Building a net-zero global economy by 2050 will require massive investments, between $92 trillion and $173 trillion worldwide over the next three decades, according to BloombergNEF’s 2021 New Energy Outlook.

The investors who want to tap into that market — and the asset managers who advise them — will be looking closely at companies’ policies and performance on environment, social and governance (ESG) as they decide where to put their dollars. In other words, the interests and demands of investors are now a significant and irreversible factor driving the global energy transition, reflecting what Eduardo Manzur of Goldman Sachs calls a “secular shift” in the market.

Manzur, energy technology sector captain at the investment banking firm, was one of four panelists at a recent webinar on the current state of ESG investing in the energy sector. He framed ESG as providing “the guidelines and the metrics for companies to actually change their behavior to address the energy transition.” The goal, he said, is to bring investors “actionable opportunities” across a range of no- and low-carbon technologies, from solar and wind to electric vehicle charging to hydrogen and renewable natural gas.

“ESG really permeates all aspects of what I do, and that’s for a couple of reasons,” said Crystal Simpson, managing director in equity capital markets at Evercore, a New York-based investment banking firm. “First, almost every investor I speak to now incorporates aspects of ESG into their investing framework, even if they are not a ‘dedicated ESG investor.’ And secondly, the pool of capital that is truly dedicated to ESG investing is growing exponentially. My clients are looking to access as much of this capital as possible.

“There is a belief among investors that companies with better ESG initiatives are higher quality companies … not just because [it is] the right thing to do, but because it’s good for business,” Simpson added. Such companies have “better accountability” and “better results over time,” she said. “It’s a bit of a litmus test for other things.”

But the reach of ESG must extend beyond investments in clean technology, said Bill Davis, portfolio manager at Stance Capital. “ESG managers tend to focus on growth companies [that] in essence actually don’t have a carbon problem to begin with,” Davis said. “Our view is that you don’t decarbonize the economy only by investing in companies that don’t have a carbon problem. So, we are actually unafraid to try and invest across as much of the economy as possible, recognizing that many of these sectors [with high emissions] aren’t going away.”

The ‘G’ and the ‘E’

According to a recent white paper, ESG can trace its roots as far back as the 1950s and 60s, when U.S. labor unions started investing their pension funds in affordable housing and health care. Today, it has become a core imperative of institutional investing. In his 2021 letter to CEOs, Blackrock CEO Larry Fink noted that in 2020, global investments in sustainable assets totaled $288 billion, up 96% from 2019, signaling a “tectonic shift” in the allocation of capital.

Davis said shareholders have been agitating on ESG issues for “quite some time, but I would say they’ve gotten much more organized in the last couple of years.”

He pointed to Climate Action 100+, a network of investors representing $55 trillion in assets, focused on pushing the largest corporate emitters of greenhouse gases to take action on climate change. Both he and Simpson emphasized the importance of corporate governance — the “G” in ESG — as a priority for many investors.

“Investors are looking for directors who understand climate risk, who are willing to assume ownership on climate risk,” Davis said, citing the shareholder revolt at ExxonMobil’s annual meeting that unseated three of the company’s directors in favor of a slate put forward by the impact-focused hedge fund, Engine No. 1.

While noting that governance can cover a range of issues, Simpson said, some of the key factors for investors are “management incentives; board diversity; even things like not ‘over-boarding’: not having board members who are on too many boards at once.”

“I think there is a strong belief that if management incentives are properly aligned and if governance is strong, everything else will fall into place better,” she said.

Manzur said investors are also still focused on the “E” — environment — part of the formula, although their priorities have evolved over the last 18 months, from an avid interest in renewable technologies to a more forward-looking approach. The questions investors are asking now, he said, are “What are the companies that have a strong profile? What are the companies that have strong growth ahead of them? And at the same time, what are the companies that are going to provide the solutions for the future for this sector to shift into the energy transition?”

Hundreds of new technologies and trillions of dollars in new investment will be needed by 2040, he said. “It’s the most massive industrial revolution because we’re not starting from zero. We’re taking out the infrastructure that’s in place and putting in new infrastructure.”

Progress, Effort, Authenticity

Thomas Amburgey, director at First Reserve, says his company is strongly focused on ESG, putting money into companies that he described as “thematically core to ESG sustainability” but not necessarily cleantech organizations. As a private equity firm, First Reserve has a portfolio with “more Old World businesses” with high carbon emissions, Amburgey said, including oil and gas, as well as sustainable packaging and industrial safety and maintenance.

“How do you decarbonize and drive environmental efficiencies across those end markets?” he said. “Industrial supply chains aren’t going anywhere, but how do you do things differently and come up with different solutions?”

On the governance side, he said, First Reserve also prioritizes board diversity for the companies it invests in. “We’ve tried to broaden our lens and our focus by thinking about how we bring in other sources on the board, and people from different backgrounds, different walks of life … women and minorities, and we found how valuable that can be in terms of driving a whole different type of debate and discourse at the board level.”

Metrics are another critical and evolving part of the ESG equation. Industry standards are still emerging, with multiple software platforms for tracking ESG performance being developed, Davis said.

“What [investors] want to see is a framework through which you are establishing baselines and measuring against those baselines and looking to improve on those baselines, with the understanding that this is dynamic and there are always going to be new issues,” he said.

“Dealing with a portfolio of 15 companies that have supply chains all over the world is really tricky,” he said. “I think people want progress and they want to see there’s a real effort. They want to see authenticity.”

First Reserve has worked with a software company to develop metrics for the companies in its portfolio, tracking carbon footprints and community involvement, Amburgey said. “We track how many hours our employee base provides to their communities; how much is contributed charitably,” he said. “You invest in the communities you operate in because that’s where you get your talent.

“Everything in our portfolio gets rated on a zero-to-100 basis, and we’re constantly trying to drive it up as close to 100 as we can get,” he said.

But without cross industry standards, “greenwashing” — overstating or simply not delivering on a company’s ESG performance — remains a risk. Simpson said investors are “pretty sophisticated” and “quick to identify greenwashing.” Companies should set a framework and objectives that investors can follow and score over time, she said.

Davis cautioned against greenwashing within the investment industry itself. “They see that [ESG] is popular; they throw products out into the marketplace; they’re just sort of chasing shiny objects,” he said. “They don’t really understand what they’re investing in.”