ESG investing is a commonly debated topic these days. Investors who participate in it examine the environmental, social, and governance criteria of a company to assess if that company’s values align with their own. Due to the environmental criteria, many ESG investors include renewable energy companies in their portfolios. When looking at recent trends, some have begun to question if ESG and renewable energy investing are sound decisions at this time.
This uncertainty might have something to do with ESG investments being particularly susceptible to volatility. They often tend to trade at a higher price-to-earnings ratio (which compares the price of a company’s stock to the earnings the company generates) than the market overall. People pay attention to the price-to-earnings ratio because it helps them understand whether stocks are being overvalued or undervalued by the market.
The Effects of Oil & Gas Prices
Undeniably, the latest round of market volatility has been more beneficial to fossil fuel companies than the renewable energy sector because oil prices are up, way up. Despite the pandemic oil market crash in the spring of 2020, some of these companies began flourishing shortly thereafter. In April 2020, a barrel of oil went for about $20. By February 2021, this price shot up to around $60. As the world began to reopen, demand for oil rose. At the start of this year, some shareholders were seeing increased dividends from Big Oil stocks. This can feel particularly rewarding during a time of high inflation and low bond yields.
Then, Russia invaded Ukraine in February, and energy prices spiked even higher. In March, U.S. crude oil prices reached as high as $130, the highest since July 2008. About a week later, U.S. gasoline prices were up to an astounding $4.33 per gallon. As of the date this blog was written, crude oil prices are coming down, but are still over $100.
What’s interesting is that in the short term, higher energy prices can cause an increase in oil production as companies in the industry look to cash in on the opportunity. Ironically enough, rushes like these can flood the supply and help to bring prices back down. Although, no industry is immune to today’s tight labor market so ramping up oil production may not happen as fast as companies would like.
On the other hand, looking forward, higher and more volatile energy prices might be the inspiration we need to further clean up the world’s energy grids. Also, high gas prices can be great motivation for switching to an electric vehicle. Although fossil fuel production is on the rise, environmental experts continue to urge societies to decarbonize and continue their efforts to slow climate change.
The Effects of Inflation & Interest Rates
Inflation has also had an impact on interest in renewable energy and ESG investing. To fight the highest CPI inflation seen in four decades, the Federal Reserve raised interest rates. This hit stocks hard at the beginning of 2022, especially technology companies that tend to suffer when interest rates rise. Tech companies often meet ESG criteria because it’s common for them to consider and address the impact each step of their manufacturing and marketing processes has on the environment. When these stocks are down, it consequently means many ESG mutual funds are down as well.
Rising interest rates also play a big role in rising energy costs. Unfortunately, renewable energy is particularly sensitive to rate hikes. There was a renewable energy boom after the financial crisis in 2008, thanks to low interest rates and high energy demand. Even during the pandemic, these low rates helped 260 gigawatts (GW) of new renewables capacity come online in 2020.
There is no doubt that in a low-interest environment, renewable energy is quite competitive. With the current rising interest rates, however, some companies have slowed or stopped projects to upgrade grids and power facilities. Although, demand for energy in general is still high, which has encouraged others to see this rough patch through and continue with their projects, feeling confident that it will be a good decision in the long run.
Volatility is unlikely to stop those who feel passionately about slowing climate change from investing in renewable energy. When putting emotions and environmental impacts aside, others even argue that decarbonizing U.S. energy grids could help protect our economy from energy swings that are occurring because of geopolitical oil shocks, like the one we are experiencing now. The most important thing for those who consider ESG criteria to remember is that investments are not black and white.
A societal shift toward renewable energy doesn’t necessarily mean money loss. In fact, it can mean the opposite. On the flip side, just because a company negatively impacts our environment, it doesn’t mean investing in their stocks won’t be profitable. ESG investors are tasked with making decisions based on their own unique perspectives and goals.
This is not easy, so no one expects you to figure it out on your own. Our financial advisors are well-versed in ESG and are happy to discuss this topic with you further. Instead of putting your money in a one-size-fits-all ESG mutual fund, they can help you pick individual assets that match your values and consider you financial wellbeing in tandem.