Just as many mission-driven fund managers have reconsidered their defense policy in the wake of Russia’s full-scale invasion of Ukraine, an analyst at Goldman Sachs says it is now time for sustainable investors to re-evaluate their approach to oil and gas companies.

It comes at a time when European energy majors have slashed renewable spending and doubled down on fossil fuels in an effort to boost near-term shareholder returns.

Investments focused on environmental, social and governance (ESG) factors tend to favor companies that score highly on certain criteria, such as climate change, human rights or corporate transparency.

Tobacco giants, fossil fuel companies and weapons makers have typically been among those to have been screened out or excluded from sustainable portfolios.

“In the same way that the sentiment on defense companies has changed with the Russia-Ukraine war, I think the sentiment on ownership of oil and gas should change,” Michele Della Vigna, head of EMEA natural resources research at Goldman Sachs, told CNBC by video call.

A persistent unwillingness to own energy majors is biased by a “major mistake” in evaluating the energy transition from the perspective of European investors, Della Vigna said — an approach that he expects to change.

Goldman’s Della Vigna outlined three reasons to back-up his view on why ESG investors should bring oil and gas stocks in from the cold.

“Let’s be clear, this energy transition will be much longer than expected. We are going to have, we think, peak oil demand in the mid-2030s [and] peak gas demand in the 2050s,” Della Vigna said.

“And we clearly show that we need greenfield oil and gas development well into the 2040s. So, if we need new oil and gas development, why wouldn’t we own these companies?”

The International Energy Agency, meanwhile, has said it expects fossil fuel demand to peak by the end of the decade. The energy watchdog has also repeatedly warned that no new oil and gas projects are needed to meet global energy demand while achieving net-zero emissions by 2050.

Della Vigna’s second point was that oil and gas companies represent some of the biggest investors in low-carbon energy worldwide, adding that a failure to both engage with, and finance oil and gas stocks would ultimately serve as a barrier to the energy transition.

In addition, Della Vigna said that unlike utilities, which he described as infrastructure builders, oil and gas companies are “market makers” and “risk-takers.”

“So, we need their capabilities, the balance sheet and the risk-taking. They are some of the largest investors in low carbon and whether we like it or not, we also need their core businesses of oil and gas,” Della Vigna said.

“Otherwise, we will not have affordable energy, especially for emerging markets, and we will have energy poverty, which I don’t think is acceptable in any ESG framework,” he continued.

“I think the energy companies that lead the energy transition should be a cornerstone of ESG funds — not a divestment target,” Della Vigna said.

“We can see the negative impacts of oil and gas. The current climate situation is not good. We see record-breaking temperatures, rising greenhouse gas emissions, oceans warming and sea level rise. I mean, why would we want to see more fossil fuels? Most ESG investors would not,” she added.

Scientists have repeatedly pushed for rapid reductions in greenhouse gas emissions to stop global average temperatures rising. These calls have continued through an alarming run of temperature records, with the planet registering its hottest year in human history in 2024.

Extreme temperatures are fueled by the climate crisis, the chief driver of which is the burning of fossil fuels.

Allen Good, a senior stock analyst covering the oil and gas industries at Morningstar, said it’s difficult to foresee a time where there will be a total acceptance of oil and gas in ESG.

He added, however, that a slightly more relaxed approach from investors is feasible on the basis that energy majors significantly increase the amount they invest in renewable and low-carbon technologies.

“I mean ESG, to me, it’s whole raison d’être is the energy transition [and] climate change. So, I would find it hard to believe that they would say they are going to start investing in oil and gas companies,” Good told CNBC by telephone.

“Now, I think what you could start to see is some loosening around the edges, whereby they come to some agreement where a company is investing X amount in renewable energy, or their earnings will be X amount in 10 years, then maybe a Total[Energies] gets into the portfolio. But someone like an Exxon or even a Chevron … I would find that hard to see how that gets in ESG,” he added.

Electricity grid demands are on the rise in part due to energy-hungry technology like AI, and while experts believe renewable energy alone is not enough, it is essential to a broader supply equation. But with funding freezes, subsidy walk backs and tariffs on key components all on the table, solar, wind, and hydrogen companies are working harder than ever to make their business models work, even if they never intended to rely on federal support for the long term.

“One of the hats I used to wear was planning for the City of New York. For the longest time, there was decreasing [energy] demand,” said Aseem Kapur, chief revenue officer of GM Energy, an arm of General Motors that the company introduced in 2022. “Over the course of the last five or so years, that equation has changed. Utilities are facing unprecedented demand.”

Beyond New York City, U.S. energy demand is poised to grow upwards of 16% in the next five years, a big difference from the 0.5%it grew each year on average from 2001 to 2024, according to the Center for Strategic & International Studies.

For the renewable energy companies looking to break into the mainstream, subsidies have helped them get through their early days of growth. But President Trump has targeted these solutions from the first day of his presidency. In an executive order from Jan. 20, the Trump administration promised to “unleash” an era of fossil fuels exploration and production while also eliminating “unfair subsidies and other ill-conceived government-imposed market distortions that favor EVs over other technologies.” Last week, Trump issued an EO pushing for more coal production.

In a six-year study breaking down energy subsidies from the U.S. Energy Information Administration from 2022 (the most recent edition), 46% of federal energy subsidies were associated with renewable energy, making them the largest slice of the energy pie. At the same time, natural gas and petroleum subsidies became a net cost to the government in 2022, reversing what had been a source of revenue inflows.

“Every company I’ve talked to recognizes that subsidies were required to help them through an R&D cycle, but they all believed they had to get to a cost parity point,” said Ross Meyercord, CEO of Propel Software (and former Salesforce CIO), whose manufacturing software solution serves energy clients like Invinity Energy Systems and Eos Energy Storage. “Every company had that baked into their business model. It may happen faster than they were planning on, and obviously that creates challenges.”

Meyercord believes that clean energy companies can handle either a subsidy decrease or a rise in tariffs, but both at the same time will add substantial stress to the market, which could have negative downstream effects on the grid — and the people who rely on it.

‘Not going to get rid of fossil fuels overnight’

Like any energy source, Kapur says success always comes down to economics. In the current environment, with interest rates, and fears that inflation will reignite, he said, “it’s going to come down to, ‘What are the most cost-effective solutions that can be brought to market?'” That may vary by region, he added, but notes that solar and energy storage have already reached parity in many cases and, in some instances, are below the cost of producing energy from natural gas or coal-powered resources.

This economics equation is true even in Texas, where the state’s Attorney General Ken Paxton has voiced anti-renewables sentiment in favor of the coal market (his lawsuit against major investment firm BlackRock and others in late November claims these firms sought to “weaponize their shares to pressure the coal companies to accommodate ‘green energy’ goals”). Wind accounts for 24% of the state’s energy profile, according to the Texas Comptroller, suggesting a penchant for any energy source that’s viable and cost-effective.

“The reality is, we’re not going to get rid of fossil fuels overnight,” said Whit Irvin Jr., CEO of hydrogen energy company Q Hydrogen. “They are going to have a very significant piece in our energy ecosystem for decades, and as new technologies come out on a larger scale, the use of fossil fuels will be curtailed, but we need to continue research, development and innovation in a way that makes sense.”

Irvin emphasizes the need for innovation from all sides, including creating new technologies that have a massive impact on large scalability and carbon reduction. “We don’t want to turn off that spigot. We just want to make sure that it’s going to the right places,” he said.

Hydrogen energy itself is one such source of innovation. Hydrogen ranges in sustainability depending on the fuel it uses to source its hydrogen. For example, green hydrogen — the only climate-neutral form of hydrogen energy — stems from renewable energy surplus. Grey hydrogen stems from natural gas methane. Q Hydrogen is working to open the world’s first renewable hydrogen power plant that will be economically viable without a subsidy. Irvin Jr. says the company, which produces hydrogen using water, plans to launch its New Hampshire facility this year.

“Hydrogen fuel cells are a really good way to provide backup power or even prime power to a data center that would be considered essentially off grid,” said Irvin, likening hydrogen fuel cell production to a form of battery storage. While hydrogen is not the most economical because of its comparative immaturity, Irvin said heightened energy demand will outcompete cost sensitivity for tech companies requiring more and more data storage.

While hydrogen projects continue to reap federal incentives to propel the industry forward, Irvin said subsidies were never part of his company’s business equation. “If they do exist, we’ll be able to take advantage of them,” he said. “If they don’t exist, that will still be fine for us.”

But that might not be true for every alternative energy company depending on where they’re at in the R&D cycle. Changes in federal incentives have real power to shift the progression of renewable energy in the U.S., especially when combined with tariffs that could stifle companies’ international relationships and supply chains. Meyercord, Kapur and Irvin all foresee private industry partnerships making a huge impact for the future of the grid, but recognize that the strain is increasing as energy tech of all kinds becomes smarter and more grid-dependent.