Commentary: Regulation Will Not Solve Our Energy Problems
Commentary by Dan Romito originally published by RealClearEnergy.org
There is a concerning precedent emerging within conventional American politics that mistakenly asserts a direct correlation between functional results and incremental regulation exists. Reality shows instead that regulation does not provide the strategic blueprint required to formulate long-term solutions and radical innovation. The U.S. Securities and Exchange Commission groundbreaking proposed climate change disclosure rule does not reflect that lesson and misses the mark.
If passed, the 512-page proposal would mandate public companies to disclose an audited set of greenhouse gas emissions data from their direct operations, energy use, and value chain (i.e., Scope 1, 2, and 3, respectively). This proposal focuses on accounting exercises rather than strategic action and represents a cost burden as opposed to a solution that would reduce global emissions to the benefit of society.
The current Environmental, Social, and Governance (ESG) investment climate is complex. There are over 6,500 unique data points within the ESG ecosystem. Much of the ESG data is uncorrelated, biased, and incredibly influential. Some of the most influential evaluation methodologies remain subjective, inconsistent, and opaque. Yet, we are seeing a “doubling down” on a system that prioritizes competitive uniqueness rather than actual empirical results.
As the global population accelerates to exceed ten billion people over the next forty years, we are going to need actual energy solutions that keep energy affordable and reliable while still preserving and protecting the environment. Developing countries, where most of the population growth will be found, will seek strategic partners to help solve problems impacting the quality of life. Mitigating child mortality, income disparity, political instability, and energy poverty are foundational tenets any society requires to establish a viable path towards prosperity. The technological prowess of the American economy, empowered by our private & public equity markets, is a formidable instrument these countries can and should utilize to build out such a foundation.
Unfortunately, our public equity markets are not as healthy as they need to be to provide the capital necessary to lift the developing world. There existed roughly 8,000 publicly traded companies in 2000. Today, there are only 4,000. Contrary to popular sentiment, most of our public companies are small. The average market capitalization for a Russell 3000 company is nearly 5,000 times smaller than Apple.
Overregulation is largely to blame. It has simply become cost-prohibitive for most publicly traded companies to operate, let alone flourish. This paradigm is especially applicable to the climate debate the SEC is attempting to address. It is foolish to believe that we are somehow going to solve the perceived climate crisis because the SEC is now going to require climate disclosures.
The unintended consequences of the proposed SEC climate change disclosure rule will compound the deteriorating health of our public equity markets. The proposed rule will likely act as a deterrent against companies going public thanks, in part, to a potential increased risk of frivolous lawsuits and the possible destabilization of the credibility of U.S. capital markets.
For the foreseeable future, fossil fuels will remain the only viable energy source for developing countries. If we empirically analyze production efficiency and environmental impact, then Norway, the United States, and the U.K. should run point on providing fossil fuels to developing countries. Academic studies tell us that over 25% of the green patents created in 2020 originated from the conventional energy and power space (relative to the renewables space accounting for ten percent) – indicating that improved energy sourcing is currently underway.
Highlighting emissions data, although helpful in some cases, is also not going to solve any functional or operational aspect of climate risk. Should an investor deem any data point material to valuation, the communication avenues to attain such information already exist. We do not need to impose another regulatory cost burden to get this information. If anything, we should rethink how we can expedite the technological capabilities public companies are already working on.
Our society struggles to materially resolve economic and societal complexities due to an unhealthy overreliance on regulation. Too often we see overly prescriptive regulations worsen outcomes. Given the immense importance U.S. public issuers play in terms of global modernization, job creation, and economic efficiency, the current SEC proposal provides little material upside.
The SEC must instead foster efficient solutions by outlining a reasonable set of performance-based guidelines for competing participants to operate within and encourage the energy innovation already taking place. By ensuring the long-term credibility of the U.S. capital markets, fostering innovative competition, and facilitating consistent access to quality capital the SEC can set forth a durable path toward solving climate change.
Dan Romito is a consulting partner at Pickering Energy Partners focusing on quantitative ESG strategy and implementation.