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October 11, 2022

Renewable energy’s ESG rating issue

Fossil fuel companies may receive better ESG ratings than clean energy firms because of inconsistent rating practices, shows research published on Monday by the Institute for Energy Economics and Financial Analysis, a US-headquartered think tank.

“Stop the outrageous false ESG assessments, where Tesla gets a bad grade, but an oil company can get a good grade,” tweeted Tesla chief Elon Musk, after his electric vehicle company was removed from Standard & Poor’s (S&P) 500 ESG Index in May 2022, while Exxon Mobil was retained. “Total gaming of the system!”

S&P, which tracks companies based on its own ESG standards, said the fossil fuel major has better environmental, social and governance credentials than Tesla. IEEFA’s research shows, however, that this view may not be shared by other rating providers, which use different analyses. It describes ESG ratings in general as “wide and conflicting”. Clean energy companies may be “underrated due to a lack of transparency and subjectivity around ESG methodology,” says IEEFA.

The report also highlights problems related to the aggregation of ESG scores into a single metric and biases due to geography and company size. Firms domiciled in countries with robust ESG regulatory reporting requirements and larger market capitalisation are often awarded more favourable ESG ratings. “Clean energy companies that fundamentally contribute to reducing greenhouse gas emissions and curbing climate change are not necessarily scoring high E or ESG marks, and risk being underrated,” says IEEFA.

IEEFA’s recommendations include standardising transparent frameworks for rating methodology and disclosure over time; adopting mandatory reporting of each E, S, and G pillar and its key sub-components; and potential regulatory intervention in the ESG rating sector.

The report also calls for renewable energy disclosure to be strengthened for rating providers and companies to ensure that ESG measures are contributing to the energy transition. “Renewable energy procurement, such as new renewable generation added to the grid, the viability of clean energy strategy, and carbon reduction should be
distinctly addressed in ESG scoring methodologies,” it states.

Read the report


A service from the Financial Times