Category: Investing in the Energy Transition

Barclays’ New Rules for Financing Fossil and Transition Activities

Exhibit: Barclays’ New Fossil Financing Exclusions, by Effective Date

Source: Barclays

Key Points: Barclays’ new restrictions on fossil financing and Transition Finance Framework support its decarbonization push and $1 Trillion commitment, by 2030, to sustainable and transition finance. The bank treads carefully with existing, diversified O&G clients, mandating target-setting. The TFF aligns with accepted decarbonization pathways and new taxonomies.

Barclays issues new rules of financing Oil & Gas and Thermal Coal. The bank this month published an updated Climate Change Statement, in which it laid out constraints and restrictions on providing financing to upstream oil and gas (O&G) and thermal coal mining and coal fired power generation companies. The thrust of the policies are (1) constraints on financing O&G expansion generally and not financing specific locations and types of hydrocarbon resource (e.g. in the Arctic and oil sands); (2) taking on new clients in O&G (if they are seeking growth, but that would seem to apply to most upstream O&G companies); (3) O&G clients must develop plans to reduce greenhouse gas emissions and have adequate disclosure; and (4) a path to cessation of funding coal mining and power generation. See Exhibit.

Also, Barclays lays out parameters for transition finance. The bank has developed a set of over 110 transition activities across 11 sectors that it classifies as high-emitting and hard to abate. In addition, activities include seven “cross-cutting” technologies including CCUS, blue hydrogen and low-carbon fuels. These, along with the principles behind their use have been published in the bank’s Transition Finance Framework (TFF).

As it relates to Oil & Gas, transition activities include Carbon Capture Utilization & Storage (CCUS) on existing oil and gas assets (whether for geologic storage or H2 production but excluding for Enhanced Oil Recovery) and investments to (1) eliminate flaring, (2) reduce methane emissions, (3) improve energy efficiency of O&G assets, and (4) electrification of O&G assets. For coal, transition activities include CCUS and coal-to-gas switching.

The TFF lays part of the ground rules for the bank’s $1 Trillion commitment to sustainable and transition financing. Barclays has committed to $1 Trillion in sustainable and transition financing between 2023 and 2030. As the bank puts it, “[t]he inclusion of transition financing…reflects…recognition of the importance of lending, facilitating funding and investing in technologies and activities that support greenhouse gas emissions reduction (directly and indirectly) in high-emitting and hard-to-abate sectors.” To support that commitment, Barclays last month formed an Energy Transition Group within its Corporate and Investment Bank, which reportedly will have over 100 bankers.

Broadly, transition finance appears to be gaining momentum. The topic of transition finance was prominent at COP28. Growth potential was marked by large cash commitments from the UAE in conjunction with large investment houses, including Blackrock and Brookfield, and concessional sources, while the Monetary Authority of Singapore released the Singapore-Asia Taxonomy (SAT) — the world’s first, it claims, with a transition category. An enabling taxonomy will let a financial institution put money into a high emitting sector (with a transition plan) and not run afoul of its Net Zero targets.

February 14, 2024

VCM 2023 Update: Retirements Stable; Transaction Volume Falls

Exhibit: Carbon Offset Credit Retirements, by Month 2023 (Millions Metric Tons CO2-Equivalent)

Source: MSCI Carbon Markets (formerly Trove Research)

Key Points: Strong YE VCM credit retirements may suggest companies eventually deliberated, but then used, purchased credits to fulfill climate commitments. Retirements were thus flattish yr./yr. in 2023; issuances likely fell more than 10% and transaction volumes perhaps >50%. Demand in 2024 may be bolstered by integrity frameworks and incremental company buyers.

Strong December brings VCM credit retirements in line with prior years. MSCI Carbon Markets (formerly Trove Research) posted its tally of carbon offset credit retirements in the Voluntary Carbon Markets in 2023. Including a record setting month in December, in which 36 million offset credits were retired (see Exhibit), MSCI counted 180MM retired offsets in 2023, down only 3% year-over-year (yr./yr.).

Note: to retire an offset credit is to take it out of circulation; in so doing, the buyer/”retirer” uses the credit to report it as an offset to its internally-generated carbon emissions. One credit is the equivalent of one metric ton of carbon dioxide equivalent.

This outcome surprises; per MSCI, retirements were on pace to fall 12% yr./yr. through the first nine months of 2023 (excluding crypto-based transactions). The pace of retirements had slowed through the course of 2023 through September and it was tempting to tie that slowing pace to greater scrutiny and integrity concerns across the VCM.

We are left to speculate about companies’ thinking. It seems plausible that companies engaged in review of credits they had previously purchased before deciding it was “ok” to use them as offsets. Further, as MSCI had identified earlier in the year, the decline in retirements by a few large buyers of offset credits had slowed their retirement cadence; this had been only partially offset by newer and smaller buyers. Perhaps more (many) of those newer entrants acted in December to fulfill annual commitments.

Issuances were presumably down more than retirements in 2023… Per MSCI, issuances as of the first nine months of 2023 had fallen 8% yr./yr. and 4Q22’s 141MM credits issued was particularly strong (it was double the pace of the first three quarters of 2022). This sets up for full year 2023 issuances to fall more than 10%. Given heightened integrity scrutiny being taken by Verra and other registries and the softer market generally, it is perhaps surprising that issuances didn’t fall more.

…while transaction volume appears likely to have fallen considerably. Ecosystems Marketplace (EM), which has conducted a survey of VCM participants and registries for a number of years, published an update in late November 2023. The report cautions that its 2023 data, which covered through mid-November, is preliminary and likely reflects very incomplete survey results. That said, with survey responses from 2/3 of the actors that responded in 2022, the fact that transaction volumes were down 80% in 2023YTD vs. 2022 certainly points to a dramatic decline — perhaps more than 50% yr./yr. (Our channel checks appear to support that as well.)

This slowdown in transactions likely reflects a pulling back by both buyers/end-users and speculators; it seems entirely plausible that they are waiting for the integration of recommendations/certifications by the integrity standards bodies (and specifically the Integrity Council of the Voluntary Carbon Market or ICVCM) into the registries.

ICVCM assessments and demand from new companies points to some recovery in 2024. Looking forward, transaction volume in 2024 —and demand generally — should depend on a few factors. These include the extent to which: (1) existing/issued credits are deemed to “fit” with ICVCM Core Principles; (2) companies conclude they can or cannot use credits they have already purchased for offsetting purposes; and (3) near term demand for offsets is bolstered by the addition of companies making climate commitments. To this last point, although data still pending, MSCI data through nine months of 2023 would suggest that the number of companies committing to align their emissions with limiting global warming to 1.5°C more than doubled in 2023 to well over 3,000.

January 8, 2024

DAC’s Recent Cost Curve Signals

Sources: CarbonCapture, Heirloom

Key Points: Frontier Climate’s Advanced Market Commitment to CarbonCapture has average per ton pricing of $440, with a plausible step down from $650 to $350 by 2028. This compares, for example, to OXY Stratos’ estimated $400-500/ton cost and expected medium-term future gen cost of <$250/ton. Frontier’s other newly announced AMC, to Heirloom, equates to $990/ton.

Frontier Climate makes two new investments in Direct Air Capture (DAC) technologies. Frontier announced two additional AMCs last week, $20MM to CarbonCapture to remove 45,500 tons of CO₂ through 2028 and $26.6MM to Heirloom to remove 26,900 tons of CO₂ through 2030. CarbonCapture and Heirloom are deploying different DAC systems. CarbonCapture’s DAC uses solid sorbents to soak up atmospheric CO₂. The company is using a modular system that allows it to upgrade existing facilities with best-in-class sorbents as they become available. Heirloom accelerates limestone’s natural CO₂ absorption properties.

CarbonCapture is developing its first facility, Project Bison, in Sweetwater County, Wyoming. The project has been delayed from its originally-announced startup this year; the company continues to target 5 million tons per year of CO₂ capture by 2030. Heirloom commenced operations of its first facility in Tracy, California earlier in November with a capture capacity of 1,000 tons per year.

Using an AMC to track a carbon removal learning curve. Frontier addresses cost reductions for both CarbonCapture and Heirloom’s approaches, albeit in different ways. For CarbonCapture, Frontier has structured the AMC with pricing declining through the agreement period. Frontier will pay “at least 46%” less for CarbonCapture’s removals by agreement end (2028) than in year 1. Backing into possible annual volumes and prices to total the $20MM commitment and $440 average price suggests that pricing could be $600-650/ton and $325-350/ton in 2024 and 2028, respectively.

For Heirloom, there are no indications of a pricing trajectory in the AMC, but Frontier notes that Heirloom is projecting a 70% decline in cost by 2030 from today, after having reduced costs by 50% since 2021.

For reference, OXY anticipates current Stratos costs of $400-500/ton declining eventually to $150/ton. Construction of OXY’s Stratos DAC plant is 30% complete and the facility is projected to start operations in 2025 at a capacity of 500,000 tons/year. OXY has characterized a potential DAC cost curve declining to $150/ton by the “Nth gen” facility. OXY has indicated its intent to aggressively build out its DAC capacity, including having 135 facilities online by 2035.

As an important aside, this month’s announcement of Blackrock taking a JV stake in in Stratos, contributing $550 million of the project’s expected $1.3 billion cost, marked a data point regarding the perceived ability to earn an adequate financial return in DAC including from credit sales and tax credits.

Frontier Background. Frontier, a public benefit LLC owned by Stripe with funding support from Alphabet, Shopify, Meta and McKinsey, is employing an Advanced Market Commitment (AMC) model, in which buyers will commit to an annual spend on carbon removal between 2022 and 2030. Frontier has now made commitments to 28 companies for a combined $126 million (MM) out of total available committed funds of ~$1.025 billion; its commitments are all to new carbon removal technology companies that Frontier deems have significant potential to scale and lower their costs. The commitments are to companies that span technology approaches to DAC; a non-exhaustive list includes (1) new adsorbents for DAC systems (examples: AspiraDAC’s Metal-Organic Framework and Calcite-Origen’s slaked lime for calcination); (2) enhanced weathering techniques (examples: Lithos’ basalt application to cropland and Travertine’s use of electrochemistry to produce sulfuric acid); and (3) synthetic biology (e.g. Living Carbon’s algae biopolymer). Frontier has noted that it is paying as much as $1,800/ton for some very early-stage commitments.

11/20/2023

The Growth in Commitments to VCM

Exhibit: Announced Capital Raises Since 2021 and Estimated Annual Project Investments, 2012-2022

Source: Trove Research

Key Points: Trove’s latest VCM Investment Trends report finds ~US$18B raised for carbon offset crediting in 2021-1H23, including >$5B from corporates. This spurred 50% investment growth in 2022. Trove cites that a tripling of current investment to 2030 is required in a 1.5°C scenario; yet even sustaining recent levels may be difficult given integrity attacks.

Recent report on investments into the VCM. A mid-September report from Trove Research updates on (1) capital raise for the Voluntary Carbon Market (VCM), reflecting survey results and the canvassing of public announcements, and (2) recent capital spend (i.e., investments) on projects. High level takeaways of the report include:

• ~US$18 Billion (B) of capital was raised in 2021 through 1H2023 for carbon credit issuance.
• Of the total, $5B was committed by corporates, with the balance from financial investors (funds, etc.) (see left chart of Exhibit and below for color on corporate sponsorship).
• Use of the capital raises is reflected in growth in project investment. Total VCM investment in carbon credit development grew to $7.5B in 2022 from $5.0B in 2021 (see right chart of Exhibit and below for color on the investments). Half of the 2021 spend went towards “feasibility”, i.e. early-stage, expenditure, which converted to later stage (“development” and “capital”) expenditure in 2022.

Corporates commit over $5B. 2021 marked considerable growth in corporates making direct commitments to purchase credits. Sizable corporate commitments over the last 18 months have included:

• single company to single projects, such as Hess’ $750MM commitment to buy credits tied to Guyana forest preservation;
• single company to a portfolio of projects, such as JP Morgan’s $200MM commitment to sponsor Carbon Dioxide Removal (CDR) activities; and
• multiple company to collective efforts to foster investment at-scale in both nature based solutions (e.g., the LEAF Coalition) and CDR new technology development (e.g. Frontier)

Project investment detail by project type. Nature based projects (Nature Restoration and REDD+) accounted for 50% of project investment vs. closer to 40% from 2012-2019. Other drivers of the growth included methane capture/management (Non-CO2 Gases in the chart) and cookstoves (Energy Efficiency in the chart). Renewable Energy declined (even in absolute terms) as crediting in all but lesser developed economies was ruled ineligible for crediting given technological/cost reduction progress. Carbon Engineering, which includes technologies targeted at CO₂ removal, was a negligible target given the early stage of these technologies. See the Payne Institute VCM primer for more on project types.

The report also notes that there are 1,500 newly registered projects since the beginning of 2021 (by the largest registries, which dominate the market). These claim to be able to reduce CO₂-equivalent emissions to the atmosphere by ~300 million tons per year (Mt/yr.), bringing the total claimed reduction potential of registered projects to ~760 MtCO₂e/yr. With that said, the report acknowledges that not all claimed carbon reduction will necessarily be achieved.

About Trove Research. Trove Research provides Voluntary Carbon Market supply and demand analysis, including market forecasting and influencing factors such as corporate commitments and government policy.

9/25/2023

Unbundling Attributes to Reveal More Value

At the end of August, standard setter Verra issued a different sort of methodology from its norm. Rather than setting the rules for funding an activity that lowers carbon emissions, this new Verra methodology lets a developer seek funding for saving time. The activity, supplying more efficient cookstoves, has been used for carbon avoidance crediting. But by isolating a separate benefit of the same activity, the new methodology highlights that there is other value in many carbon projects that is very likely being under-recognized.

Verra’s methodology, called Time Savings From Improved Cookstoves, captures the hours per day saved in both gathering firewood/biomass and cooking (more efficient cookstoves require less fuel and cook faster). The freeing up of such time allows (primarily) women to pursue other activities of greater economic, societal and personal value. The methodology was written by C-Quest Capital, one of the largest carbon project developers globally.

The idea that carbon emission avoidance activities have other benefits is not new. These so-called “co-benefits” are customarily denoted as progressing United Nations Sustainable Development Goals, or SDGs. Cookstoves, for example, are thought to advance SDG 3 (improved health), SDG 5 (gender equality), SDG 7 (modern energy and increased energy efficiency), and SDG 8 (enhancement of job opportunities). Thus, a buyer of carbon offsets can choose credits that have specific SDGs, or that have a minimum number of SDGs, to make a societal contribution beyond climate mitigation.

Carbon offset credits with SDGs frequently carry a premium to those without. For example, ACX Exchange-traded Global Nature Tonne Plus (GNT+) series contracts, which have certified co-benefits, currently trade at a ~$5/ton premium to ACX’s GNT contracts of similar vintage (note: with a contract one is buying credits selected by the exchange from projects that have specified attributes rather than from a specific project).

Yet, it is almost impossible to imagine that such premia reflect a true market assessment of the value for these SDGs. That’s where unbundling these different attributes comes in: it spurs independent analysis of their value. Admittedly, assessing that value may not be easy. For example, for time savings, it is plausible to quantify hours (the Verra methodology relies on surveys), which lends itself to a crediting methodology. However, academic literature has shown both a wide range in estimates for hours saved and acknowledged that more work must be done to value them.

With focus, the net effect of adding a time-savings consideration is most likely that it will put greater value overall on the activity. It may well be that this “value of time” largely remains ‘bundled” with carbon offset crediting, as opposed to widely trading as a separate security. But the point is that through the act of unbundling, it will have fostered a process to accord value to an activity more consistent with its societal impact.

To date, unbundling has been introduced “the other way”, i.e. to give value for environmental attributes of commercial products. Examples include Renewable Energy Credits (RECs) and, more recently, the crediting mechanisms for differentiated natural gas from Xpansiv (Methane Performance Credits) and EarnDLT (Certified Emissions Tokens). These gas crediting mechanisms are allowing society to put a value on avoided methane, which is now finding its way into buyers’ RFPs for “bundled” natural gas, i.e. they will buy differentiated gas and are offering to pay a modest premium for the relatively lower climate impact of that gas.

It is tempting to suggest that this new time savings credit has an ambition that would have been better received two years ago. Then, there was a surge of interest in carbon offset crediting that corresponded with an awakening to the understanding that the private sector needed to be forceful actors in addressing global warming and biodiversity decline. Further, there was a collective conversation about valuing things that were not typically given much weight, including the longer-term financial risks of climate inaction. It was before anti-woke legislation and before environmental advocates waged campaigns against carbon offsetting practices. Yet if we acknowledge that communities (and businesses) of all sorts must change behavior for the good of the planet, we need to create mechanisms that will adequately fund such behavior change. More transparency about the various ways it makes an impact can only help.

9/15/2023

VC’s Rotation to Emerging Verticals in 1H23

Exhibit: Venture Capital Investment by Climate Tech Vertical ($ Billions), 2021-1H23

Source: CTVC

Key Points: A 40% drop in VC investments yr./yr. in 1H23 reflects declines in more mature verticals, like Transportation and Energy, partially offset by increases in emerging, under-invested verticals Industry and Built Environment. This “rotation” is arguably sustainable and may prove productive in developing important climate mitigation opportunities.

Overall Venture Capital funding in climate tech fell 40% year-over-year in 1H23 vs. a ~50% decline for the overall market. Per market tracker Climate Tech VC (CTVC)’s mid-year report, total climate tech investment by venture capital (VC) firms totaled $13.1 Billion (B) in the first half of 2023, down 40% from a year earlier and down 35% from 2H22. Total VC market data for 1H23 appears to be unavailable, although the market was down 53% yr./yr. in the first quarter of 2023 (1Q23) and was not expected to have improved in 2Q23.

CTVC notes that seasonality in the VC market (there is generally an uptick in the 3^rd quarter of a year) makes yr./yr. comparisons more relevant.

The number of climate tech deals rose 8% yr./yr. in 1H23 to 633. The growth came in earlier-stage funding rounds — the number of “Seed” round funding deals rose 34% yr./yr. to 280, for example, while Series A rounds were essentially flat at 171. The growth in Seed deals was partially offset by ~40% declines in the numbers of Series C and Growth round deals.

In other words, average deal size fell in 1H23 as the deals shifted to earlier stages (although later stage funding deals also got smaller, in part from the lack of “mega” deals). Dollars invested in Seed rounds rose 23% yr./yr. in 1H23 to $1.1B. Dollars invested in Growth rounds fell 64% yr./yr. in 1H23 to $2.8B.

The average Seed round deal size in 1H23 was $4.9 Million, -4% yr./yr. The average Growth round deal size in 1H23 was $107 Million, -37% yr./yr. Impacting the decline in deal size were a few “mega deals” in 2022 including Northvolt ($2.7B) and Rivian ($2.5B) whereas the largest deal in 1H23 was Zeekr ($0.75B).

CTVC posits digestion and IPO challenges for the decline in later stage deals… CTVC offers as a possible explanation for the slowdown in larger/later-stage deals that VCs had made significant investments in 2021-22 and could be pausing to see how these investments evolve. Further, market challenges, like limited opportunities to IPO, could be weighing on overall VC market demand, particularly for later stage growth companies.

…But also potential “rotation” into different climate tech verticals. By climate tech vertical, investment declines (in absolute $ terms) yr./yr. in 1H23 were led by more mature verticals: Transportation (-$3.0B to $3.6B, -45%), Energy (-$2.8B to $3.1B, -47%) and Forest & Land Use (-$1.7B to $1.7B, -49%). See Exhibit. More mature verticals have a greater share of later stage funding rounds, which fell in number and in size yr./yr. in 1H23 as discussed above.

In contrast, emerging verticals grew, including Industry (+$0.1B to $1.8B, +7%) and Built Environment (+$0.1B to $1.2B, +7%). (Built environment includes energy efficiency, construction, and heating & cooling.) CTVC suggests that with large industry players investing in mature markets — established automakers heavily focusing on EVs and batteries, for example — it might not surprise that VCs are looking away from transportation and to emerging opportunities.

July 13, 2023

When Governments of Developing Economies Get an Equity Stake

Exhibit: RE and Fossil Fuel Projects, Average Spread in Debt Costs by Ownership, 2011-2022

Source: UNCTAD

Key Points: A 1,700-project review in UNCTAD’s latest World Investment Report quantifies the extra financing costs for LDCs’ projects; factors include lower credit ratings, lower leverage, and longer time to close. And a host government equity stake in Developing Economies has lowered financing by ~80 basis points relative to “only” policy or loan support.

UNCTAD’s annual World Investment Report. The United Nations Conference on Trade and Development (UNCTAD) published its annual World Investment Report (WIR) this week. The report is a compendium of trends and challenges in financing the investments required for countries to achieve their Sustainable Development Goals (SDGs) by 2030. It notes that developing countries need US$1.7 Trillion in annual investment in renewable energy (RE) but received $540 Billion in clean energy foreign direct investment in 2022.

The characteristics of more expensive financing in Least Developed Countries. As part of the report, WIR 2023 includes a review of ~1,700 project with yield type information financed from 2011 through 2022. The review characterizes some of the additional sources of financing cost for Least Developed Countries (LDCs) relative to Developed and Developing countries. To illustrate:

• The average interest rate spread (to a project base rate that can be considered a risk-free rate) is 283 basis points (bps, with 100 bps=1 percentage point) for Developed countries, 290 bps for Developing countries and 386 for LDCs.
• The proportion of a project financed by debt (vs. equity) is 75% on average for Developed countries, 71% for Developing and 67% for LDCs. (The higher the debt proportion of total financing, generally the less expensive the financing.)
• The proportion of projects bucketed as “highly leveraged” (classified as having a spread >400 bps over the base rate and akin to having a very weak credit rating) was 24% in Developed countries, 23% in Developing countries and 55% in LDCs.

In addition to that data on cost spreads, other observations in WIR23 point to higher costs in LDCs as well. The report notes, for example,

• sovereign credit ratings for the vast majority of LDCs are below investment grade. Most banks have internal or regulatory limits (e.g. Basel III) on how much they can lend (on a non-recourse basis) to non-investment grade countries.
• the average number of days to close (i.e. finalize) financing on energy sector projects was 156 for Developed countries, 282 for Developing countries and 524 for LDCs; this significant delay is itself a source of costs.

A government equity stake in the project has made a meaningful impact. The project review also found ~80 bps lower borrowing costs in Developing economies when the host government had an equity stake vis-à-vis when it (or Multilateral Development Banks) had provided other, non-equity forms of support such as subsidies, (concessional) loans or loan or price guarantees. Interestingly, there is relatively little benefit, in terms of lower financing cost, between projects with this non-equity government support and those that receive no government support at all. See Exhibit.

By way of explanation, the report suggests that non-equity government support can often be crucial to a project developer’s “go/no-go” decision, by improving risk-adjusted expected financial returns. Yet, such support is less effective in changing credit risk perception among lenders. Instead, a project’s actors — sponsors, equity investors, contractors, customers/power off-takers, and country administrators — as well as the size of the project (with larger projects being harder to reverse) are more responsible for lenders’ credit risk perceptions.

WIR23 notes, however, that a government equity stake can factor into the longer negotiating time for Developing countries and LDCs and, at too high a level, allow for concerns regarding project governance.

RE vs. Fossil. The project review finds significantly (150+ bps) higher borrowing costs for fossil fuel vis-à-vis RE projects, regardless of ownership profile. See Exhibit. The report suggests that regulatory and stranded asset risks may help account for some of this gap. Additional color on the projects might be helpful, but it seems plausible that market risk (less off-taker contracting) amidst volatile hydrocarbon pricing through the 2010s played a role in the higher costs as well.

July 6, 2023