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ESG Analysis: Knowing the Risks Offers Rewards for Investors
By Tyler Collins

The recent $18 billion ruling against Chevron is one of the largest court judgments for environmental damage in history. This recognition of massive environmental liabilities underscores the need for deep analysis of environmental, social, and governance (ESG) factors in investment decision-making.

Texaco, which was acquired by Chevron in 2001, operated oil extraction facilities in the northern region of the Ecuadorian Amazon. A group of local Ecuadorian citizens filed a class-action lawsuit against Texaco in the U.S., alleging the company had intentionally used substandard environmental practices that led to massive soil and water contamination. The case was eventually transferred to Ecuador and re-filed against Chevron in 2003.

A more recent example: After BP’s Deepwater Horizon catastrophe, the company’s share value dropped 54% in the first half of 2010, with BP’s market capitalization falling $105 billion from April to June of the same year.

The magnitude of capital markets’ response to “ESG events” has increased significantly over the past decade. According to research by MSCI, an ESG event five years ago saw a -4% share price change within eight weeks, with a volume spike of 44% from pre-event levels. However, within the last five years, we have seen -33% share depreciation on average and a 450% jump in volume from pre-event levels. In other words, negative ESG events have demonstrable negative effects on stock prices.

The United Nations estimates that the world’s largest 3,000 companies produce $2.2 trillion in environmental damage each year. If these companies were held accountable for these externalized costs, nearly one-third of their profits would be lost.

“If you look to the first decade of the century, it’s clear… that traditional financial analysis does not anticipate the full spectrum of risks…” said Chris McKnett, the Vice President and Head of ESG at State Street Global Advisors at a recent round table debate.

As ESG events evoke a greater response from capital markets, and jurisdictions begin to force corporations to internalize environmental costs, ESG integration is becoming increasingly valuable to the investment process of long-term investors.

Analysis of Aguinda v. ChevronTexaco.

MSCI Report: Integrating ESG Into the Investment Process

Mention of specific companies or securities should not be considered a recommendation to buy or sell that security.  Past performance is never a guarantee of future results.

Posted: December 12, 2012