Both negative and positive screening aim to steer clear of players with the most significant adverse impact on the environment. However, whereas the former typically entails investing away from big oil entirely, a positive screen will consider including certain oil majors in a portfolio based on their environmental, social, and governance (ESG) ratings.
Companies may be selected because they are actively working to improve their scores, or they may have strong scores already. Case in point: Shell has a higher ESG score than some other, more outwardly ESG-friendly companies such as Tesla. However, it is excluded from many investment portfolios on the basis of negative screening.
Shell Demonstrates Steps toward Change
MSCI gives Shell an AA rating on ESG metrics—the second-highest score possible and the top score out of 28 companies in the integrated oil and gas industry. The Anglo-Dutch firm has set out a strategy to reduce carbon emissions and shift the business away from fossil fuels, aspiring to become a net-zero emissions energy business by 2050.
Shell pledges to increase its offerings of low-carbon products and solutions such as biofuels, electric vehicle charging, hydrogen, and renewable power as well as carbon capture and storage. The company’s plans also include building low-carbon businesses of “significant scale” over the coming decade. Meanwhile, the oil and gas giant is looking to reduce emissions from its fossil fuel operations through measures such as increasing efficiency and emission capture/offset. Shell was also one of the first oil majors to link executive bonuses to carbon targets.
The company anticipates a rising need to supply low-carbon energy products and services to accelerate its transition to net-zero emissions, although it says it will not end oil and gas activities “too early” for other energy sources to catch up. Shell has set the most ambitious targets in the oil industry, but a Dutch court ruled that the company must reduce CO2 emissions even further: 45% by 2035 versus its target of a 20% reduction by that time. Negative portfolio screening accounts the overall environmental impact of Shell’s products but not recognize the company’s efforts to grow its renewables footprint.
Fund Suggests a Split Approach
In a proposal from one of Shell’s biggest investors meant to help Shell appeal to different sets of investors, hedge fund Third Point has urged the oil and gas major to split into two parts. The fund’s plan would have part of the oil giant focus on clean energy activities while the other houses Shell’s historic fossil fuel business. In turn, the clean energy business could be better positioned to attract investment from ESG funds. With Shell’s share price a little lower than it was two decades ago, the plan has the potential to garner support from shareholders.
Third Point notes that a new company that includes Shell’s renewables, liquified natural gas, and marketing businesses might even develop about the same enterprise value as the whole of Shell presently does. Ultimately, the group also argues that this approach could bring environmental benefits.
With a lower valuation and higher cost of capital, the brown energy business may be more likely to focus on paying out dividends to shareholders and less likely to invest in production. Yet such an outcome is far from certain; management may take an alternate view, particularly as higher oil prices have in the past led to increased investment in oil wells. Such companies also have the potential to be acquired by private equity funds, removing shareholders’ influence from the equation altogether. Shell’s existing approach—using cash from the oil business to invest in renewables—may be a more assured way of advancing green energy at the expense of fossil fuels.
Investors Weigh Pro-ESG Intentions
MSCI acknowledges Shell’s progress on issues of corporate governance, toxic emissions, and waste. Shell gets an average score on health and safety and carbon emissions, but its AA ESG rating from September 2021 marks continued improvement from an A ESG rating by MSCI in 2019 and its previous BBB status.
However, one metric on MSCI’s score sheet will naturally rankle many ESG-conscious investors. According to MSCI, Shell has an Implied Temperature Rise of 2.72 degrees Celsius, which is on track for warming that would imperil the global climate and life on earth. This means MSCI does not believe Shell is aligned with the Intergovernmental Panel on Climate Change goal of limiting the global temperature increase in the year 2100, compared with pre-industrial levels, to 2 degrees. Shell is even further from accordance with the Paris Agreement limit of 1.5 degrees, and some may choose not to invest in the company based on this metric.
The counterargument states that ESG funds should take measures to encourage oil majors to make a strategic, long-term commitment to net-zero emissions. If investors reward businesses such as Shell that try to make a change for the better, it may send out a message to other oil majors to improve their own practices.
Choosing to invest in Shell and other similar companies on the basis of positive ESG screening may require active communication and education efforts on the part of investment managers so that their intentions are properly understood. Some ESG index funds have faced criticism for their investments in oil and gas, and portfolio managers may find investors unpleasantly surprised when an ESG-focused investment strategy chooses to invest in an oil and gas company, notes Investment Executive.
Nevertheless, S&P Global points to tentative signs that positive screening is gaining traction. Shell may present an opportunity to explore whether investing in oil and gas companies with good ESG scores can encourage pro-ESG behavior such as cutting emissions and switching to renewables.
Any company, security, fund or other investment identified herein is provided solely for illustrative purposes and should not be construed as a recommendation or solicitation for the purchase or sale of any such investment.