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The SEC Climate Rule and Inflation
As the quality improvement movement was gaining traction the phrase, “Quality is Free” was often heard. Phil Crosby, one of the leaders of the movement, famously said,
Quality is free. It’s not a gift, but it’s free. The ‘unquality’ things are what cost money.
It is noticeable that discussions to do with the SEC’s proposed Climate-disclosure rule are hesitant about making a similar claim. Companies who show leadership in reducing greenhouse gas emissions may gain a competitive advantage. But it is doubtful that a climate-disclosure program will pay for itself, let alone make a profit.
A recent article by Gabriella Hoffman reinforces this idea. In An Inconvenient Truth: ESG Is Fueling Inflation Woes she talks about the cost of ESG (Environmental, Social and Governance) programs.
As more financial leaders scrutinize so-called sustainable investing, there’s ample evidence suggesting ESG exacerbated the 9.1% increase in the consumer price index. Of the three ESG prongs, the “E” factor—which accounts for environmental stewardship and natural resources development in business practices—is primarily contributing to inflation.
She quotes Seema Shah, who uses the term “greenflation.”
. . . the push to transition away from fossil fuels, notably in the form of advancing net-zero policies, “created a chain reaction resulting in higher energy prices and, ultimately, higher consumer costs.”
Thermodynamics, Not Finance
The fundamental reason that climate initiatives are expensive is rooted in thermodynamics, not finance. Fossil fuels, particularly oil, are energy dense, available, dispatchable, flexible, portable and safe. No other energy source possesses this unique mix. Therefore, there is bound to be cost as we transition to alternatives such as solar, nuclear or wind.
Advocates of wind and solar correctly point out that the installed costs of these energy sources have been dropping sharply. This is encouraging, but it is important to recognize that alternative/”green” energy currently enjoys what amounts to a free subsidy from the traditional power plants. When the wind is not blowing, or the sun is not shining, coal and gas-fired power plants increase their output to make up the difference. If the day ever comes when solar and wind provide most of our energy, they will somehow have to fund swing sources of power, or massive energy storage. This will not be cheap.
SEC Climate-Disclosure Rule
The SEC’s proposed Climate-disclosure rule uses the term ‘ESG’ 99 times. In general, the agency seems to be supportive of a link between the climate reporting and the broader topic of ESG. However, the proposed rule expresses many uncertainties and questions as to how the two topics fit with one another.
Indeed, the SEC is concerned about the costs of ESG initiatives. For example, the following is from page 335 of the proposed rule.
Recent academic work provides evidence of firms’ engagement in obfuscation and other misleading efforts (so-called “greenwashing”) to manipulate the set of information available on corporate websites and sustainability reports with the goal of attaining higher ESG ratings . . . Additionally, a study suggested that models and metrics used by ESG providers for appropriately classifying funds are not always transparent and consistent across ESG providers.
On page 378 we read,
Another commenter, a Fortune 500 energy infrastructure firm, reported that it employs a full-time, management level director that spends about 25% of his time developing sustainability reports and other ESG initiatives. This commenter also reported that it pays a third-party consulting firm more than $250,000 annually to assist in its ESG and sustainability report process.
A deep-seated problem with climate change programs is that people do not want to know about the “inconvenient truths”. Even those who intellectually accept that the climate is heating up and that humans are the cause of the change are reluctant to change their lifestyle. It could be that most people intuitively understand that addressing climate change is costly, and that it will require a drastic reduction in living standards.
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