Category: Sustainable Finance Lab Post

Buyer Beware with Startup Carbon Offset Offerings

Buyer Beware with Startup Carbon Offset Offerings

 

 

 

 

 

 

 

Sources: Company Websites

Key Points: Startup firms in the carbon offset space are issuing their own credits and providing marketplaces for them. Using blockchain technology, they offer the promise of transparency, and are addressing opportunities for large scale carbon emissions avoidance. But buyers must pay attention to wide variability in methodologies and inconsistent information.

Last week, carbon trading platform CarbonKerma launched a blockchain-based marketplace for carbon offset credits it is generating from Carbon Capture and Storage (CCS). A similar model is appearing for other offset types; for example, there have been at least three blockchain-based initiatives launched in the last year targeting the shutting in of oil and gas wells (CarbonPath, ZeroSix and Onyx Transition).

Blockchain promises transparency and immutability, which can help address integrity concerns (such as the “double selling” of credits). It has become firmly rooted in the carbon market, with use in leading exchanges, namely ACX (formerly AirCarbon Exchange). And it has been embraced by global development institutions, including working to build bridges and interoperability across different (countries’) blockchain-based marketplaces.

What blockchain also appears to be fostering, however, are initiatives in which one company assumes multiple roles in what is traditionally a more fragmented chain in the voluntary carbon market (VCM). In other words, some of these startups, using blockchain, are assuming the role of offset project developer, standard setter/registry, issuer, and marketplace.

This consolidation of roles isn’t inherently bad or dangerous from a product quality (i.e. offset integrity) perspective. But the startups, with their respective methodologies, do make things more complicated if nothing else, as they are bringing divergent approaches.

An environment with a small number of established standard setters (firms such as Verra, American Carbon Registry (ACR) and Climate Action Reserve (CAR) are over 15 years old), brings a consistency and discipline to the standards-setting process. These firms implement and publish protocols and methodologies developed to establish the integrity of any carbon offset issuances. And, perhaps counter to public perception of low offset integrity and accusations that these entities suffer from conflicts of interest, they proceed with considerable care to oversee individual project applications. This measured approach has led to frustration on the part of would-be developers, who see the established registries as being overly conservative (slow) in accepting new sources of offsets as well as delays in processing individual applications.

The startups, on the other hand, are manifesting a wide range in their approaches and disclosure of their procedures. This can easily create confusion. To illustrate in the oil well plugging space, ACR’s recently issued methodology applies only to orphaned wells and only credits for avoided Scope 1, i.e. methane, emissions; CarbonPath and ZeroSix have methodologies that address producing (owned) wells and issue credits for leaving oil in the ground, i.e. Scope 3 avoidance.

But even these two have divergent methodologies. CarbonPath credits only ½ of its calculated avoided Scope 3 emissions, reserving the other half to address leakage concerns (that there will be another well drilled to offset the lost production from shutting down the target well); ZeroSix takes no such discount (it offers a different take on the economic theory behind price elasticity and argues that it is “very conservative” in its crediting).

As for disclosure, the three have their methodologies available on their websites. But CarbonKerma, has not disclosed its methodology, claiming that it is proprietary.

In a market that is unregulated, it falls on buyers to decide what standards are adequate (and there is an ecosystem of ratings agencies and others offering input). And the startups are to be lauded for bringing fresh resources and opportunities to the offset crediting space, particularly for industrial activities that hold great promise for decarbonization.

But if one thing has been made clear by the controversies in the VCM over the last year, the details of what lies behind offset crediting — in terms of determining baseline, additionality and leakage, as well as the rigor applied to measuring the impact — are anything but simple. One carbon offset often simply doesn’t look much like another (although the industry desperately needs credible categories of credits to simplify matters). And with the “jury still out” in terms of much of society’s comfort with offsets, primed in part by press coverage that appears openly hostile to them, issuers and corporate buyers would be wise to carefully consider the specifics from these startup sources.

June 26, 2023

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Continued Growth in Companies Using Internal Carbon Pricing in 2022

Continued Growth in Companies Using Internal Carbon Pricing in 2022

Exhibit: Companies Using or Planning to Implement an Internal Carbon Price, 2015-2022

 

 

 

 

 

 

 

 

 

 

 

Source: CDP and World Bank Group

Key Points: The number of companies using Internal Carbon Pricing (ICP) rose again in 2022 (to 1,200 of 8,400 surveyed). Most ICPs are too low to reflect accepted views of the societal cost of carbon, but having the mechanism is an important step — it drives developing the ability to assess carbon footprints and it can drive significant behavioral change.

An incremental 12% of companies surveyed using an internal carbon price in 2022. The World Bank Group, in its latest annual State and Trends of Carbon Pricing report, released in late May, includes information about companies’ Internal Carbon Pricing (ICP) policies and intentions in 2022. The World Bank gets this ICP information from an annual survey conducted by CDP (formerly the Carbon Disclosure Project). (The CDP’s last report on its survey was published in 2021 and assessed its 2020 survey results.) Of the 8,402 companies responding to CDP’s latest survey, 1,203 have ICP, up 12% from the year ago survey and up 40% from 2020. Further, another ~1,500 companies responded that they intend to implement ICP within the next two years. See Exhibit. Based on CDP’s earlier surveys, ~1/2 of the world’s 500 largest companies (by market capitalization) are putting a price on carbon.

Companies seeking to use ICP to change behavior and drive low carbon investment. The survey respondents indicated that the primary reason for having ICP is to spur low carbon investment and energy efficiency measures. A smaller number of respondents indicated that it was to help them navigate regulations at a business-unit level; approximately ½ of the companies with ICP are already subject to either a carbon tax or ETS and another 15% expect to be so within the next three years. In its earlier report, CDP cites that its data finds correlation between a company having ICP and “taking other strategic actions to integrate climate change issues into their business strategy.”

The ICP companies are using tends to be low, however. Although average or median ICP were not provided with this year’s results, in prior years’ reports, CDP has indicated the median ICP reported was $25-30/ton of CO2-equivalent. With that said, the reported ICP range is wide, with ~16% of reporting companies using an ICP below $10/ton (and some ICPs are pennies/ton) and ~10% reporting over $100/ton. As the World Bank report notes in its State and Trends report, it has been recommended that a carbon price of at least $40/ton be used to encourage behavior more consistent with limiting global warming to below 2º Celsius. This allows for the concern that the pricing isn’t motivating adequate behavioral change, although having an IPC at all brings an important awareness to companies’ investment and operating decisions.

The financial services sector leads in the number of companies with ICP; power and fossil fuel companies lead in the proportion of their sector having ICP. The World Bank report notes that the services industry leads sector groups with ICP in place, with >1/4 of total companies (i.e., >300 services companies surveyed have ICP), followed by the manufacturing sector and then materials. Within the services industry, the report notes the financial services is particularly well represented. This is consistent with anecdotal information, for example, of asset managers using carbon pricing as part of assessing risk of various portfolios.

As a proportion of the number of survey respondents within a given sector that have an ICP, the power and fossil fuel sectors have historically led. In the CDP’s last published results from its 2020 survey, for example, 71% of companies in the power sector had ICP, followed by 67% of companies in the fossil fuel sector and 52% of respondents in the financial services sector.

June 8, 2023

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Zimbabwe’s Attack on Carbon Offsets 6/6/2023

Zimbabwe’s attack on carbon offsets

Payne Institute Program Manager Brad Handler and Director Morgan Bazilian write about how Zimbabwe’s announcement that it is canceling all carbon offset contracts in its borders and demanding a larger government share of any new ones is wearily familiar to those who have experience with resource nationalization.  But tearing up contracts can only set a bad precedent for developing economies seeking to attract investment that might benefit their communities.  June 6, 2023.

Ensuring Sustainable Supply of Critical Minerals for a Clean, Just and Inclusive Energy Transition 5/22/2023

Ensuring Sustainable Supply of Critical Minerals for a Clean, Just and Inclusive Energy Transition

Payne Institute Director Morgan Bazilian and other researchers write about how the global clean energy transition involves large-scale deployment of a suite of renewable energy, energy storage and other new technologies. These are highly mineral-intensive and accelerated adoption of such technologies will significantly increase the demand for critical minerals (CMs). Challenges to sustainable supply of CMs include inadequate investment in mining, increased and more volatile prices, higher supply risks, negative environmental and social impacts, concerns about corruption, misuse of public finances, and weak governance. May 22, 2023.

CDR Portfolio Option Introduced

CDR Portfolio Option Introduced​

Exhibit: The NextGen CDR “Ecosystem”

 

 

 

 

 

 

 

 

 

 

 

Source: Mitsui O.S.K. Lines

Key Points: NextGen CDR hopes to progress CO2 removals at scale by offering (1) vetting, oversight and portfolio construction services to buyers and (2) advanced market purchases, i.e., revenue visibility, to sellers. NextGen launched in late April with five buyers committing to ~200K tons; it is targeting selling 1MM tons by 2030 at an average price of $200/ton.

NextGen CDR Facility introduced. Sponsors South Pole and Mitsubishi have launched the NextGen CDR Facility. The facility is designed to pool multiple large-scale sources of technology-based Carbon Dioxide removal (CDR). NextGen is facilitating the purchase and sale of CDR credits, ensuring compliance with industry best practice for credit issuance and CDR performance. Its ambitions are to contract for 1 Million (MM) tons worth of offsets at an average price of $200/ton by 2030.

Three initial sources of credits. See Exhibit. Although other technologies are expected to be added to the available portfolio, the initial sellers of CDR credits into the facility are:

  • 1PointFive’s Direct Air Capture facility under construction in Texas. The facility targets removing 500 thousand (K) tons per year and is expected to be operational in 2025.
  • Summit Carbon Solutions’ biomass carbon removal and storage project in the U.S. upper Midwest. The project envisions partnering with 30 ethanol plants across five midwestern states to capture CO2 emitted during the fermentation process and send it to a sequestration site in North Dakota via pipeline. The project targets 9MM tons per year. Sales to NextGen from this project may reach $30 Million.
  • Carbo Culture’s biochar project in Finland. The company targets storing 2.5MM tons by 2030. Carbo Culture had previously signed advanced market purchase agreements with Zendesk and Rothschild & Co. Construction of its first commercial facility is underway; the company envisions several operating facilities by 2026.

Five founding buyers committed to buy 193K tons starting in 2025. Mitsui O.S.K. Lines, BCG, LGT, Swiss Re and UBS have committed to buy CDR credits as the sources scale up operations.

Creating a technology portfolio for buyers. NextGen is seeking to provide large CDR buyers an option to buy a portfolio, enabling them to invest in several technologies with less effort than having to source, perform due diligence, and contract each on their own. Buyers may be attracted to the portfolio as a way to help sponsor several technologies or to hedge against the risk that a particular technology does not pan out as envisioned. Buyers also get the benefit of yet another source of vetting for project integrity — NextGen is sourcing its credits that have been vouched for by the International Carbon Reduction and Offset Alliance (ICROA, an integrity body) but will also continue to provide independent monitoring services.

NextGen is funding technologies just as they are scaling up; April also saw earlier stage CDR funding support. NextGen is slotting into the development lifecycle as technologies are scaling/commercializing. This stands in contrast to, for example, Frontier Climate, which is supporting a wide(r) array of CDR technologies earlier in their development, although also through advanced market commitments (Frontier has accordingly assumed thought leadership responsibilities regarding valuing technology uncertainty). Also in April, Frontier received commitments for $100MM from another four buyers, bringing its total advanced market commitments to over $1 Billion.

May 3, 2023

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Insight Into the Higher Cost of Capital in Emerging Economies

Insight Into the Higher Cost of Capital in Emerging Economies

Exhibit: WACCs in Select East Asian Countries, Onshore Wind and Utility Scale Solar

 

 

 

 

 

 

 

 

 

 

Source: Imperial College and IEA, Payne Institute

Key Points: A recent IEA/Imperial College report compares financing costs of renewable energy (RE) across the ASEAN. The differences stem from perceived country/currency risk, electric power policy, (contractual) relationship with the utility/buyer and “depth” of financing options. The report is part of a broader initiative to lower obstacles to RE development.

A strikingly large range in cost of capital (i.e., cost of financing) across countries. The authors derived Weighted Average Cost of Capital (WACC, see below for more detail) ranges for each country by renewable energy (RE) technology. The WACCs range from approximately 6.5-8% for utility-scale solar projects in Malaysia to approximately 10-13.5% for utility-scale solar in Vietnam. See Exhibit. The high WACCs create a significant, although not the only, obstacle to RE deployment at scale in those countries.

The WACCs for all the countries studied include some risk premium vis-à-vis developed economies. This is reflected, for example, in currency exchange risk vs. the US Dollar; the report suggests this adds ~1-3 percentage points, with Malaysia at the low end and Vietnam and Indonesia at the high end.

Challenges in Vietnam and Indonesia. The higher WACC in Vietnam and Indonesia reflects, per the interviewees, greater perceived business and financing risks from:

  • integration challenges (of tying in newly constructed electricity generation into the grid)
  • power curtailment risk (by the state-owned utility that is to buy the power)
  • contractual risk (with the state-owned utility)
  • underdeveloped banking systems (tends to result in higher interest rates; this may be due in part to a more limited track record, at least in Indonesia)

Report Background. The International Energy Agency (IEA) and the Imperial College London recently published a joint report on the financing costs and challenges of developing new RE sources in the ASEAN region (the Association of Southeastern Asian member states). It offers interviewees’ assessments of the WACC and issues/challenges for different RE projects. The report gathered cost of capital data from representatives in these countries via interviews with private and public investors and industry sources.

The report is part of a larger effort to increase transparency of the components of the cost of capital for RE in emerging economies; that effort is a World Economic Forum/IEA initiative called the Cost of Capital Observatory, of which the Payne Institute’s Sustainable Finance Lab is a working group member. It is hoped that greater transparency can help spur development of concessional support and policy changes to lower perceived risks and thus lower the cost of financing.

The Cost of Capital Observatory’s efforts have included a survey of (different) professionals conducted in the Summer of 2022. A follow up survey is to be released in May. Some of the original survey data was integrated into the IEA/Imperial report’s cost of capital estimates (our thoughts on the original survey results are here).

 WACC defined. The WACC of a project is determined by its cost of debt and its cost of equity (otherwise known as the expected return on an equity investment), weighted based on how much each (debt and equity) comprises of the total financing. To illustrate, if a project is financed with 70% debt that has a 7% interest rate and 30% equity with a 12% expected return, the WACC would be (.7*.07)+(.3*.12) = 8.5%. The cost of equity is estimated by adding a risk-based estimate of the returns to that of a risk-free rate of return. The WACC is lowered by having lower costs of debt and equity — and these are lowered when investors perceive lower risks in the project — and/or, generally, with more of the financing coming from debt vs. equity.

4/26/2023

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Voluntary carbon markets’ growth challenges 3/31/2023

Voluntary carbon markets’ growth challenges

Payne Institute Sustainable Finance Lab Program Manager Brad Handler writes about how the 20th anniversary of the US’ biggest carbon conference, North America Carbon World, was held last week and conference participants voiced concerns over public perception and difficulties integrating carbon instruments into broad investment portfolios.  March 31, 2023. 

Credit Suisse Demise Opens Another Hole in Climate Financing

Credit Suisse Demise Opens Another Hole in Climate Financing

Exhibit: Blue Bonds Principles

 

 

 

 

 

 

 

 

 

 

 

 

Source: The Nature Conservancy

Key Points: Climate finance is more vulnerable than other sectors to a banking crisis because fewer banks engage with emerging companies/newer financial products. We discussed SVB in a separate article; here we note Bloomberg reporting of a Credit Suisse niche in “nature” bonds — blended finance vehicles that lower debt costs in exchange for nature action.

SVB’s bankruptcy looks set to slow startups’ development. Silicon Valley Bank’s (SVB) outsized role in providing banking services (including specifically venture-related loans) to startups included a dominant presence in some segments of “climate tech,” new technologies directed at producing carbon-free energy or in some form of decarbonization. The bank’s demise thus threatens to slow climate tech companies’ commercialization and growth, which, in turn, suggests a slower pace of energy transition (although calibrating how much of a delay or impact might be impossible). A silver lining, as we discussed in in an opinion piece in The Hill, it is that one would hope for a diffusion (of people in the climate venture capital ecosystem and of knowledge of emerging technologies) to many banks that can lead to much more financial support over time.

Credit Suisse’s fall may slow novel environmental bond issuance. In what admittedly is a smaller example than SVB, the investment bank played a key role as a facilitator in issuing some novel nature-protection related bonds. The largest category of these is “Blue bonds” (see description below). Per Bloomberg, Credit Suisse was the sole arranger of the largest blue bond issued to date, $364 Million (MM) to Belize in 2021, and of a $150MM issuance to Barbados last year. Blue bonds appeared poised to grow, with Bloomberg reporting that Gabon ($700MM), Ecuador ($800MM) and Sri Lanka ($1 Billion) all working towards issuance.

Credit Suisse was also the sole structurer and joint book runner on the World Bank’s $150MM “Rhino bond,” designed to fund the protection of black rhinos in South Africa.

Blue bonds offer a chance for a country to lower its debt burden in exchange for protecting ocean areas. A relatively new product, blue bonds are loans with two purposes: 1) to refinance a country’s outstanding debt and therefore offer some relief and 2) to allocate some of the newly borrowed funds to a program to preserve and protect ocean areas (see Exhibit). Blue bonds are thus an extension of debt-for-nature swaps first conceived in the 1980s.

Blue bonds have been orchestrated and managed by The Nature Conservancy (TNC). Grant funding (sourced in part from TNC as one of the recipients of The Audacious Project) helps initiate projects. Loan insurance provided by the U.S. International Development Finance Corporation (i.e. public support) helps private investors accept lower returns and so the new loan carries a lower interest rate. Also, for at least the Belize debt, the proceeds were used in part to buy back existing bonds that were trading a steep discount, thereby lowering the country’s outstanding loan balance.

3/22/2023

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VCM Pricing Stronger Than Standardized Contracts Suggest

VCM Pricing Stronger Than Standardized Contracts Suggest 

Exhibit: Standardized Contract (the lines) and Individual Trade (the circles) Price History, $/Ton CO2e, 2021-2022

 

 

 

 

 

 

 

 

 

 

 

 

 

Source: Xpansiv

Key Points: Well-publicized integrity concerns have weighed on the VCM, including on offset credit pricing. But the dramatic decline in pricing of standardized contracts, which are more easily tracked than project-specific trades, is somewhat misleading. Corporates continue to pay up for specific offsets, particularly from projects sanctioned since 2019.

Standardized contract trades double in 2022 to 28% of Xpansiv’s volume. In a report issued in the beginning of March by Voluntary Carbon Market (VCM) trading leader Xpansiv, trades of standardized contracts (SCs) on its CBL exchange doubled in 2022 to 32 Million tons of CO2-equivalent (CO2e); the proportion of SCs of CBL’s trades slightly more than doubled to 28%. For reference, CBL’s total volume declined 5% year-over-year in 2022, to 116 Million tons CO2e. See below for more discussion about SCs.

As has been noted previously, ongoing integrity concerns weighed on the market through the course of 2022 relative to 2H2021, in various ways. Pricing slid through the course of the year, as represented in the trajectory of SC pricing (see solid lines in the Exhibit).

Standardized contract pricing has become the floor for the trades in their project type; buyers paying a premium for specific project offsets. Despite the share growth of the SCs noted above, the ongoing integrity concerns in the market have made many companies less willing to give up individual project scrutiny. Thus a large majority of companies are not buying SCs and rather are buying project-specific offsets after due diligence is performed on the specific project and its attributes.

Xpansiv avers that SCs have emerged as important reference points for these project-specific trades and that the SCs have become the baseline, or the floor, in their respective categories. From that floor, individual project attributes, such as vintage or co-benefits, drive a price premium to their “reference” SC.

This can be seen in the Exhibit. Each circle denotes a trade; its color reflects that it would qualify as one of the SCs (GEO, N-GEO, C-GEO) — but the seller elected to sell it as a specific project vs. putting it into the standardized pool.

The largest discrepancies in prices vs. the SCs are of the N-GEO-type projects (in green), which are derived from nature-based activities. As can be seen in the Exhibit, trades of nature-based project contracts by year-end 2022 were as high as $15/ton CO2e whereas the N-GEO SC had sunk to $2.00-2.50/ton.

In particular, buyers paying more for newer vintages of carbon credits. The Xpansiv report notes that credits issued from N-GEO-qualifying projects in 2019-2021 all carried premia of $12+/ton to the SC in 4Q22, while N-GEO credits issued in 2016-2017 traded below a $4/ton premium. In other words, the vintage of the project was the distinguishing attribute for credits as a later vintage is associated with more stringent rules and thus higher quality.

Background on the Standardized Contract. The SC was introduced in the VCM in 2020. Its intent was to simplify the purchase for corporate buyers — by obviating the need for project due diligence — and to foster the development of a futures market and thus allow buyers to lock in a cost for their offsetting commitments.

Exchanges have added various SCs to “fine tune” their offering. Xpansiv’s CBL, which is thought to be the carbon industry’s largest exchange, is among them. In addition to its original Global Emissions Offset (GEO), CBL now offers three SCs for carbon offsets (one, the SD-GEO, is not shown in the Exhibit).

More information on SCs is available in the Payne Sustainable Finance Lab VCM Primer.

3/14/2023

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The Recent Reshaping of Renewable Energy Investment

The Recent Reshaping of Renewable Energy Investment

 

Exhibit: % of Renewable Energy by Finance Source, 2013-2020

 

 

 

 

 

 

 

 

 

 

Source: CPI

Key Points: Renewable energy (RE) investment shifted to commercial lending/securities from project finance in the 2010s, reflecting growing comfort with solar/wind technologies as well as a China industrial policy tool. The shift likely helped RE growth in 2021-22 in the OECD. “Direct” institutional investment is seen as a key enabler in developing economies.

A detailed study of renewable energy finance trends. In late February, the Climate Policy Initiative (CPI) and International Renewable Energy Agency (IRENA) published their third biannual report of investments in Renewable Energy, segmenting by region, technology, source of financing and grid/off-grid. The data and analysis concentrate on 2013-2020, although there is some data available through 2022.

No significant growth in RE investment in 2014-2020… The value of investment in RE from 2014 through 2020 was relatively unchanged, fluctuating between $260 Billion (B) and $350B (see figures at the top of the Exhibit for annual detail). A step-up in RE investment began in 2021 and reached $500B in 2022 (please see this recent Payne blog for discussion).

…But there was a change in where the money came from to make the investments. The composition of the financing sources, however, shifted considerably, to a mix of 56% debt/44% equity in 2020 vs. 23% debt/77% equity in 2013. The shift occurred largely as project-level (project financed) equity was replaced by balance sheet (i.e. corporate) debt. Project-level equity fell to 10% of total sources by 2017 from 30-40% in 2013-2016; balance sheet financing, in which a company borrows from commercial lenders or securities markets, grew to 30% of total sources by 2020 from 0% in 2014 (see Exhibit).

The maturation of solar and wind technologies allowed for the shift.  The growth in commercial lending and marketable securities, which are less expensive and much more broadly available than project financing, reflects increased comfort with solar and onshore wind technology. The growth in lending was, however, not all driven by market forces. It also reflected policy decisions — the most important example being in China, which established a Feed-in Tariff to encourage wind development and directed Chinese state-owned financial institutions to lend to wind projects.

Institutional investor direct project investment is well below 1% of total financing. The study notes the very limited role institutional investors, including pension funds, insurance companies, sovereign wealth funds and endowments and foundations, play in directly funding RE investment. These entities combined to invest in a range of $300 Million to $1.3B per annum over 2013-2020.

These institutions do provide capital support, investing through established capital markets (i.e., they buy listed stocks and bonds). But with their collective tens of $Trillions of assets under management, their direct participation in projects is seen as a powerful tool in fostering significantly more RE development in developing economies. It is perceived that direct investment is required for developing economies given relatively immature capital markets and lending institutions in these countries.

The argument that this group might be interested in making these direct investments is based on the idea that they have:

  1. longer investment time horizons,
  2. stated goals to decarbonize their investment portfolios, and
  3. (arguably) some willingness to earn more modest rates of return (as long as the risk profile is commensurately lower).

Spurring more direct investment from these entities, however, involves overcoming a number of hurdles, including providing local knowledge and country- and project-specific risk amelioration; it likely also requires them making specific changes in their investment mandate to include more tolerance for longer term, less liquid holdings (i.e. to be willing to hold onto their investments for a long time).

3/6/2023

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