Ideological criteria will now influence state and local government credit ratings, thanks to S&P Global Ratings. In addition to rating governments on financially meaningful criteria, in March the largest of the three major credit rating firms began applying an environmental, social and governance, or ESG, rating system. But Utah is not about to submit to these subjective standards. State officials, including myself, recently wrote a letter to S&P objecting to the ESG indicators and ratings it assigned to Utah and asking the company to withdraw them.
ESG is sometimes dressed up to appear objective with complex quantitative “metrics” and “analytical frameworks”. But this blurs the distinction between subjective judgments and objective financial assessments.
S&P Global says it “integrates [ESG] risks and opportunities in the analysis of the credit rating” of public issuers. This includes ambiguous and open-ended categories such as how a state scores on “carbon management,” “political unrest resulting from community and social issues,” and “negative publicity that leads to reputational risk.” Leaving no doubt as to the subjectivity of the measurement, notes S&P, “the consideration of ESG risks and opportunities in our credit rating analysis will require a qualitative view of an entity’s ability to anticipate and plan for a variety of emerging risks”. Unlike quantifiable financial measures, this qualitative vision depends entirely on the convictions of the person who constructs it.
It is easy to see that these beliefs are leftist. S&P assigns a lower ESG score to states that have both “physical risks” like earthquakes and natural disasters and a higher percentage of their economy tied to natural resource extraction, like Texas, India. Alaska and Louisiana. S&P’s Environment category, after noting the financial mitigation of natural disasters through federal-state partnerships, focuses its assessment on the costs of the transition to “net zero” and policy changes that it says will be needed to “reduce” greenhouse gas emissions.
Certainly, if a state’s finances are too focused on a particular industry, it will affect its financial outlook due to the risk of lower revenues if that industry’s fortunes contract. But a traditional credit rating already takes into account the diversity of industry in a state, so why create an ESG measure that could be politicized? Instead of focusing on the financial risk associated with economic concentration, ESG measurement indicates whether a state or local government is allowing what S&P considers too much oil, gas or coal extraction.
In addition, traditional power generation has national security, economic, and even environmental benefits for US states. Many countries are looking for sources of natural gas and oil to reduce their dependence on Russia after its invasion of Ukraine. In this environment, states like Texas, Alaska and Louisiana have a huge market advantage and could see improved cash flow. Not only does their fossil fuel revenue benefit a free democracy, but Russia’s natural gas exports to Europe burn 41% dirtier than US natural gas. Exporting US natural gas would create a significant environmental benefit. Authoritarian regimes like Russia threaten the environment, human rights, free societies, and democratic government, among other things, all of which should be important to ESG proponents. The fact that S&P’s ESG metrics have completely ignored or missed these variables exposes some of the major flaws of ESG ratings. Such scores place a value judgment on policy issues that have no right or wrong answer, are highly complex, and impossible to predict.
As the Russian situation has shown, ESG ratings depend on variables that can change quickly. Before Russia attacked Ukraine, Europe was moving away from fossil fuels and military spending. That changed almost overnight. This is why markets are so valuable; they encapsulate many different visions of the future and their organic structure allows for rapid adaptation. ESG scores, on the other hand, stick strictly to one point of view and are slow to capture changes in the world. The minds behind S&P’s ESG metrics seem to believe that a transition to green energy is inevitable and therefore punish states that produce traditional energy for “climate transition risk”. But no one really knows what this “climate transition” will look like. There are no widely accepted and economically viable alternatives to fossil fuels on the market. Nobody knows where they will come from, what they will be or when they will arrive.
The false certainty of ESG metrics about future events and the resulting inability to track unforeseen current events leads to misallocation of capital. They create bubbles in favored industries while starving others that could be profitable.
Solutions to our toughest challenges, like climate change, can only come from innovation. The presence of rigid ESG factors in the market discourages innovation by imposing compliance, penalizing creativity and punishing the industry with the greatest incentive to find alternatives: the energy sector. Hydraulic fracturing has dramatically reduced carbon emissions in the United States, but it could cost you dearly according to S&P’s ESG metrics.
Utah has managed its finances prudently for decades and as a result maintains the highest possible credit rating of any major corporation, allowing the state to borrow money at the lowest rates and to save taxpayers’ money. But under the new ESG regime, these financial factors could be overridden by subjective political factors.
These settings also threaten the democratic sovereignty of Utah and other states. The ESG disclosures that many companies have felt compelled to release have also led to frivolous lawsuits and shareholder resolutions, an additional tax drag on companies. The extension of this regime to the municipal sphere is an invitation to litigation and other coercive tactics that will sabotage the self-determination and independence of states.
States like Utah value our constitutional republic, which has guaranteed freedom, and free markets, which have fostered innovation and generated prosperity for generations. All states, governmental jurisdictions, companies, individuals and investors who also share these beliefs should join us in opposing ESG.
Mr. Oaks is Treasurer of Utah.
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