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By Anthony Milewski, Chairman of Nickel 28 Capital

Carbon credits: Fighting climate change with capital market solutions

Of all the elements that form environmental, social and governance (ESG), none is growing faster, or is of more concern to fund managers and consumers, than decarbonization. The biggest growth driver of this trend is, of course, the fight against climate change. Now rated as the number one concern for North American fund managers, decarbonization has given birth to an entirely new industry: carbon credits.

Okay, to be entirely accurate here, carbon credits actually came into existence a few decades ago and they are based on a straightforward concept. Everything we do has a carbon footprint. While numbers do vary, the average person generates around 4 metric tonnes of carbon every year. For companies, that number is magnitudes higher, especially for those in industries like shipping, aviation, power generation and manufacturing.

The carbon credit industry essentially puts a price on carbon. Polluters — those with a positive carbon footprint — purchase credits from companies or organizations that have a negative carbon footprint. Examples of the latter include clean power such as hydro, solar, wind and nuclear, organizations with major reforestation and marine protection, as well as others that provide strong environmental support.

Carbon is a serious business backed by numerous governments worldwide, and it’s getting bigger by the day.

The carbon markets

Generally speaking, there are two types of carbon markets: the Compliance Market and the Voluntary Market.

The Compliance Market is regulated by governments in various countries. The EU has the largest market, but others, including the US state of California, along with countries like Canada and China, are developing their markets. It’s designed to tax and curb emissions. Speculation is allowed, but it’s really a cap-and-trade — you cap the amount that a company can emit and then that company can buy and sell carbon credits. Tesla (NASDAQ:

TSLA

), for example, makes most of its money at this time by selling carbon credits.

The Voluntary Market is far more interesting because it trades in a completely different way to the Compliance Market and has far more upside. Let me give you some examples of the Voluntary Market in action.

When you buy an airline ticket, or you order a package of some sort and you see the option that, for a small fee — let’s say $7.95 — you can offset your carbon footprint, that is the Voluntary Market. Or when a company states that it is going to be carbon neutral by a given date, those credits will be purchased on the Voluntary Market.

What’s happening is that the Compliance Markets are trading at a much higher level to the Voluntary Markets, and companies are saying to themselves, “If we can get out ahead of this and be carbon neutral by purchasing Voluntary credits, then maybe we won’t get forced into the more expensive Compliance Market.”

Aviation, shipping, mining … these are all industries that have major limitations when it comes to reducing the emissions they produce, so carbon offsetting is really going to be their best option.

The demand side

To describe the growth drivers as robust is an understatement. You have consumers demanding accountability from corporates across the spectrum, with a perfect example being the pressure on Apple (NASDAQ:

AAPL

) and Google to obtain cell phone

battery metals

from clean sources. Then, on the investing side, you have the BlackRocks (NYSE:

BLK

) and Vanguards of the world that collectively control multi-trillions of dollars, telling public issuers, “If you don’t adhere to ESG principles, then we won’t invest in you.”

We are in a fascinating time here because there are no set ESG principles and we are still years away from consolidating them into one standard. A subset of the ESG overlay is carbon, specifically carbon footprints, and there has been a real awakening in the last 24 to 36 months in terms of what it means to calculate and offset your carbon footprint.

When you’re talking about addressing your carbon footprint you’re really talking about addressing the supply chain, the processing, how your executives travel — the list goes on. Decarbonization has been in the background for a few decades, but it’s now having its moment. You can’t go a day without some company announcing it is offsetting its carbon footprint, going carbon net zero.

Generating credits

In the Compliance Markets, credits can be generated in a number of ways, with obvious examples being clean

energy

, like renewables or nuclear. In the Voluntary Markets, a large proportion of credits are being generated through nature-based solutions such as reforestation. These are major projects and often back by global companies. Just recently, Apple and Goldman Sachs (NYSE:

GS

) announced a new fund to support a $300 million project to offset their carbon footprint by replanting forests. Delta Airlines (NYSE:

DAL

) just put $30 million into a carbon offset project in Indonesia.

Vintage, quality and co-benefits

The Compliance Markets are a supply-and-demand situation and are mostly traded by hedge funds and other corporate types. The Voluntary Markets are a bit more nuanced. Credits are traded based on the year they were generated (vintage). Some of the older credits that have yet to expire, and were generated before standards become stricter, do not necessarily have the same quality as more recent ones. Then there is the issue of co-benefits, which is essentially where a company is thinking, “How marketable are these specific credits in terms of public relations or investor relations?” All of these factors affect pricing, sometimes dramatically.

A tightening market

The market is still developing, but it’s doing so at a rapid pace and that means it’s going to get tighter. In the early days, the Voluntary Markets had a lot of problems with too many competing standards, lack of transparency and all of the teething troubles that come with a new industry.

Although we are still some years away from a single set of globally accepted standards, things have now matured to the point at which most verification and measurement is handled by a handful of reputable organizations like the Verra Registry.

As the industry has matured, the corporate world has felt more comfortable about getting involved, and today things have come together in a way that few could have foreseen a decade ago. Jump online and run a quick search — it will be hard to find a major corporation that doesn’t have some sort of carbon offset plan, and most of those plans will involve buying credits every year on the Voluntary Markets.

It’s a remarkable situation in which capital market solutions are being used to fight climate change and save the environment.

Getting involved

The Compliance and the Voluntary carbon credit markets both have their merits. Part two of this carbon credit series will look at ways investors can get positioned in both.

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About Anthony Milewski

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.

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