Tesla S&P ejection tip of the iceberg of ESG’s problem with nuance

Elon Musk may be a bit ‘marmite’ but when ExxonMobile scores higher than Tesla there is clearly a disconnect


“A clear case of wacktivism” is how Elon Musk described Tesla’s removal from the S&P 500 ESG index at the end of May.

“Exxon is rated top 10 best in world for environment, social & governance (ESG) by S&P 500, while Tesla didn’t make the list! ESG is a scam. It has been weaponised by phony social justice warriors.”

He has a point. On pretty much every environmental measure, ExxonMobil is a difficult company to love. Not only is it one of the largest carbon emitters in the world, it has also been under fire over its record on microplastics.

In April, California’s attorney general has subpoenaed ExxonMobil as part of an investigation into the petroleum industry for its alleged role in causing a global plastic pollution crisis. The company remains on LGIM’s exclusion list because of its poor record on engagement.

At the same time, Tesla is widely credited for pioneering electric vehicles, which are likely to prove a vital step in achieving net zero.

It has helped overcome many of the barriers to adoption of electric cars, extending battery life, installing charging infrastructure and improving drive quality.

Musk may be a polarising figure, but it is difficult to put Tesla below ExxonMobil in terms of its impact on society.

Discrimination and poor working conditions

However, S&P’s reasons for excluding Tesla go to the heart of the problem with ESG analysis. The S&P index weights according to the best companies in each individual sector on a range of environmental, social and governance factors.

Environmental factors do not hold any more sway than any other factor and for Tesla, social and governance factors have weighed on its rating. In particular, S&P cited reports of racial discrimination and poor working conditions.

Earlier this year, the California Department of Fair Employment and Housing filed a lawsuit against Tesla, saying the company had allowed racial harassment and discrimination to persist for years at its manufacturing plant in Fremont. It also mentioned the company’s inadequate response to a federal safety investigation.

The way S&P’s carbon emissions are measured also creates some problems for Tesla. The ratings consider a company’s direct greenhouse gas emissions, but not its Scope 3 emissions. These are emissions from the use of products, so the fact that Tesla makes non-carbon emitting cars isn’t much of an advantage.

However, this may say more about the limitations of ratings than about Tesla.

Jefferies said in a recent note: “Simple ratings do not allow investors to take a more subtle and nuanced approach and make their own informed decisions around the inherent tradeoffs in many ESG issues. As such the baby can get thrown out with the bathwater, especially when an investor may be more focused on one aspect of ESG…

“In our view, good ESG investing should instead acknowledge the risks associated with governance issues, but also weigh them against the environmental positives and opportunities in the equity with the investor making the ultimate decision.”

One out of three ain’t enough

In general, ratings do not offer a good way to look at the future impact of any individual company.

Baillie Gifford investment analyst Abhishek Parajuli says this is a particular problem for companies that have significant social impact but score poorly elsewhere: “Because social change is hard to measure, it often gets ignored. As a result, ESG analysts penalise companies that have governance and environmental concerns even if they are completely transforming society.

“It is relatively easy to measure a firm’s direct carbon emissions and add those of its power providers or even its supply chain.

“At the end of it all, you have a neat number to present. Governance metrics also fit in a form, with nice neat boxes for the experience or diversity of a board. Find the answer, tick the box, move on. That is not true of social metrics.”

He gives the example of Indian group Reliance, which has built a vast technology ecosystem, with a far-reaching positive impact on remote education and healthcare across the country during Covid, but is still considered an ESG laggard because of governance concerns.

Hector McNeil, co-CEO and founder of HanETF, adds: “We need to be clear what ESG screening is. It is not simply about companies that are providing climate solutions; it is about the risks and profiles of the companies in question. Innovating and pioneering climate change solutions is great and admirable, but it doesn’t give you automatic inclusion in an ESG index.

“It should be noted that Tesla hasn’t gotten ‘worse’ from an ESG perspective, according to S&P Dow Jones Indices. It’s that everyone else is getting better. So, Tesla has fallen out the index due to its relative ESG score. If Tesla improves on these fronts perhaps it will be re-added. We should expect companies to come in and out of ESG indices as each company makes progress at different pace.”

Musk’s wrath is perhaps understandable, as is investors’ bafflement that an electric car maker could be rated lower than an old-fashioned oil company.

It shows the importance of understanding what the ratings can and cannot measure in terms of a company’s sustainability metrics.



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