The total amount of carbon dioxide (CO2) emitted each year by human activities is around 50 billion tons. The graph below shows The evolution of the concentration of atmospheric CO2 from 1984 to 2019. The red line indicates the level not to be exceeded by 2100 to respect the limit set by the Paris Agreements. The graph shows that at such a pace, our trajectory leads us to a concentration of atmospheric CO2 above this limit. Although the planet does have a certain capacity to absorb and store CO2, it is still insufficient to neutralize all anthropogenic emissions.
Globally, terrestrial and ocean reservoirs, real carbon sinks, absorb 13 Gt CO2/year and 9 Gt CO2/year respectively, i.e. a total of 55% of our greenhouse gas (GHG) emissions each year. This imbalance between emissions on the one hand, and natural absorption and storage on the other hand, leads us to today's challenges: how companies try to neutralize their carbon footprint, how they integrate it into their reporting, and how investors can expose their portfolio to carbon pricing mechanisms, as well as to underlying technologies.
One carbon quota is a document allowing to emit 1 ton of CO2 or its equivalent for any other GHG (TCO2eq). Quotas are part of a mandatory carbon quota market, as there are various forms around the world. These markets, such as the European Emissions Trading System, operate under the terms “Cap-and-Trade”. The annual supply of quotas (or TCO2eq) from regulators is gradually being reduced, encouraging projects with the best GES/cost returns. Nonetheless, some companies fail to emit less TCO2eq than their quotas allocated by the government. These same companies are therefore turning to the quota market to buy as many as needed from surplus businesses. Thus, the supply and demand of quotas set the price. Carbon quotas are a tool that focuses on reducing GHG emissions.
As an investor, it is interesting to turn to ETFs that reflect the average price of a carbon quota through the world's quota trading systems, to contribute to and benefit from the growth of these markets, which is necessary to achieve the Net Zero objective. Among the most popular, the Chinese management company Krane Funds Advisors has an ETF that replicates the price of 1 tCO2eq on the California and European quota markets, as well as an ETF combining the 3 largest quota markets in the world. The latter, KraneShares Global Carbon Strategy ETF (KRBN) is based on the IHS Markit Global Carbon Index, which itself tracks carbon quota futures contracts.
One carbon offset credit, often confused with a carbon quota, is a document certifying that a company has financed projects to avoid or store 1 tCO2. These credits are traded on the voluntary carbon credit market, which can be found at various scales around the world. The global voluntary market in terms of $/year is estimated at 0.4 billion in 2020, 10-25 billion in 2030, 40-115 billion in 2040 and 90-480 billion in 2050. Unlike its mandatory counterpart, which offers prices up to $87 For the European market, the voluntary market offers carbon credits for only $2 to $8 per tCO2eq.
As a source of income for companies that issue carbon offset credits, the underlying projects can take various forms, the most common of which are renewable energies, the improvement of energy efficiency, the capture and storage of CO2 and methane, as well as projects for reforestation, afforestation and integration of vegetation into other forms of land use. As an investor, this promising market exposes the portfolio to a decorrelation of market cyclicality, as well as significant long-term growth. Among the growing options are NETZ.NEO, a fund managed by Carbon Streaming Corporation, whose business model is based on investing in projects that generate carbon credits in order to sell them.
Compliance with regulations that are being strengthened regularly involves real challenges for companies. Indeed, they must first measure their emissions covering scopes 1 to 3, then implement strategies to reduce them accordingly. Thus, every year, companies must choose between buying more and more expensive allowances, or launching long-term emission reduction projects, and thus buying fewer allowances.
Regular reporting by companies on their extra-financial performance, or CSR report, is mandatory in Europe as part of the Extra-Financial Performance Declaration (DPEF), imposed by the NFRD on large companies. For others, it is not always mandatory, and the detail of its content is often based on volunteering. Businesses have every interest in buying carbon offset credits to meet their resolutions to achieve carbon neutrality by 2050, for which demand from consumers and investors is growing.
While the data provided on the carbon footprint of businesses is heterogeneous, the inclusion of carbon credits in its calculation is even more so. For example, in the US, only 20% of listed companies include their emissions in their CSR report. Among them, Apple does not specify the proportion of carbon credits in its net zero strategy. Others, such as BlackRock, JPMorgan or even Disney, used the Nature Conservancy, the world's largest environmental group, which sold carbon offset credits based on the protection of forests that have already proven to be well preserved. Since the purchase of these credits did not add anything to the forest conservation in place, these companies falsely declared to offset their carbon footprint in this way.
In the US, a proposal from the SEC, a financial regulator, would make it mandatory to include GHG emissions in financial reports, as well as other metrics related to climate and corporate governance in this area. This proposal aims to be published in December 2022 and is similar to the generally accepted best practices concerning reporting. The calculation of emissions should therefore exclude any carbon offset credit, i.e. the reporting of these emissions would remain at the discretion of companies. We could eventually see the emergence of a scope 4 dedicated to carbon offset credits, making it easier for companies to be transparent about their net emissions.
Carbon credits remain a recent tool, used by companies for investors. They finance projects to reduce future emissions, or to capture and store carbon. It is this second type of project that will be supported in the next part.
There are a multitude of technologies that allow the capture and storage of carbon dioxide. DAC, or direct capture of CO2 from the air, is a promising technology provided economies of scale are achieved. Global Thermostat for example uses this technology, and Climeworks manages the largest installation of its type. But this technology is still far too expensive today: up to $600 per TCO2eq. As natural reservoirs of CO2, the oceans are also an opportunity for DOC techniques for “direct ocean capture”. These methods use a variety of technologies to deacidify the oceans, capturing their CO2 and by extension, reducing the concentration of atmospheric CO2.
However, carbon capture and storage (CCS) technologies are by far the most widespread because of their profitability. So we will focus on this one. In general, CCS technologies make it possible to capture more than 80% of carbon dioxide from fossil fuel extraction plants before it is even released into the atmosphere. This CO2 is then stored in liquid or solid form. More specifically, CO2 can be captured in the pre-combustion phase, but the most common method today prefers capture during the post-combustion phase. Variants of CCS technology include CCUS, adding a U to the acronym for “use,” which includes all technologies that find a use for extracted CO2, rather than simply storing it underground or at the bottom of the oceans. BECCS, another variant, combines bioenergy with the CCS process. Biomass is converted into energy, and the CO2 emitted during this conversion is captured and stored.
Although necessary to achieve Net Zero, CCS and derivatives technologies cannot replace emissions reductions, in part due to their cost. According to various sources, capturing 1 tCO2eq would cost between $75 and $145. Carbon capture facilities require high initial costs, which is a second barrier to the development of CCS technologies. The profitability of this system can be based on the sale of carbon credits for the TCO2eq generated, or the use of CO2 to make cement that is more resistant and less polluting. Unfortunately, the most widespread use remains injecting into the soil to increase pressure (“EOR” for “enhanced oil recovery”) and thus extract more fossil fuels. It is therefore difficult to talk about neutrality or even carbon compensation in this case.
Nevertheless, projections point to a future rich in opportunities with accelerating growth. It is estimated that the global CCS market is expected to quadruple by 2025 and reach $50 billion, according to a Rystad Energy study. In addition to the 56 equipment and stations already in operation on the planet, 84 new private projects should come into service by then. These initiatives are expected to increase industrial storage capacity from 41 million TCO2eq currently to 150 million TCO2eq. Europe and North America concentrate 63 of these 84 initiatives. In particular, Norway plans to open Longship, the largest climate project in its industrial history. Private companies that use these technologies include for example Quest and NET Power. They attract the attention of major investors, such as Carbfix, benefiting in particular from the investment of Bill Gates. Public companies include Aker Carbon Capture, for which the CCS is the exclusive entity of its activities. These extend to Northern Europe and opportunities are emerging in the US.
The climate emergency weighing more and more heavily on our societies, combined with a constantly growing demand for energy and increasingly stringent regulations, make the use of CCS technologies inevitable. Numerous innovations continue to emerge to capture, store, but also reuse CO2, giving the carbon capture market and, by extension, that of carbon offset credits, a promising future. A source of opportunities and diversification, this industry deserves its place in our investment portfolios.
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