s burial of ESG commences with an acknowledgment of sin. Specifically: contrary to the ESG investment postulate that shunning so-called sin stocks is good for society and boosts investor returns, sin stock exclusion does neither. “Social activists seem impervious to one common-sense principle of finance: adequate funding is invariably found when the underlying commercial activity it supports is broadly legal and generates acceptable returns.” Academic studies evaluating investor returns show that it is often better to be “bad” than “good,” and sin shares have historically outperformed the broader market, their higher dividends benefiting investors who chose not to divest.
Because Keeley is a former advisor to some of the world’s largest foundations, his discussion of the virtue competition of leading university foundations is withering. Having declared climate change, ecological destruction, and biodiversity loss an existential threat, Cambridge University’s investment office is ending all direct and indirect investment in fossil fuels by 2030 and pursuing an investment strategy to support the transition to a carbon-neutral global economy. “Given that the volume of assets that will not follow Cambridge’s divestment strategy is so large, the direct financial impact on any company they may choose to include or exclude is statistically meaningless,” Keeley says. There was no compelling evidence or new studies suggesting higher returns from the strategy, but it does necessitate a change in the university’s investment model that implies a reduction in investment returns of £40 million ($48 million) a year. What is Cambridge getting in return for this loss of income, which, Keeley suggests, could fund research into carbon-reduction technologies or scholarships for underprivileged students? The sum of £40 million a year is an awful lot of money for a university to spend on purchasing virtue protection from its own members.
Cambridge’s decision to throw away investment returns contrasts with Stanford’s ethical investment framework, which obliges its investment managers to place proper weight on ethical issues that can have a bearing on economic results “but not to use the endowment to pursue other agendas.” Indeed, it’s hard to improve on Stanford’s approach to investment: “The businesses in our portfolio provide highly valuable goods and services to the world. We believe that well-run companies which respond to genuine consumer needs in a responsible fashion have a beneficial impact on society.” The difference between Cambridge and Stanford highlights a hard truth about ESG investment. Reflecting the dualism inherent in ESG investing, Cambridge’s commingling of investment objectives—supporting a global energy transition and investment return—sacrifices investor returns for zero societal impact beyond the mental well-being of a limited number of individuals versus the purity of Stanford’s focus on risk-adjusted investor returns.
Keeley’s evaluation of rival university investment strategies leads up to the two most important sentences in the book:
Limiting one’s income-generating opportunity set without advancing one’s values or environmental goals merits deeper reflection. It could even be self-defeating, given others with contrary views and values could profit from one’s self-imposed and strategically ineffective restrictions.
The first sentence accords with modern investment theory, which emphasizes the importance of portfolio diversification to maximize—Keeley tends to use word “optimize”—risk-adjusted returns. It forms the theoretical basis for investing in broad, index-tracking products, a theory validated by empirical data, when less than 15% of active stock managers beat a broad index over any five-year period, and is the basis of the spectacular growth of the three largest index investment managers: BlackRock, Vanguard, and State Street.
By inference, it casts as anomalous ESG index-tracking products that radically constrain portfolio diversification. These have turned out to be bets on tech rather than ESG. According to Keeley, Google owner Alphabet, Amazon, Apple, Meta, and Microsoft compose 22% of the S&P 500 but often make up 30% or more of most indexed ESG and active strategies, a bet that, until recently, paid off.
The ESG constraint also runs into a logical objection. An ESG-constrained investor cannot be better off than an unconstrained one. In principle, an unconstrained investor can replicate exactly the same portfolio as an ESG-constrained investor, whereas the latter is barred from the range of investment choices open to the unconstrained investor. As a result, the unconstrained investor will always possess an advantage, as Professors Bradford Cornell and Aswath Damodaran explain in their March 2020 paper “Valuing ESG: Doing Good or Sounding Good?”:
[T]he notion that adding an ESG constraint to investing increases expected returns is counter intuitive. After all, a constrained optimum can, at best, match an unconstrained one, and most of the time, the constraint will create a cost.
In addition to the likelihood of financial detriment to investors from pursuing exclusionary ESG policies, Keeley explores the systemic implications of ESG for financial stability from crowded trades. Does the world have upward of $120 trillion of conscientious companies and proven ESG strategies to invest in? “No, it does not.” He cautions regulators against branding an investment product as sustainable:
[T]he official designation of any investment as “sustainable” officially suggests that its value will be sustained. Official certifications like these lure investors who might otherwise be more skeptical and discerning to reposition their capital; why, after all, would any regulator encourage the public to buy something that was unsafe? But the prices of all securities and products—sustainable or not—are destined to incur volatility. When they do—not if but when—the most overvalued securities invariably fall the most.
Volatility indicates risk. Normally, it would be expected that increased disclosure, by enabling more information to be incorporated into the prices of securities, would reduce volatility. Paradoxically, this appears not to happen with sustainability and ESG disclosures. Keeley reports that researchers from the University of Oregon and Harvard Business School found that increased ESG disclosures made corporate valuations more volatile and led to greater disagreements among various ESG raters.
Why is this? Keeley suggests that these problems might recede over time; but there is a fundamental problem that time won’t cure. Sustainability (the “E” in ESG) is not an objective property of a company, unlike a credit rating, which attempts to measure a company’s ability to service and repay its debt. Neither does sustainability necessarily drive stock prices, unlike the creditworthiness of a company, enabling the accuracy of a credit rating to be observed against the market prices of a company’s debt securities.
There is a neat parallel with the labeling of organic food. Keeley recounts that it took 10 years from the passage of the Organic Foods Production Act in 1990 to finalize rules on what counted as organic. The purpose of the law, Keeley writes, was to protect organic food artisans from “organic quacks.” But, some might argue, since the concept of organic produce is nonscientific—itself derived from quackery—what counts and doesn’t count as organic is a matter of opinion that now has legal backing. Sustainability, too, is a nonscientific concept, as can be seen by reference to its origin in the report of the UN World Commission on Environment and Development, better known as the Brundtland Report, in 1987:
In essence, sustainable development is a process of change in which the exploitation of resources, the direction of investments, the orientation of technological development, and institutional change are all in harmony and enhance both current and future potential to meet human needs and aspirations.
Does it need saying that harmony and enhancing current and future human needs and aspirations permit a vast range of different, even contradictory, interpretations? Nowadays, sustainability has come to be defined almost exclusively in terms of reducing greenhouse gas emissions, principally carbon dioxide, and switching energy generation from hydrocarbons to renewable sources, principally wind and solar. In How the World Really Works, scientist and polymath Vaclav Smil notes that today’s list of what constitutes planetary boundaries is very different from what would have counted 40 years ago. Acid rain would have topped the list because “a broad consensus of the early 1980s saw it as the leading environmental problem.” (Acid rain is an example of a strong scientific consensus that turned out to be mistaken—acidification of streams and lakes was caused by changes in land use, not power-station emissions.)
Adopting 100% renewable scenarios (“essentially the academic equivalents of science fiction,” says Smil) would have global consequences for land use and mineral extraction—never mind its sheer impracticality and detriment to human welfare. There is growing evidence of the negative impacts of renewable energy on biodiversity, in what the eco-modernist Michael Shellenberger calls “wind energy’s war on nature.” The American Bird Conservancy reckons that bird deaths caused by collisions with wind turbine blades exceed 1 million annually. Wind farms are one of the leading causes of bat mortality in North America and Europe, increasing the risk of extinction of some species. A German study estimates that German wind farms kill 1,200 tons of insects a year, with knock-on detriments to insect-eating bird and bat populations higher up the food chain.
Part 3: ESG and the Clash of Values
In the third of his four part review of Terrence Keeley’s Sustainable, Rupert Darwall writes that ESG rests on a vision of the free-market economy that says capitalism needs to be led by people with the right values, which raises the question: Whose values? This makes ESG inherently divisive, explaining the pushback ESG is now generating in red states. Keeley proposes a solution in keeping with the pluralism and diversity of modern America.
Sustainability is an open-ended concept capable of many diverse interpretations involving multiple conflicting trade-offs and real costs. Moreover, the goal of securing inclusive, sustainable growth contains a second duality: that of harmony between society and nature, on the one hand, and promoting harmony within society, on the other, the latter to address what Keeley calls our second systemic vulnerability—“growing income inequality and its corrosive impact on social cohesion.” This raises the question: Who decides? Keeley quotes Bono: “Capitalism isn’t immoral: it’s amoral. It’s a wild beast that needs to be led.”
ESG provides answers about who decides and who leads. In Keeley’s telling, the most powerful people in investing are those who curate stock and bond indices—companies such as MSCI, S&P Dow Jones, and Bloomberg. They decide what goes in and what comes out of an index, thereby skewing performance measurement. But reading Sustainable suggests a slight modification. According to Harvard Business School professor George Serafeim, a coauthor of the study cited earlier, the only way for companies to outperform will be for them to make material ESG issues central to their strategy. “If companies are bold and strategic with their ESG activities, they will be rewarded,” Serafeim claims. What counts as ESG? In a chapter titled “Hardwiring Corporate Goodness,” Keeley writes that “recognized and universally followed” standard setters like the Sustainable Accounting Standards Board (SASB) and Taskforce on Climate-related Financial Disclosures (TCFD)
must continue to identify and set the right objectives for which corporations must strive to achieve. If they prioritize the wrong material risks or set the wrong methodologies for measuring them, their essential role in directing corporations to make further progress on a range of socially desirable objectives, including the UN’s Sustainable Development Goals, will be compromised.
Until its merger last year with the International Integrated Reporting Council, the SASB’s largest funder was Bloomberg Philanthropies. In 2014, Michael Bloomberg was appointed SASB chair and, a year later, founded and then chaired the TCFD. Whereas other index providers like MSCI and S&P Global also provide ESG ratings, Bloomberg scores the trifecta of influencing ESG standard setting as well.
In contrast to traditional financial disclosures, which pertain to cash flows, financial liabilities, and monetizable assets, the motivation for ESG disclosures principally involves normative values and attaining wider societal objectives. (ESG standards are sometimes justified on the grounds of firms disclosing risks likely to affect stock prices, but the evidence suggests that this is a smoke screen. Welcoming the SEC’s March 2021 proposed rule on climate financial risk disclosure, Michael Bloomberg said that its adoption would “accelerate the transition to clean energy and net-zero emissions.”)
Two observations can be made. The first concerns differing visions of the economic process in a market economy. Whereas Bono sees capitalism as needing to be directed and Keeley writes of ESG as an effort to recalibrate the corporate world into “a more benevolent force,” the author of The Wealth of Nations famously wrote that it was not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner “but from regard to their own self-interest.” In Capitalism, Socialism, and Democracy, Joseph Schumpeter took Adam Smith’s insight into the era of the Industrial Revolution when he argued that the hunt for profits propelled the stream of inventions that characterizes it.
In his 2004 book, David Henderson also made the distinction between the motivation of individual businesses and the aggregate outcome of their activities. The immense improvements in people’s material welfare do not depend on a conscious attempt by business leaders to make the world a better place. “The advances that capitalism has brought about did not arise from the resolve of business leaders to make them possible, but from the operation of competitive market economies,” Henderson wrote. Keeley comes close to this when he writes that the most important business of business “is and will always remain the promotion of enduring prosperity, not the single-minded pursuit of cleaner air or enhanced economic mobility.”
The emphasis on ESG, linking executive remuneration to ESG objectives rather than to long-run value generation, along with the belief that ESG ratings drive stock prices (which they do, in the short term)—when trillions of investment dollars are chasing limited ESG investment strategies—risks displacing investor analysis of the factors that maintain and sustain the viability of a company’s business model and distracts management from giving attention to continually investing in a company’s intangible capital to sustain its long-term profitability. The vibrancy of capitalism depends on companies competing against one another to innovate new products, services, and processes. Capitalism’s continued legitimacy depends on sustaining its capacity to keep raising people’s material well-being—what Keeley rightly calls “the most important business of business.” Rather than in some way redeeming capitalism, ESG threatens the ability of free-market capitalism to deliver this good and thereby imperils its survival in anything like its current form.
The second observation relates to politics. Values are inherently subjective. In the opinion of Karl Popper, an open society is based on the idea of not merely tolerating dissenting opinions but respecting them. Respect does not require agreement, but it does mean that when collective action is required that elevates one set of values and priorities over others, it is legitimized via the mechanism of representative democracy and the ballot box. ESG dispenses with that, short-circuiting the democratic process and popular sovereignty.
This is not an abstract or a theoretical concern; as Keeley observes, getting to net-zero carbon emissions—something that BlackRock currently demands of its investee companies—requires the behaviors of every human to change. The energy transition has a direct and deleterious impact on the livelihoods of hundreds of thousands of people working in the energy sector. Keeley cites an estimate by the International Renewable Energy Agency that a shift to renewable energy could create three times more jobs than it destroys. The International Labour Organization reckons that the energy transition would eliminate 6 million jobs and create 24 million new ones. These estimates imply labor productivity declines of 75%–66%. This is not how economies grow.
In addition to their poor labor productivity, wind and solar suffer from steep curves of output value destruction. Their output is uncorrelated with demand, so when the weather is favorable, they all produce and the value of their output falls. Wholesale electricity prices—affecting generating technologies that did not cause the problem of market oversupply—can even go negative. Despite huge subsidies—federal, state, and hidden noncash subsidies from the rest of the grid—wind and solar employees cannot escape the inferior economics of renewable energy. Last year, average annual wages for workers in the oil and gas extraction sector, at $100,007, were very nearly double those of a solar PV panel installer ($50,710) and 70% more than for wind turbine technicians ($58,580). By threatening to eliminate high-paying blue-collar jobs and advancing an agenda that many communities oppose, ESG deepens divisions in a politically polarized nation without earning the democratic legitimacy of winning elections. ESG’s twin goals of sustainable growth and inclusive growth are not only in conflict; ESG is a force deepening the political division of America.
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Keeley’s deconstruction of ESG proceeds almost subliminally as a counterpoint to his praise. “ESG has been an unqualified force for good,” he says, but 131 pages earlier, he suggested that it’s too late for marital counseling to save ESG: “In the interests of all sides, it may be best for ‘E,’ ‘S,’ and ‘G’ to divorce.” Rather than “doing well by doing good,” as ESG promises, the logic of Keeley’s case is that investors in conventional ESG products are likely to end up not doing very well and feeling good, rather than doing good. The weight of ESG money has propelled highly rated ESG stocks pushed to unsustainable valuations. “Profits must eventually justify inflated price-earnings (PE) multiples, or those inflated multiples must come down,” he argues. “This is simple financial physics.”
Rather than loading up on already-expensive stocks with high ESG scores, investors should seek out less highly rated ones that are likely to improve their ESG ratings. “Financially, it will always be preferable to own companies before they adopt best practices,” Keeley points out. On the “doing good” part of the ESG dual mandate, Keeley shows that ESG strategies that exclude carbon-intensive stocks don’t result in lower emissions. All investors are doing is buying a bit of carbon accounting with no real-world impacts. “What should be targeted instead is additionality—that is to say, improvements that wouldn’t have occurred but for specific investments.”
When investing to do good, impacts should be knowable rather than presumed. “When one knows that an ethical or values-based decision may create negative tracking error, every effort must be made to ensure potentially foregone income is compensated for by attaining one’s other desired goals,” Keeley argues. Investors should be aware of what their non-risk/return objectives are costing them in order to ensure that society gains at least as much positive impact as the investor’s sacrifice of financial return. “Verifiable impact is the sine qua non of all impact investing,” according to Keeley.
Keeley’s logic leads ineluctably to the dissolution of ESG’s dual mandate into two separate ones. As an investment advisor of 40 years standing, Keeley says that he does not believe that every investment should include measurable impact as a determinant factor. His “solution”—like Henderson, he uses quotation marks, and explains that a unidimensional, comprehensive solution to humanity’s environmental, social, and economic challenges does not exist—involves partitioning risk/return optimized investments in one portfolio and impact investments in another. Here we arrive at Keeley’s formal dissolution of the ESG dual mandate and, with it, justification for ESG index products and ESG exclusionary strategies. Instead, focused investment motives reign supreme.
Keeley sizes the impact portfolio on there being an annual investment requirement of $3.5 trillion, made up of $2.5 trillion a year to fund the UN’s 2030 agenda for sustainable development and $1 trillion a year estimated by the BlackRock Investment Institute to finance additional energy-transition investments. This works out at 1.6% of over $220 trillion of financial assets under the direct control of ultra-high-net-worth individuals and global institutions, an annual allocation which runs for 10 years, which Keeley dubs his 1.6% solution.
Doubtless there will be questions about the willingness and the ability of these institutions—Keeley does not examine the implications for fiduciaries and their exclusive duty of exclusive loyalty to beneficiaries—to apportion assets to the 1.6% impact pocket, but those questions also arise with respect to any assets invested in ESG products. On the deployment side, the BlackRock Investment Institute’s estimate of $1 trillion a year to finance wind and solar projects in developing economies rests on a widespread misconception about the fundamental economics of renewable energy.
Wind and solar are inferior, inadequate, and partial substitutes for hydrocarbon-derived energy. Widespread deployment of wind and solar in Western nations depends on massive, recurring subsidies from consumers, the model used in much of Europe, or a mix of government subsidies and portfolio standards, as in the United States. The Congressional Budget Office estimates that the Inflation Reduction Act will cost taxpayers $161 billion with respect to new clean energy-tax credits over the next 10 years while Credit Suisse reckons that federal climate spending over this decade will run at $66 billion annually. This is money that goes out and doesn’t come back.
Furthermore, developed nations have mature, often overengineered, grids that are connected to nuclear, coal-fired, and gas-fired power stations. The essentially parasitic relationship between, on the one hand, existing grid infrastructure, power generators, and customers, and, on the other hand, renewable energy explains the attractive returns available to wind and solar investors when the underlying economics are not attractive. Because those investors are shielded from the worsening grid economics their investments cause, they have no financial interest in learning about this exploitative relationship. We are still in the emperor’s-new-clothes stage of renewable energy, even though the facts are plain.
This has major implications for the composition of the $1 trillion in annual funding. Rather than being a financing flow of private-sector debt plus about $100 billion of government and development bank de-risking finance, it needs to be a 100% outright resource transfer, with no expectation that it will be paid back. Even then, developing countries will be worse off than if they had been allowed to pursue a conventional power-generation pathway due to the inherent shortcomings of weather-dependent power generation. Burdening developing economies with trillions of dollars of new debt to finance low- or negative-return renewable assets is the very last thing they need.
Whatever objections there might be to Keeley’s numbers, 1.6% is a solution—no quotation marks required—to the contradictions of ESG. It recognizes that the ESG dual mandate does not and cannot operate as advertised. It materially reduces the threat to financial stability posed by inflated ESG valuations. It replaces ESG ratings with granular impact analysis of individual investments. By unbundling the ESG conglomerate, it better reflects the pluralism of modern America and the diversity of its values and economic interests.
Part 4: ESG and the Perpetually Just-Over the Horizon Climate Apocalpyse
Concern about catastrophic climate change has been the biggest factor driving ESG, yet the likelihood of climate change being catastrophic and the attainment of net zero are not open to debate or challenge by participants in financial markets. In the last of his four part review of Terrence Keeley’s Sustainable, Rupert Darwall argues that this undermines the function of financial markets as efficient, unsentimental allocators of people’s savings in a way that maximizes growth and economic well-being.
The importance of Sustainable is reflected in the authorship of its foreword, which is by BlackRock’s CEO, Larry Fink. Acknowledging the controversy surrounding sustainable investing and the lively debate that it has ignited, Fink writes: “I have always believed that the best way to work through big and important questions is through open and robust debate—challenging conventional ideas, finding new solutions.” Concern about climate change is the principal factor that drove the prodigious growth of ESG and sustainable investment. Although not theoretically synonymous, in practice they are—whenever there is a conflict between “E” and “S,” the “E” of climate change invariably nullifies the “S” of employee and wider stakeholder interests. Thus BlackRock requires the companies that it invests in to produce specific plans to align their activities with the global goal of net-zero greenhouse gas emissions by 2050, commonly but mistakenly referred to as alignment with the Paris climate agreement, which specifies achieving a balance between anthropogenic emissions from sources and removal from sinks “in the second half of this century,” a goal that is not binding in international law and that has not been legislated by the U.S. Congress.
Financiers—managers of other people’s money—decided to preempt the political process because of their belief that climate change is likely to cause a planetary catastrophe, in Keeley’s words, because they believe that “humanity is in a race to save itself from an unknown and unknowable climate disaster.” Yet, as he points out, every doomsday prediction to date has proved to be wrong. We know this because we’re still here, and, in material terms, humanity is better off than ever. A 2021 paper, “Apocalypse Now? Communicating Extreme Forecasts,” examined 71 predictions of climate-caused apocalypse dating from the first Earth Day in 1970 and found that by the end of 2020, 48 (61% of the total) of the predictions had expired—and failed. Across half a century of forecasts, little has changed; the apocalypse is always about 20 years out. One of the paper’s authors, Paul Fishbeck, professor of social and decision sciences at Carnegie Mellon University, commented: “If I observe many successive forecast failures, I may be unwilling to take future forecasts seriously.”
That heuristic with respect to serial forecast failures is all but universal in finance and investing, the glaring exception being climate change. (Keeley is rare for being a financier who rejects climate catastrophism and says so: “claiming humanity cannot survive if temperatures rise another two to four degrees Celsius is simply untrue.”) Page one of Sustainable recounts Keeley asking a prominent climate scientist at a large investment conference how much global temperature might have risen in 50 years’ time. As much as 4.5 degrees Celsius, an answer that Keeley describes as a “gut punch.” This implies an average warming of 0.9 degrees Celsius per decade—not 50% higher, not double, but a rate five times greater than the 0.18 degrees Celsius per decade observed increase over the past 35 years. How can this claim be remotely plausible?
Keeley compares the prospect of a 2–3-degree Celsius rise in global temperature since the Industrial Revolution to the last ice age, when global temperatures were about 6 degrees lower than today, the implication being that humans are 20%–30% of the way to a climatic transformation equivalent to prematurely plunging into the next ice age, but in the opposite direction. The last time global temperatures were as high as today, there was no ice covering Greenland or much of the Arctic and Antarctica, Keeley writes.
What happens to that ice over the next ten, twenty, fifty, or one hundred years is pretty much anyone’s guess. All we know for sure is that there will be much less of it unless the earth’s temperature drops meaningfully soon.
In its sixth assessment report, the Intergovernmental Panel on Climate Change (IPCC) stated that at a sustained warming level of 2–3 degrees Celsius, there is “limited evidence” that the Greenland and West Antarctic ice sheets would almost disappear “over multiple millennia.” As for the whole of Antarctica, a 2015 analysis of temperature data from 14 weather stations on the edge and the interior of the continent found a rise in temperature of 0.35 degrees Celsius since 1954 and 0.0 degrees Celsius since 1969.
To put in perspective fears about future climatic changes being of a similar scale as re-glaciation, the average amount of incoming solar radiation at the top of Earth’s atmosphere is 340 watts per square meter. In its fifth assessment report, the IPCC estimated the human-caused enhanced greenhouse effect at 2.83 watts per square meter—less than 1% of incoming energy from the sun. By contrast, Milanković cycles, which explain the succession of long-duration ice ages and briefer interglacials, cause variations of 100 watts per square meter in Northern Hemisphere summers above the 65th parallel, i.e., changes in energy two orders of magnitude or 35 times greater than that from the enhanced greenhouse effect.
This discussion of the relevance of Milanković cycles to human-caused climate change took place during the American Physical Society’s climate change workshop held on January 8, 2014, in Brooklyn. It must count as one of the rarest occurrences in the modern world—genuine debate between climate scientists, three supporters of the current consensus and three dissenters, on climate science—and demonstrates why debate is essential for improving the conversation on climate. By the same token, the workshop showed why supporters of the consensus are determined that such debates must not happen again.
The workshop was moderated by Steven Koonin, a theoretical physicist at New York University who had served as an undersecretary in the Department of Energy during President Obama’s first term. Later in the daylong workshop, Koonin observed that for climate models to reproduce past climate, greenhouse gas forcings had to be scaled down. When it came to making the centennial projections, these scaling factors were removed, resulting in a 25%–30% over-projection of warming by the end of the century. Why? “Well, we took exactly the same models that got the forcing wrong and which got sort of the projections wrong up to 2100,” responded William Collins, lead author of the chapter on climate modeling in the IPCC’s fifth assessment report. “Why do we even show centennial-scale-scale projections?” Koonin asked. “Well, I mean, it is part of the [IPCC] assessment process,” came the reply.
Based on this exchange, it’s fair to conclude that climate science is held to lower ethical standards than corporate America; if a company issuing securities to the public files a Form S-1 with the SEC containing financial projections that the filer knows to be misleading, it would run the risk of incurring civil and, in the case of its officers, criminal liability. Koonin’s dissatisfaction with the quality of climate science and the climate messages being projected to the public led him to write Unsettled, which Keeley references for pushing back against climate catastrophism and the spending of trillions of dollars on intermittent energy generation.
The quality most lacking in the climate conversation is sobriety. There are no prizes for dialing down climate alarm—on the contrary. Koonin’s views are unlikely to be acceptable at BlackRock, where Keeley says that a 2020 edict forbids portfolio managers from being climate-change deniers or contrarians on climate change. Keeley also notes that Sir John Templeton viewed investor sentiments as reliable counter-indicators: “By consistently leaning against them, a handful of legendary investors like Sir John himself amassed multibillion-dollar fortunes.” It is hard to reconcile these two positions, and the attempt to do so takes us into the nature and purpose of financial markets. Keeley’s guide is Robert Shiller, Nobel prizewinner, professor of economics and finance at Yale, and author of Finance and the Good Society. Finance has a specific responsibility for stewarding society’s assets efficiently and fairly while facilitating its most profound aspirations. Shiller also writes that a good society has “limited ability to make everyone’s dreams a reality—and finance is all about reality.” Insofar as the former view on facilitating aspirations is inconsistent with reality, it will be washed away like a sand castle by an incoming tide.
ESG is an attempt to change reality, not to understand it, which accounts for its intolerance of dissenting opinion. If, however, views like Koonin’s turn out to be anywhere close to being right, then ESG is promoting the largest misallocation of resources in history, an outcome with calamitous consequences for savers and the economy more generally; and is emboldening the enemies of the West, as can be seen in the current energy crisis and Vladimir Putin’s exploitation of net zero. That being the case, the day of ESG’s burial cannot come soon enough. Terrence Keeley’s Unsustainable brings forward that day.
