How Europe's Energy Woes Could Affect ESG

There are a couple of reasons for the near-term volatility. First, European natural gas inventory builds are behind schedule following last year’s long and cold winter. Second, Europe depends on Russia for more than 40 percent of its natural gas imports. And Gazprom has thus far only met its contractual obligations rather than selling more on the spot market.

The long-term problem is Europe’s renewable energy strategy. Wind and solar power are inherently less reliable than fossil fuels because of their variable output and the difficulty of storing that output. A shortfall in wind energy meant that utilities had to turn to natural gas to provide electricity, exacerbating the commodity’s already-sky high demand.

Of course, there are solutions to these problems. For example, nuclear power provides almost one quarter of Europe’s electricity in a reliable manner and without any emissions. When using wind or solar power, governments and private companies should use conservative rather than aggressive estimates to ensure they meet expectations.

Another solution is phasing out fossil fuels on a less aggressive schedule, although doing so comes at the risk of missing climate action targets. For instance, some experts suggest using natural gas as an intermediary step rather than moving from coal power to wind and solar power. That way, utilities have some wiggle room to address renewable energy challenges.

President Biden has emphasized climate change as a central component of his presidency. While renewable energy policies are necessary to reach emission targets, Europe’s rapid transition to solar and wind underscores the importance of planning. Indeed, the U.S. has seen its own spike in natural gas prices due in part to underinvestment in fossil fuels.

High energy prices could lead to a backlash against renewable energy on the part of consumers and investors. If there’s less interest in renewable projects, wind, solar, and other renewable energy, companies could see slower growth rates and margin pressure from fewer subsidies, creating a genuine risk for ESG-focused investors in these kinds of projects.

At the same time, the underinvestment in fossil fuels and the sudden spike in prices could encourage investors to abandon ESG-friendly renewable energy companies in favor of conventional energy companies. The outflow of capital from renewable energy companies could translate to a higher cost of capital and slow ESG momentum.

Despite these risks, the energy crisis could also open the door to new opportunities. For example, a revival of interest in nuclear power could reignite interest in the VanEck Uranium + Nuclear Energy ETF (NLR) and other nuclear investments. Meanwhile, demand for energy storage could help the Lithium & Battery Tech ETF (LIT) and similar themes.

Be sure to check our Portfolio Management Channel to learn more about different portfolio rebalancing strategies.

The global increase in fossil fuel prices could cause a backlash against renewable-focused companies and ESG investments. With the Vanguard ESG US Stocks ETF (ESGV) and other ESG investments near record highs, investors should keep these risks in mind when investing in renewable energy companies and other ESG-focused portfolios.

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