Tesla, Exxon Mobil And S&P 500's ESG: How Does This Work?

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Tesla is a stock that continues to create news, because it pushes the envelope in many ways. One of the strangest recent news reports was that Tesla (NASDAQ:TSLA) has been excluded from the S&P 500 ESG Index in the latest rebalancing. Elon Musk ensures that there are often controversial issues raised that keep Tesla in the news, but excluding Tesla from a major sustainability index? Where did that come from? This is a curious development that made me reflect on the quality and meaning of the S&P 500 ESG Index. I have little doubt that this exclusion will have essentially no impact on Tesla’s share price, but it does raise questions about the value of the S&P 500 ESG Index to investors. Here I dig a little deeper.

What Is The S&P 500 ESG Index?

Dow Jones defines the S&P 500 ESG Index as follows : “The S&P 500 ESG Index is a broad-based, market-cap-weighted index that is designed to measure the performance of securities meeting sustainability criteria, while maintaining similar overall industry group weights as the S&P 500. I’ve highlighted a key element of the definition, because I think this is critical in considering inclusion of companies like Exxon Mobil and exclusion of Tesla.

Rebalancing The S&P 500 ESG Index

Margaret Dorn, Senior Director, Head of ESG Indices, North America S&P Dow Jones Indices, has a blog (May 17 2022) directed towards clarifying some key points about the latest rebalancing of the S&P 500 ESG Index, which has as a newsworthy outcome dropping Tesla from the Index (while keeping Exxon Mobil (XOM) as the ninth largest constituent of the Index at 1.443%; the largest holding is Apple Inc (AAPL) at 9.657%).

Why Tesla Was Removed From The S&P 500 ESG Index?

In Margaret Dorn’s blog the basis for Tesla’s exclusion was given. It seems that Tesla’s S&P DJI ESG Score didn’t change but its global industry peers did better, effectively pushing Tesla down the ranks. The reason Tesla didn’t do better seemed to revolve around i) lack of a low carbon strategy!!! ii) issues about code of business conduct and iii) Media & Stakeholder Analysis indicated three controversial issues (two separate incidents centering on racial discrimination and poor working conditions at Tesla’s Fremont factory and Tesla’s handling of the NHTSA investigation after multiple deaths and injuries linked to its autopilot). This wider lens is why Tesla has been dropped.

It seems that Tesla’s playing its part in taking fuel-powered cars off the road is acknowledged, but industrial issues and analysis of accidents involving its automated driving program pushed its rank down. At a personal level, I’ve just had a near miss from a head on collision caused by a driver on my side of the road rounding a bend. I’m a fan of automated driving and if Tesla makes it work, that is a big positive for me. Humans are not reliable at the wheel. Innovation involves risks … to put autopilot into perspective, Tesla produces quarterly accident data for it global fleet. Q4 2021 results were that Tesla vehicles driving with autopilot (autosteer and active safety features) recorded one crash for each 4.31 million miles driven, while Tesla drivers not using autosteer recorded one crash for every 1.59 million miles. NHTSA’s most recent data indicates that in the US there is one automobile crash every 484,000 miles. Does the S&P 500 ESG Index consider these facts? Or is getting into the undergrowth about specific cases of investigation by NHTSA more important?

Tesla Makes Clear To Investors Its Views On ESG

Tesla defines that its purpose is “to accelerate the world’s transition to sustainable energy”, which is a big goal.

The Tesla 2021 Impact Report is a 144 page document that makes clear what Tesla does in the ESG area. As a late to the party investor who is thinking (again) that now might be the time to invest in Tesla, I found the document most useful. In typical Tesla fashion the document gets to the point and isn’t shy about pointing out what is wrong with ESG indices. It makes the following point “Current ESG evaluation methodologies are fundamentally flawed. To achieve acutely-needed change, ESG needs to evolve to measure real-world impact”.

Two headline commentaries from the Tesla 2021 Impact Report are worth reading in full, so I reproduce them here :

1. What ESG Measures Today: Investment Risk

Current environmental, social and governance (ESG) reporting does not measure the scope of positive impact on the world. Instead, it focuses on measuring the dollar value of risk/return. Individual investors – who entrust their money to ESG funds of large investment institutions – are perhaps unaware that their money can be used to buy shares of companies that make climate change worse, not better. An obvious example of this is measuring the impact of the automotive industry. One might think that the more electric vehicles an automaker sells, as a percentage of total volumes, the better its ESG score. However, this is not the case. As long as a company continues to slightly decrease emissions of its manufacturing operations while churning out gas-guzzlers, its ESG ratings are likely to go up. Vehicle use-phase emissions, which represent 80-90% of total automotive emissions (included in Scope 3 of ESG reporting), tend to be misreported due to the use of unrealistic assumptions or not reported at all. It’s easy to see why some oil & gas companies rank higher than Tesla on “Environmental Impact.” “The most striking feature of the [ESG rating] system is how rarely a company’s record on climate change seems to get in the way of its climb up the ESG ladder—or even to factor at all.” (ESG Mirage: Bloomberg Businessweek).

2. What ESG Needs To Become: Company Impact

We need to create a system that measures and scrutinizes actual positive impact on our planet, so unsuspecting individual investors can choose to support companies that can make and prioritize positive change. On the product front, companies should be required to use real-world data wherever remotely feasible and make it clear when estimates are provided instead of real-world figures. An example of this is vehicle “use-phase” emissions, accounting for the vast majority of lifecycle emissions. Automakers’ estimates on lifetime vehicle mileage and lifetime fuel consumption vary dramatically and almost never reflect real-world data. Automakers often have access to this data, but they don’t disclose it. When it comes to a company’s employees, it is essential that they’re treated well, with a system in place to prevent discrimination of any kind, that they have a safe workplace and that they are rewarded appropriately, with significant upside if their employer does well. Many ESG ratings evaluate: “Does this ESG issue impact the profitability of the company?” We need a system that evaluates: “Does the growth of this company have a positive impact on the world?” This evolution of ESG needs to be championed by institutional investors, rating agencies, public companies and the general public. As the world needs to strive for a substantial positive impact, we won’t be referring to ESG in this report. Instead, we’ll talk about Impact.

The core point Tesla makes is that ESG Indices should help guide investors interested in making the world better, which in today’s world means addressing climate change as a key priority.

Where Does That Leave XOM Being Included In The S&P 500 ESG Index?

In the above commentary by Tesla about the auto industry, Scope 3 emissions are raised as the most significant issue. The same applies to the oil and gas industry. Exxon Mobil has made an art form of focusing in great detail on Scope 1 and Scope 2 emissions from its business (e.g., net zero by 2050 for its Scope 1 and Scope 2 emissions), but it does not address Scope 3 emissions and this is where the company makes its greatest contribution to exacerbating the climate crisis. Scope 1 & 2 emissions, (120 million tons of CO2 equivalent in 2019), are a small part of the overall emissions resulting from XOM’s business, as Scope 3 emissions (570 million tons CO2 equivalent in 2019) are the dominant part of XOM’s overall negative impact on the sustainability of its business. Increasing its oil and gas production dramatically accelerates Scope 3 emissions.

As Tesla indicates, by making reductions to its Scope 1 and Scope 2 emissions, XOM stays in the S&P 500 ESG Index, while at the same time growing its Scope 3 emissions with dramatic negative changes in its overall climate impact. The question for S&P 500 ESG Index makers is as to why the Index is constructed to allow index inclusion for companies that have extremely destructive sustainability business plans.

Note that there is considerable lack of agreement by different ratings agencies on ESG, with Moody’s giving XOM a lower ESG rating than Tesla. A broader commentary on ESG investing is covered in a recent Seeking Alpha article by James Emanuel.

Elon Musk Is Controversial

Humans are flawed and some wear their flaws as a badge. Elon Musk’s recent twitter pronouncements about requiring employees to return from work at home are deliberately provocative. In two tweets on May 31, he left no doubt : “Anyone who wishes to do remote work must be in the office for a minimum (and I mean “minimum”) of 40 hours per week or depart Tesla. This is less than we ask of factory workers.” …. The tweets continue in an uncompromising way.

The above is designed to be controversial, and it is, but as regards the business of Tesla and its goal to address climate change through decarbonizing transport, this hardly ranks as a significant issue. Elon Musk’s eccentricities hardly rate as the basis for excluding Tesla from S&P 500 ESG Index. Given the way that Tesla’s exclusion from the index is positioned (“they (Tesla) will once again have an opportunity to be reviewed for inclusion in years to come”… presumably when they come out of the naughty corner!), one can’t help but suspect that the S&P 500 ESG Index is joining Elon Musk in the sandpit.

Conclusion

Tesla’s exclusion from the S&P 500 ESG might be one of those rare events where most everyone is happy (or at least not too dissatisfied). Tesla investors are accustomed to bearing the brunt of criticism, in part because Elon Musk is not the most diplomatic person. Tesla investors know that the company has almost single-handedly proven that electrification of wheeled transport is not only possible, but also capable of rapid implementation. Tesla investors know that the final step will be release of the Tesla Semi, which will do for heavy wheeled transport what the Model 3 has done for personal transport. On the other hand investors who don’t like Tesla will feel vindicated that there is something about Tesla that, in their view, doesn’t ring true. I doubt that the exclusion from the S&P 500 ESG Index will change investor views or have a significant impact on Tesla’s stock price. Tesla’s recent short term price movements are more related to Elon Musk’s Twitter adventure. Tesla is a highly polarised stock. Of 17 Seeking Alpha authors in the past 30 days, two strong buys and four buys are counterbalanced by one strong sell and four sell suggestions, with six in the middle with a hold. Wall Street ratings are more positive with 12 strong buys and seven buys out of 38 analysts in the past 90 days. There are 11 hold recommendations, five sell and three strong sell. I’m still agonising about the right time to take a stake in Tesla.

On the other hand exclusion of Tesla from the S&P 500 ESG Index is useful because it brings focus on the criteria for inclusion/exclusion from the S&P 500 ESG Index. Tesla’s position is that the index misses the key issue of real-world impact that a company has. The fact that Exxon Mobil is included in the S&P 500 ESG Index makes one wonder how the inclusion criteria can allow this for a company whose business goal is to make things worse regarding climate impact. Of course Tesla should pay attention to the reasons for its exclusion, but for me the bigger issue is the value for investors like myself of the S&P 500 ESG Index. I prefer Tesla’s take on what ESG should be about.

I’m not a financial advisor but I’m very focused on ethical investment. I hope that my take on the controversy about Tesla’s exclusion from the S&P 500 ESG Index is of interest to you and your financial advisor as you consider the bigger picture of investing.