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Unregulated Social Investment Ratings Threaten Booming Energy Economy

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Over the past decade, remarkable technological advances have propelled the United States into a new role as a global energy superpower. The twin achievements of hydraulic fracturing and horizontal drilling have brought new life to our domestic oil and gas industry, adding hundreds of thousands of jobs to our economy while significantly lowering the cost of energy for consumers.

Renewable energy technology has taken significant steps forward while the fuel efficiency of our transportation fleet has improved dramatically. We have begun exporting liquefied natural gas (LNG) and oil in record-breaking volumes that are pulling our trade balance out of the rut it has been in for too long.

But every good party eventually attracts a party crasher. In the case of America’s energy renaissance, a proliferation of investor activism on environmental, social, and governance (ESG) issues, aided by dedicated rating agencies, threatens to spoil the fun.

A new report from the American Council for Capital Formation (ACCF) details how these self-appointed agencies have in recent years convinced investors to follow their “ratings” of a company’s ESG profile when deciding how to vote on proxy proposals or make investment decisions. The ACCF report, which is aptly titled "Ratings that Don’t Rate: The Subjective World of ESG Ratings Agencies," shows that ratings often fail to identify risk, bias larger companies over smaller ones, favor companies in certain locations over others, and unfairly compare companies in the same industry with different business models.

Some have heralded the recent rise in environmental and social resolutions as a new age of capitalism in which companies will not merely seek to maximize profits, but also serve a social purpose. But as is usually the case, the devil is in the details, and "social purpose" is in the eye of the beholder. Or put another way, leaving the fate of America's energy renaissance and its economic benefits up to BlackRock CEO Larry Fink may not be the best strategy for your 401(k).

With the assistance of ESG rating agencies and a small cabal of unregulated proxy advisory firms, investment asset managers like BlackRock have been pushing ESG resolutions in corporate boardrooms in growing numbers. These firms, including Sustainalytics, Institutional Shareholder Services, have set their efforts toward “decarbonizing” our economy by encouraging investors to pass crippling ESG proposals one energy company at a time.

But innovations in the energy sector have reduced air pollution and given the oil-producing cartel OPEC a boot in its backside. Let’s take ExxonMobil, for example. Most people will have seen its recent “Energy Lives Here” ad campaign, detailing the company’s advancements in biofuels and energy efficiency technologies that will play a significant role in reducing greenhouse gas emissions in the future. But ExxonMobil's investment in new technology hasn’t stop ESG rating agencies from depicting the international oil company as a ruinously managed businesses whose traditional energy production could bring about the apocalypse.

Indeed, ACCF found that American companies are punished in a number of ways by ESG ratings. For example, since U.S.-based businesses are not required by regulators to disclose as much information as their counterparts in Europe and elsewhere, ESG rating agencies give them lower scores. Similarly, small, innovative companies that are among some of our best job creators are less likely to receive favorable ratings because they often don’t have the resources to respond to requests for information from agencies. In both cases, the result is that it’s more difficult for American businesses to secure investment because rating agencies show preference to European-based companies and the flow of capital follows.

The ACCF paper highlights a bewildering example of this conundrum by showing how one agency considers European car company Volkswagen to have better ESG performance than Tesla, the American electric vehicle manufacturer whose mission is to produce low-emission cars for the masses. As readers will undoubtedly be aware, Volkswagen recently was embroiled in an environmental cheating scandal that crushed its share price.

How can we trust ESG rating agencies to decide who among America’s leading energy companies is a responsible place to invest? For anyone who’s had a chance to look at ACCF’s research, the answer will be no.

Investors should ask the ESG rating agencies for better accountability, transparency and accuracy or stop using the services altogether. It would be a travesty with long-lasting repercussions to let these rating agencies run roughshod over the American energy renaissance by fooling investors into believing that our country’s fastest-growing industry is a bad investment.