Munich Re and Newton’s 3rd Law

A big win for the divestment movement, a big loss for humanity

With energy now above 5% of the S&P 500 and having sharply outperformed all other sectors in 2022, we are unsurprisingly seeing a greater willingness by a broadening group of investors to take a fresh look at traditional energy companies. It was starting to look like we were past peak divestment. However, news that the German insurance company Munich Re will no longer underwrite new investments in oil and gas projects or midstream oil infrastructure is a troubling reminder that we are nowhere near on-track for a healthy energy evolution era to emerge from the messy energy transition quagmire the word is currently in. In fact, just the opposite: if Munich Re's decision spreads to other leading insurance or capital markets providers, there is much more energy, economic, and environmental pain still to come.

Munich Re on its own is replaceable in insurance (and reinsurance) markets. The issue is that unlike the very large universe of investors only a small portion of which are likely to choose divestment, the number of major capital markets and insurance companies is more concentrated. The leaders and boards of these companies are under intense pressure from climate only ideologues to end fossil fuel participation. Energy in all its forms is a high CAPEX industry; no aspect of the energy industry can survive without access to capital markets and insurance.

With traditional energy having badly underperformed over the previous decade, it's not a big leap for some of these leaders and boards to ask "why bother”? For many, traditional energy is no longer (or at least not currently) a major profit driver. I can appreciate that it's tempting for them to wonder: “Wouldn't it be easier to divest from fossil fuels and stop getting yelled at by the climate crowd”? With energy taken for granted by its 5 billion daily users (out of an 8 billion person addressable market), the loudest critics are winning to our collective detriment.

Newton's 3rd law of physics states that for every action, there is an equal and opposite reaction. Not sure the “equal” part holds in this case, but the growing pushback on the ESG movement from political leaders in right-leaning US states and a new trend of what might best be called "anti-woke ESG" funds has emerged. While there is an urgent need to push back on the virtue signaling aspect of ESG, as I have repeatedly stated, the substantive portion of ESG is needed but can be challenging to separate from the narrow-minded "climate only, anti- US/Canada/Europe fossil fuel, electrify-everything-but-only-with-intermittent-energies" ideology.

Moreover, anti-woke ESG is frankly targeting the small potatoes of investor voting; it is the major capital markets and insurance providers where risk is highest toward bad outcomes for energy supply, the economy, and environmental health. Ultimately, efforts to limit oil and gas supply is likely to be favorable for energy sector profitability in the short- and medium-term (lets call it the 2020s). Long-term, however, it is bad for economic health to the detriment of all of humanity including traditional oil and gas companies.

Munich Re exits the oil and gas business: A big f---ing deal

Most so-called "climate actions" have thus far been largely symbolic or of only modest relevance: ANWR (Alaska) opposition, university endowment fossil fuel divestments, Keystone XL (probably the most negatively impactful of this list), bans on plastic straws, ICE vehicles, and plastic bags, etc. Munich Re is a potential game changer, especially if it starts the exodus of large western capital markets and insurance companies from financing and underwriting crude oil and natural gas projects. This has long been a goal of the climate activist community. They come over the top in the form of direct pressure on the leaders and boards of financial services companies and from below via pressure on investors via the bad (i.e., virtue signaling) portion of the ESG movement.

From purely an execution standpoint, give credit where credit is due: climate activists have convinced Munich Re—Munich f---ing Re!—to exit the crude oil business entirely and investment in new natural gas fields but, somehow, not natural gas midstream (what do they think will flow through the midstream gas infrastructure?). Munich Re on its own is replaceable. The bigger question is whether this is the start of a trend. To simplify, all companies in just about all sectors depend on capital markets providers (e.g., JP Morgan, Goldman Sachs, Morgan Stanley), insurance and reinsurance companies (e.g., Munich Re, AIG, Zurich), and investors (e.g., institutional long only, pension funds, hedge funds, retail).

Given the very large number of investors and investment management firms, it is a pretty slow process to use the bad portion of ESG to try to influence behavior. This is not so when it comes to capital markets and the insurance industry which are dominated by too-big-to-fail behemoths. The European versions of these firms were already sliding down the slippery slope of succumbing to climate only ideology. Munich Re, a German firm ironically enough, is the first to announce its intention to exit the underwriting of new investments in oil and gas fields and oil infrastructure; it indicated it would stay involved in the midstream natural gas value chain. You can read Munich Re’s policy paper here.

Whose next? And when? Notably, Munch Re's announcement did not come at the trough of COVID when oil prices were low after a decade of poor energy sector results and when the less energy educated could convince themselves we could have a quick and painless energy transition. It's announcement came on October 6, well after Russia's invasion of Ukraine and as Germany is ramping its use of lignite coal for power generation.

To be sure, Munich Re is a private business entitled to make decisions it feels are in the best interests of its shareholders. But to effectively draw from the IEA's calamitous Net Zero 2050 report that declared there should be no new oil and gas investments in order to be aligned with Paris climate objective suggests climate only ideology was a key driver of the decision.

The divestment movement makes us all worse off

When major western academic institutions, and, now, more disturbingly, financial services companies go down the divest fossil fuels road, let us be clear on what they are divesting: it will overwhelmingly be US, Canadian, and European oil and gas projects or companies and related exposures. Let us also be clear on who will suffer most: the least fortunate among us in our home countries and around the world.

Are you a financial services company or an Ivy League (or equivalent) institution that has faced demands to divest from fossil fuels? Some questions regarding your divestment plans:

• Were you investing in Russia or Iran that might warrant such divestment initiatives?

• If no, is it mainly US, Canadian, or European oil and gas companies you were forced to divest?

• Are those companies major investors in oil and gas projects in troublesome regions such as Russian or Iran?

• If not, how is stopping oil and gas projects in the US, Canada, and Europe consistent with much needed social and environmental justice for the least fortunate?

• Should the poor burn cow dung for cooking or heat as they do in impoverished parts of India?

• Is burning fire wood or trash better for CO2 emissions when heating one's home?

• Can a Tesla Model Y or Ford F-150 Lightning be recharged on candle light?

• How does limiting oil and gas supply in the US, Canada, and Europe help energy transition when all it actually means is that we increase dependence on less friendly areas with worse labor and environmental oversight?

The divestment movement, as focused on US, Canadian, and European oil and gas companies, makes us all worse off by making energy less available, less affordable, less reliable, and less secure. As a result, it is worse for the environment and climate. It is the least fortunate that will suffer the most.

Anti-woke ESG: Missing the point and behind the curve

Pushing back on high-profile ESG advocates in the financial services sector may make for entertaining headlines and social media shares—and may very well prove to be a viable business strategy—but, in my view, doesn’t seriously address both the deficiencies with ESG or the opportunities to improve ESG to focus solely on the substantive issues that are needed. In the simplest terms, I cannot believe there is a single anti-woke ESG instigator that would argue for weaker corporate governance measures or that believes worker health and safety standards should be softened, as examples.

At the end of the day, anti-woke ESG falls for the trap that ESG itself is the issue. It isn’t. It’s “climate only” ideology that is the problem. The biggest bang for the buck is with the financial services companies and Munich Re’s recent news should be the shot heard around the world.

While I think anti-woke ESG is mis-placed, I do agree with the need to improve the application of ESG, which will be one of the pathways to a healthier energy evolution era. Some suggestions:

• Improve energy literacy: an easy start is to read the great Vaclav Smil, with my favorites being Numbers Don’t Lie, Energy and Civilization, and How The World Really Works;

• Recognize there is nothing sustainable or equitable about prematurely eliminating viable forms of energy that are affordable, reliable, and secure;

• Applying a one-size-fits-all climate approach to all companies in all sectors is absurd and leading to energy scarcity and economic and environmental harms;

• Stop trying to turn investors into policy makers.

With all that said, anti-woke ESG backlash is targeting the small, slow moving potatoes in the battle for a healthier energy evolution. It is the major capital markets and insurance providers that need support. Yes, the beauty of capitalism suggests that newer entrants can theoretically fill in if the big guys exit oil and gas. And an oil and gas world starved of capital and insurance will likely be better for oil and gas industry profitability (due to a lack of new supply), especially if smaller oil and gas entities are not able to survive. But over the longer-term (i.e., beyond the 2020s), artificially limiting oil and gas investment is bad for human prosperity, bad for the economy, bad for especially the least fortunate among us, and therefore bad for oil and gas companies.

---

⚡️On a personal note…

I have college-aged kids. Should I care if the institutions they attend are in the divestment camp? I am not sure. I like the experiences they are having and I don't know (and haven't checked) what the policies of their universities are beyond the normal generic commitments to sustainability and net zero objectives. While I am paying the tuition, my children can, will, and should develop their own views on what they believe in and support. As a parent, I think I am going to stick my head in the sand and not look too deeply as it is definitely better for them to continue where they are.

Perhaps the real question is should those of us that support a healthy evolution era divest from the divesters? I don't know. I think the answer is "no" and engagement, discussion, and debate is better. For example, I really enjoy interacting with many people in the environmental community even as most of them I will guess hold a different view on the divestment movement and the nature of this post.

I really don’t take issue with environmentalists or even the die-hard climate crowd for that matter. They are entitled to believe what they believe and aspects of their causes are relevant and worthy of their fight. If there is ire to dispense, it is with the ruling elite—in government, in policy circles, in academia, and increasingly in business. It is this latter group that is the focus of this post.

---

⚖️ Disclaimer

I certify that these are my personal, strongly held views at the time of this post. My views are my own and not attributable to any affiliation, past or present. This is not an investment newsletter and there is no financial advice explicitly or implicitly provided here. My views can and will change in the future as warranted by updated analyses and developments. Some of my comments are made in jest for entertainment purposes; I sincerely mean no offense to anyone that takes issue.

Regards,

Arjun