OPINION - Should You be Positioning for Decarbonization? Part 2

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By Anthony Milewski, Chairman of Nickel 28 Capital

Click here to read part one of the series.

Investing in carbon credits

In the last few years, the carbon credits industry has become big business, and over the next few years we will be approaching critical mass as the industry reaches into just about every human endeavor.

The compliance carbon credit markets have already reached US$261 billion in transactions — leaping upwards from US$170 billion in 2018. The voluntary markets have more than doubled their 2017 value of US$146 million to hit US$320 million. All of this is just the tip of the proverbial iceberg.

If these rapid trajectories come as a surprise to you, it’s because the carbon credit markets have been growing under the radar, with most of the trading carried out by a small number of big banks and funds. With more investors starting to take notice, a big question looms: Considering the market is still in the process of maturing and opening up to the broader investment community, how can you actually position yourself?

Getting in on the action

For investors, there are a few different ways to play the carbon markets, but even though the carbon markets are massive, it’s not so easy.

Let’s look at compliance or regulated credits first. These are the markets in California and Europe and certain parts of Canada and other regions, and they require you to be set up with a large bank. You’ll need to have a private client account, and you’ll probably need to be a pretty wealthy investor for them to allow you to access those credits.

If you’re a hedge fund, your broker can provide access to compliance market credits. By way of an anecdote, on any given day Morgan Stanley (NYSE:MS) trades billions of dollars worth of European carbon credits. That’s just one bank on one day out of all the different spectrums of credits. It gives you a sense of the depth and liquidity of those markets.

There have been some attempts at exchange-traded funds (ETFs), but so far the regulated market is accessible at this time only to wealthy individuals, and more specifically to fund managers and corporations that are set up with large banks. That’s not to say an individual retail investor can’t invest, but you’re going to need to jump through a lot of hoops.

The voluntary markets are also not particularly easy to access, but there are signs that is about to change. As things currently stand, if you want to trade voluntary carbon credits then it’s certainly possible, but you have to put in a lot of leg work.

The DIY approach

So what does that leg work entail? To start with, there’s a short but steep learning curve in terms of carbon credit market education: You are going to need a solid understanding of the factors that impact credit-generating assets and how they help to determine current and future value. Those factors include things like asset type, location and vintage. Even more importantly, you need to be fully up to speed on the issue of standards.

It’s this last factor that I want to touch on. Voluntary credits have to be registered with an industry body like Verra or Gold Standard. Ultimately, the value of the credit is created through the registration process because it imparts the all-important scientific backing and credibility. There are a number of competing standards out there, and they vary in the value that they can deliver. It’s worth noting that there’s almost no value in credits that do not go through this verification and registration process.

If you’re an individual investor, you will need to go through the process of opening up an account with one or more of the industry standard organizations so you can view their registered credits. However, you are also going to need an intermediary or someone to help you source those credits directly from the organization generating them. And so, once again, while it’s viable, it’s a little bit prohibitive in terms of the time and effort required.

Notwithstanding the time commitment, the price of these credits has gone up massively, with the regular market trading near or at all-time highs; in the voluntary market, we’ve seen some of the credits double and triple in value in the last six months.

A simpler path to direct exposure?

An alternative to investing significant amounts of your own time in order to buy and sell credits yourself is to invest in some of the startups that are out there.

The market is so dynamic at this time that it’s impossible to say just how many new players will appear over the next year or two. The likely source of entrants will come primarily in the form of ETFs.

One such ETF is the KraneShares Global Carbon ETF (ARCA:KRBN); others such as the Carbon Avoidance ETF and various environmental, social and governance (ESG) ETFs are in various stages of being launched.

Many of the companies that may go public through a special purpose acquisition company or reverse takeover are currently being acquired and/or invested in by large US private equity firms and international corporations, having the net effect of keeping viable options limited for equity investors at this time.

Most of these players are, understandably, keeping their cards close to their chest right now, but one potential early entrant onto the publicly listed scene is Carbon Streaming. The company has an interesting approach that utilizes a financing strategy ubiquitous inside of the mining, oil and gas space. It has announced some big investments in carbon offset projects, and although at time of writing the company was private, it has made clear its intention to list this quarter.

Indirect exposure

When most people think of carbon offset projects nature-based solutions tend to come to mind, such as reforestation, protecting old-growth forests or marine ecosystems, or else clean energy like hydro, wind, solar and nuclear. However, there are a lot of other companies out there that are working hard to become part of the solution to climate change. I’m talking specifically about carbon capture technology.

Now, at this point a lot of that technology is either uneconomic without subsidies or it’s very early stage. And so, by and large you’re looking at venture-style investments, likely into a private vehicle. But there are some other tangential routes you can take. You have BlackRock (NYSE:BLK) and other funds buying companies that are pursuing clear, achievable carbon-neutral strategies. Potentially by buying into an ETF or one of these funds that focuses on ESG, you also capture some play on carbon credits.

Watch very closely

The industry is young and it’s moving fast. A few years from now, as we get closer to a single set of global standards, it will become much easier for retail investors to take part. However, as with all early stage markets, some of the greatest upside is to be gained by investing early. Watch for changes and in particular for new players stepping forward in the coming months. The barriers to getting positioned are going to fall fast.

Mr. Anthony Milewski has spent his career in various aspects of the mining industry, including as a company director, advisor, founder and investor. In particular, he has been active in the commodities related to decarbonization and the energy transition, including nickel, cobalt, copper and carbon credits. Anthony has served on the London Metals Exchange Cobalt Committee, which includes representatives from the largest mining and commodities companies globally, to represent the interests of the industry to the board of directors the LME.

Read more from Anthony Milewski:

OPINION — Cobalt’s 3 Month Price Hike a Sign of Things to Come?

OPINION — Should You be Positioning for Decarbonization? Part 1