Palm oil can be up to 40 times more polluting than diesel

Author: Jon Sigurdsen, Portofolio Manager

In 2004, the then Gucci chief executive Domenico De Sole and his wife Eleanore paid $8.3m for the Mark Rothko painting “Untitled 1956" and hung it in their home. In 2011, frustrated, they took it down. The painting was a fake sold through Knoedler & Co, a Manhattan gallery, which shut suddenly that year.

The moral of the story? Buyer beware. That same warning applies to investors with environmental, social and governance mandates as ESG strategies flood the market. Often, the portfolio manager of an ESG fund will select a biodiesel stock over an oil company. You may assume that the former is more sustainable — but that is not necessarily the case. Some biodiesel companies that use food crops to produce diesel have a carbon footprint larger than oil companies.

Palm biodiesel, for instance, is derived mainly from forests in Malaysia and Indonesia. According to a report by the Royal Academy of Engineering, palm biodiesel from peat and forest lands produces between three and 40 times more greenhouse gas emissions than diesel production, while deforestation in order to grow palms for palm oil and biodiesel can directly threaten local biodiversity. Palm biodiesel is not the only villain among biodiesel feedstock. Biodiesel from soyabean, corn, rapeseed and sunflower, among many other foods, can be as unsustainable or worse. It should be impossible for unsustainable biodiesel companies to penetrate ESG screening but they are in many ESG funds. Investors would be better off investing in oil and gas companies, which have historically performed well. In fact, some oil and gas groups have diversified with their own investments in renewables. Why, then, do some ESG investors choose biodiesel over oil and gas? The problem stems from the industry’s emphasis on negative ESG screening, which weeds out “dirty” companies in favour of “clean” ones.

In this case, there is no doubt that biodiesel is a renewable and an important step towards reducing carbon emissions, particularly for aviation and shipping. That means every biodiesel company will always score higher than any oil and gas company in an ESG fund, regardless of whether the company is sustainable or not. Negative ESG screening can also change industry or regional exposure in a portfolio. In the example of palm biodiesel, the investor could unknowingly put funds into the destruction of Asian rainforests and may also incur an unintentional overexposure to Asian markets, depending on how many other Asian companies are in their portfolio.A positive approach to ESG screening would be to consider the steps biodiesel companies take to be sustainable.