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Investing in Carbon Capture Strategies

Sustainable Finance November 13, 2020
Sustainable Finance November 13, 2020
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As momentum builds in the global effort to halt climate change, many countries are beginning transitions to a lower-carbon economy, driving institutional investors to look increasingly for resulting opportunities to put capital to work.

It’s no surprise, then, that the ESG pool and forward-thinking investors are seeing that they can both help the world reduce its carbon footprint, and generate a return for their clients through investment tools from carbon capture credits to carbon sequestration technology and other things in between.

While the transition will happen over decades, now’s the time to start thinking about ways to invest in the burgeoning carbon asset class.

The Case for Carbon Investing

The case for carbon investing is fairly simple: the amount of CO₂ the world produces must come down, and making that happen requires big investments in a number of areas.

Consider this: On April 7, in the midst of worldwide COVID-19 lockdowns, the global carbon dioxide emissions fell to levels that the world hasn’t seen since 2006, according to a study from Nature, with daily global CO₂ emissions decreasing by 17% in early April compared to 2019 levels. The report also said that emissions could fall by between 4% and 7% in 2020, depending on the level of restrictions put in place for the rest of the year.

While this is good news, it also reveals how much more still needs to be done to reduce emissions; even with the pandemic significantly disrupting individual behaviors, 80% of emissions were still being produced. The study’s estimated CO₂ reduction for 2020 is also still below the 7.6% annual reductions that the U.N. has said must happen if global average surface temperatures are to stay below 1.5°C

A material reduction in CO₂ can only happen if businesses continue to reduce their carbon footprint and if we find ways to accelerate taking carbon out of the air. That means there will need to be investment in new solutions that enable the reduction of carbon.

Creating Carbon Credits 

One avenue that is creating investment opportunities is in generating carbon credits and selling them to CO₂ emitting companies to help them offset their emissions. In understanding this space, investors must familiarize themselves with the two types of carbon market – regulated and voluntary.

Like trees, soil can also sequester carbon, which can then generate carbon credits.

In regulated environments, the government sets greenhouse gas emission targets for different industries or products. Companies that emit beyond those targets must pay taxes or penalties. The hope is that companies will find more efficient ways to produce their product, thereby reducing their emissions and the taxes they must pay. However, in these markets, it is often possible to offset emissions by buying carbon credits from someone who has either overachieved their targets or is engaged in a decarbonizing activity. Over time, regulations can become more stringent and penalties can rise, increasing demand for credits even as their pricing rises.

In the voluntary market, companies choose of their own accord to offset their carbon footprints. As more businesses commit to reducing their carbon footprints, demand for credits will climb, pushing the cost of those credits higher (or incentivizing new supply). Pricing in the market is subject to greater risk: as an example, the pandemic reduced the need for airlines to buy credits, for instance, which hurt demand. Over time - with the increasing focus on environmental footprints - it’s expected that demand will outstrip supply, but today most projects that create credits do so as part of their revenue model, rather than the sole driver being due to current pricing.

The challenge, then, is how to create models that generate credits today, even when the price may not be sufficient to create a business model on its own. One option is to find ways to ‘unlock’ credits through a change in behaviour in an existing business, finding operational changes that reduce or store carbon and produce enough value in credits to more than pay for themselves. An example of this would be working with owners of lands to reforest or implement advanced forestry techniques in existing forests that increase the long-term storage of carbon dioxide.

Like trees, soil can also sequester carbon, which can then generate carbon credits. Regenerative agriculture, which involves using innovative technologies to rehabilitate farmland and make soil stronger and healthier, also makes it better for pulling carbon out of the air. Implementing regenerative practices can lead to significant sequestering of carbon, creating an opportunity to generate credits as an additional revenue stream.

There are other options, too, like ensuring wetlands are preserved, but the goal is the same: to take carbon out of the air in return for carbon credits.

According to a report from Vivid Economics, the carbon removal industry could be worth $1.4 trillion annually by 2050, compared to $1.5 trillion for the oil and gas industry today. That means that more money is set to flow into natural carbon-removing processes, which could result in new carbon capture opportunities and technologies. One such innovation is enhanced rock weathering, in which certain types of rocks are ground up and spread across a large area, speeding up the planet’s natural rate of carbon absorption.

Carbon Sequestration and Utilization

One way in which companies are capitalizing on carbon at scale is through carbon sequestration, which involves pulling carbon out of the air, or taking it from a carbon-producing company, and storing it somewhere, such as underneath the ground. Just as storage companies make money from keeping goods locked up in a warehouse, carbon sequestration operations generate revenue by storing carbon for someone else. In some jurisdictions, there are additional incentives for this activity that can create revenue streams beyond carbon credit generation.

An extension of this idea is to not only store carbon, but use the CO₂ to create other products. For instance, it’s possible to turn carbon into alcohol or other chemicals that can be used for industrial processes. This approach allows the business to make money through the storage of carbon and the sale of chemicals, essentially converting a waste product into value. This multi-revenue approach creates a bridge where pure sequestration may not yet be economical based on current carbon pricing. In the energy sector, one example of this is EOR+ which takes enhanced oil recovery (EOR) and combines it with monetizing carbon sequestration. In EOR+ carbon is taken out of the air or removed directly from carbon-emitting companies and transferred to an oil well. That carbon is then thrust into the ground, which pushes the oil up. The carbon is stored underground in the pockets of rock where the oil used to be, essentially, forever, while the oil is produced with a much lower carbon footprint. This reduces the carbon intensity of the extracted oil significantly and, when including the carbon sequestered, it’s possible to achieve net-negative oil – oil that sequesters more carbon than is emitted in its extraction and consumption.

As the carbon-related investment landscape continues to grow, new opportunities will present themselves.

In some regulated markets, there’s an opportunity to create funds that hold credits, which would create near term scarcity and incentivize the faster transition to carbon. At the same time, investors would own an appreciating asset. Financing arrangements can generate credits by providing the upfront investment required to implement new forestry or farming practices. There are also many promising carbon startups attracting private investment that could, one day, find their ways into the public markets via IPO or special purpose acquisition vehicles (SPAC), an area where there has been a notable increase in the number of vehicles mentioning decarbonization or GHG mitigation as targets.

The bottom line is that the carbon market is quickly becoming an area investors should be thinking about carefully. With a global need to reduce emissions and an evolving policy landscape, the potential exists for companies that create the solutions to carbon problems to be rewarded handsomely for doing so.

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Jonathan Hackett Co-Head, BMO Energy Transition and Head, Sustainable Finance

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