ESG in the Biden era: emissions hit US utilities at the bottom line

March 08 2021

John BriggsHead of Strategy, Americas

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Alvaro VivancoHead of LatAm Strategy and Macro Analysis

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4 minute read

Markets punishing high-emitting power providers and rewarding emission reductions after Joe Biden’s election victory highlights a growing need among both businesses & investors to focus on industry-specific ESG policy risks. In this feature, our specialists explore the link between a shift in US climate policy and the financial performance of utilities and highlight key risks you should consider.

President Joe Biden’s election victory in November 2020 ushered in a much more climate-focused US administration than that helmed by his predecessor. One of Biden’s clearest goals, for the US to have 100% carbon-free electricity by 2035, is undoubtedly a challenging proposition for most utilities and will require a substantial move towards renewables and other emission-cutting activities.
How has that titanic shift in US policy affected the market’s perception of utilities – and what can other businesses & investors learn from that? We started by comparing the longer-term financial performance of energy companies in both the US and Europe (between 31 December 2019 to 31 January 2021) with a period we feel broadly aligns with the influence of a Biden victory (between 30 October 2020 and 31 January 2021) to see if any special factors might have influenced performance. 
Then we dug a bit deeper, comparing equities (stocks) and credit default swaps or CDSs (insurance investors can purchase against a bond default) of US utilities with their ESG ratings, carbon intensity and distance to zero-emissions.
Click here to find out more about what a Biden presidency means for businesses. 

Asset performance in context: US utilities underperformed but oil fuelled broader energy company outperformance

Over the longer period that encompasses all of last year, US energy companies underperformed on all fronts, with US utility CDS spreads widening nearly three times as much as their European counterparts, and all other energy companies in the US slightly underperforming European companies as well, albeit by a lesser degree (see charts below).

CDS performance (positive = wider) for US and EMEA utilities, all other energy companies (>$10bn*) from 12/31/19 to 1/31/21

CDS performance (positive = wider) for US and EMEA utilities, all other energy companies (>$10bn*) from 10/30/20 to 1/31/21

Sources: NatWest Markets, Bloomberg. *For this analysis, we only considered companies with a market capitalisation of $10 billion or more.
There is, however, a clear difference in performance during the post-election period: US utilities saw their CDS continue to widen (signalling greater risk in the eyes of investors), while European utilities saw an improvement close to 10%. 
As for other energy companies, the US did see outperformance, but we attribute this to the influence of oil: West Texas Intermediate (WTI) crude oil futures reached historical lows on October 30th of last year and rallied 45% through the end of January; 9 of the 10 best performers in this category over that period were oil refiners, or oil and gas exploration and production companies.

ESG ratings & carbon intensity: which was the better predictor of market risk perception?

Zooming in on US utility companies, it is interesting – though not wholly surprising – to find that their ESG ratings alone were not a particularly good predictor of subsequent asset performance, whether CDSs or equities. CDSs generally widened, but there is no clear consistency where lower rated companies underperformed higher-rated companies. Similarly for equities, performance is a bit all over the map. 
The fact that ESG ratings are relatively static and encompass other social (‘s’) and governance (‘g’) elements might explain the lack of market response to the policy change, something we also detected in the financial industry – which also suggests some sectors may need more dynamic & specialised tools to account for industry-specific idiosyncrasies. 
But things get very interesting when we start looking at carbon emissions. Conceptually, where companies stand on current emissions and against their stated intentions to reach zero carbon emissions by 2035 should be a key driver given Biden’s electoral victory – and we found this to be the case. The charts below show US utilities’ asset performance grouped into the top and lower quartiles (lowest and highest emitters, respectively) and the middle 50%.

US Utility performance, based on 2018 carbon emissions levels (for CDS performance positive = wider)

US Utility performance, based on 2018 carbon emissions levels (for CDS performance positive = wider)

Sources: Bloomberg, NatWest Markets, MSCI
The fact that companies in the bottom quartile in terms of emissions had a 19% drop in equity prices versus a gain of almost 7% for those in the top quartile over 2020 is quite telling and indicative of a strong correlation to the policy change. Indeed, the results show the market’s ability to both punish and reward companies based on carbon intensity, which also reduces the chances of the behaviour responding to an uncorrelated third factor.
Our analysis of US utilities also shows that actions matter more than words. Some companies with ambitious plans for carbon reduction but high absolute starting levels did not benefit as much, at least in terms of asset performance. This seems intuitive to us because investors will want to see more certainty around emission reductions before financial benefits become apparent. 

For investors & businesses, the numbers speak for themselves 

The much better correlation to actual carbon emission versus broader ESG scores also reinforces the importance of looking at industry-specific factors.
  • For investors deploying capital, it’s less about avoiding specific sectors and more about finding the right ESG lens across industries. 
  • For businesses transitioning towards more sustainable ways of doing business, it’s less about trying to do everything at once and more about being targeted in how specific – and potentially more acute or impactful – ESG risks are addressed in the broader context of that transition.
These are important considerations against the common criticism that ESG issues are too broad and hard to quantify. In this case, the numbers speak for themselves.  

Clients who would like to discuss this topic further should get in touch with their NatWest C&I representative or contact us here.

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