Climate change has now emerged as a major investment theme. Even mainstream fund managers are screening investments on climate criteria. In September last year, Janus Henderson – a major UK fund manager – introduced the need for portfolio companies to have science-based climate targets or demonstrate significant capital expenditure on sustainability projects, into its GBP 1.8bn European opportunities fund. This is typical of how investors are reacting to the both the risks and opportunities presented by climate change.
On the opportunity side, infrastructure funds and specialist climate technology vehicles have made headlines in recent years, but these are often inaccessible to retail investors or mainstream funds. Public markets provide a direct way for climate-friendly companies to tap into this trend. But is this a wise move in volatile times?
Some of the ways to track the net zero investment trend have been in place for many years. Shares can be bought in companies active in technologies for emission mitigation, for instance solar, wind or energy efficiency – and there are now several funds that specialise in holding such equities.
Lower risk options include a number of quoted funds in London and North American that hold renewable energy plants as assets and pay dividends from the operating cashflows, known as ‘yield cos’. Between them, these entities have raised tens billions of dollars from stock market investors since 2013. In the UK some of the more well-known funds include Bluefield Solar Income Fund, Foresight Solar Fund, Greencoat UK Wind, NextEnergy Solar Fund and Renewables Infrastructure Group. In the US equivalents include Atlantica Yield, Brookfield Renewable Partners, Terraform Power and NextEra Energy Partners.
There are also a substantial number of exchange-traded funds that track indices set up to select stocks on the basis of ESG (environment, social and governance) performance. These funds however can include a wide range of investment themes, and only the “thematic” ones take positions in businesses that provide environmental solutions. ESG funds that take a “screened” approach often include many of the same stocks as broad indices such as the S&P500, while excluding just a few others such as coal miners and gunmakers.
Carbon plays
Investors looking to access more direct opportunities in emission reduction projects and the price of carbon have fewer options, although more carbon-specific products are now being offered. A number of exchange-traded funds now track the price of carbon allowances on official ‘compliance markets’ such as the European Emission Trading System. Examples include WisdomTree, SparkChange and KraneShares.
The price of carbon on the European ETS has risen sharply already, from less than 20 euros per tonne of CO2 in 2018 to nearly 80 euros in early 2023. Whether it climbs further depends on the vigour of the European economy, regulatory moves coming from the EU and the price of gas.
The market for voluntary carbon credits has received a lot of attention recently and investment opportunities are now emerging. Companies around the world can offset their emissions by buying – ‘retiring’ – voluntary credits that are generated from projects that reduce carbon emissions or store carbon in the long term. Many types of projects can be included, such as afforestation, nature restoration, renewable power and energy efficiency. Trove Research analysis suggests the global voluntary carbon market could expand from around USD 1.3 billion in 2022 to some USD 30 billion by 2030.
In December, the London Stock Exchange said that it had given its Voluntary Carbon Market (VCM) designation to Foresight Sustainable Forestry, the first fund to receive this status. Meanwhile, in North America, voluntary offset specialist Carbon Streaming Corporation has completed 18 months as a quoted company on Toronto’s NEO exchange. Other firms from different parts of the carbon offset value chain have considered, or are considering, floating on public markets.
Foresight Sustainable Forestry, or FSF, raised GBP 130 million in its initial public offering in 2021, with a follow-up GBP 45 million issue in June 2022, and has seen its shares edge upwards from the flotation price of 100p, to 105p in mid-January 2023. It limits the geographical profile of its projects to the UK, and has timber as its primary output for sale, with carbon credits as secondary.
In its latest results statement, in December, FSF said that it had a portfolio of 27 afforestation projects, plus 22 forestry plantations and one mixed allocation property. It said: “As well as commercial trees, [the approach at its afforestation sites] will include the planting of a significant hectarage of native broadleaf trees and reinstating wetlands and reducing grazing levels on large areas of open ground.”
Richard Kelly, co-lead for the Foresight Sustainable Forestry Company, told Trove that 40-50% of FSF’s investment will go into afforestation projects that will generate carbon credits. The main driver of returns at FSF will be the afforestation of marginal, cheap grazing and bare land, leading to a big uplift in its value, underpinned by the sale of timber, he added.
Foresight said in December: “The potential of our current capital base alone is expected to create up to 5 million carbon credits by 2050.” The fund will offer these credits to shareholders in lieu of cash dividends – the shareholder making that choice can then opt either to ‘retire’ the credits, using them towards its emission reduction goals, or to sell them. In theory this gives corporate entities the chance to retain the value of their FSF shares, while also picking up credits in each dividend round. Whether this prospect will entice companies onto the share register is not yet clear – a sceptic might argue that it means tying up capital, which is something that corporates do not usually want to do.
Carbon Streaming Corporation offers a different investment opportunity. The company provides upfront investment and ongoing operational payments to carbon credit projects in return for a share of credits produced.
If the voluntary carbon market continues to grow, more investment opportunities such as these will emerge. However, that does not mean it is without risks.
It has not been plain sailing for Carbon Streaming so far. From its IPO in July 2021, the stock almost doubled to a peak at the end of that year but has since fallen by more than 80%. The company’s share price journey mirrors the trend in US technology stocks reflecting a negative reaction to novel sectors and a general correction in the technology sector, albeit with a more severe contraction. It also reflects the link between the voluntary carbon market and the general economic environment (Trove calculates a 90% correlation between carbon market demand and the S&P500) along with more random events, such as the Indonesian government’s moratorium on the verification of carbon credits from forestry projects.
Looking back
These public companies are not the first time investors have had access to the carbon credit market. Several publicly-listed carbon development companies were created in the period after 2005. These entities based their business on the Certified Emission Reduction (CER) credits generated by the Kyoto Protocol’s Clean Development Mechanism. Three UK-based firms – Camco, EcoSecurities and Trading Emissions – floated on London’s Alternative Investment Market, with plans to source CERs and sell into the European Emissions Trading scheme and developed country governments.
Their story however was mixed. Heavily dependent on the Kyoto Protocol and the use of credits in the EU ETS, they suffered when the Kyoto protocol ended in 2012 and the EU ETS stopped importing credits at the same time. Trading Emissions and Camco wound down their carbon credit development businesses, while Ecosecurities managed to exit from AIM during the market peak, selling to JP Morgan in 2009. Camco remained in climate business and pivoted to battery storage rebadging as RedT in 2015 and eventually delisted in 2020 when it merged with Avalon Batteries. Separately, a new privately-owned version of Camco was created to focus on managing renewable energy investments in Africa and Asia.
Looking forward
These examples provide useful lessons for publicly listed carbon market ventures. Firstly, prices of the underlying credit can be volatile. Trove’s analysis of weekly weighted average voluntary offset prices ranged between USD 7 and USD 11 in 2022, and some standardised credit contracts such as CBL’s GEO fell by over 50% during the year. Secondly, diversity and agility are critical. Carbon markets can shapeshift over time and having exposure to multiple sources of demand and supply provides important resilience.
Today’s voluntary carbon market is a different animal to the credit markets created under the Kyoto Protocol, and in theory, less risky. Long term climate commitments of thousands of companies should be more resilient than a scheme dependent on policy decisions from a single body. These targets also go out to 2050 so provide long term visibility. The flip side is that the supply of carbon credits can increase rapidly, capping potential price increases. Quality control processes, such as that proposed by the Integrity Council on the Voluntary Carbon Market (IC-VCM) and the actions of the main standard setting bodies, eg Verra and Gold Standard, will be critical in controlling supply and maintaining a high integrity in the market.
There is undoubted public and institutional interest in the decarbonisation investment theme, and carbon credit vehicles provide direct exposure to the price of carbon. Given their highly specific nature, however, investors would be wise to see these as part of a diversified portfolio, covering a range of asset classes connected to low carbon opportunities.