ESG’s Inflation Conundrum

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Aaron White, vice president of sustainable investments at CIBC Asset management.

Inflation has affected all areas of the economy, and ESG investing has not been immune. We’ve seen sentiment shift globally around the accelerated need for climate change solutions due to the perceived competing priorities from both inflation and energy security. Due to the global geopolitical, economic and social factors looming over global economies, many have argued against investing in the climate transition, including some countries recommissioning old coal plants.

High global energy prices have also been a significant factor in the debate around emission reduction plans and the need to stem inflation in the near term. While these short-term headwinds to the energy transition are material, I believe it will be short lived. According to the IEA, Russia is not expected to regain its share of the oil and gas market post-conflict and developed markets have seized the opportunity to accelerate their commitment to clean energy. While there have been short-term setbacks in the area of energy price volatility and overall emissions growth, concentrating the bulk of investment into low carbon energy solutions should provide the world with significantly better outcomes over the long term.

There are three main factors that support this view. Firstly, as investment and innovation and transition solutions increase, new technologies will scale to the point where their costs come down. And we’re already seeing significantly lower costs in more traditional renewable sources like solar and wind, including being some of the lowest cost production of electricity in the world today. But we’re also starting to see increased investment in more hard-to-abate sectors like steel, cement, heavy goods vehicles, as well as shipping, where we’ll ultimately see that cost curve reduce and should see through both regulatory intervention and cost reduction, those more renewable and sustainable sources of transition taking over in the general economy.

Secondly, with several nations committing to net zero by 2050, the likelihood of dramatic policy intervention pushing the cost of fossil fuels to end users higher increases exponentially over time. And in Canada, we’ve already seen a commitment from the government to increase carbon taxes through to $170 a ton, and would anticipate that other governments around the world will continue to implement policies that push the cost of fossil fuels higher, including the introduction of tariffs focused on normalizing carbon prices across the world.

And then thirdly, with recent geopolitical events having highlighted the volatility and uncertainty of traditional energy prices globally, reinforcing the need for additional investments into alternative energy sources, this investment will not only pay dividends in terms of the reduction of cost, but will also increase energy security as countries reduce the reliance on global oil supplies.

Taking these factors into account, investments in the climate transition will help solve both energy security and inflation issues over the long term, while also being more economical, as well as more impactful to environmental preservation. And despite some short term headwinds in the energy transition, the costs of inaction are far greater, particularly if delayed investment leads to a runaway climate scenario.

Lastly, in any conversation, including ESG and inflation today, I think it’s really important to look at what is currently driving inflation. While there isn’t consensus, a significant number of economists are citing corporate profits as the largest contributor to inflation over the last several quarters. We also saw the Congressional Subcommittee on Economic and Consumer Policy release their report analyzing profit margin increases across several industries, including shipping, rental cars, meat processing, and oil and gas, which showed that margin increases have expanded at a rate of over 50 to over 250% depending on the industry.

This leaves the question of how investors should think about their role as an owner of companies that are contributing to an affordability crisis among our most vulnerable populations. How should companies balance prices and pass through costs in a system where shareholders are the primary, if not only, stakeholder of relevance to many management decisions? Do we need to rethink the importance of all stakeholders in a balance between maximizing investor return and its impact on the society that facilitates the opportunity to generate those results?

In an environment where energy costs and environmental impacts dominate the conversation of ESG, it’s important not to lose sight of the social considerations and how we as investors contribute both positively and negatively by enabling the companies with which we invest.