Follow Smart Money to Carbon Trade

The recent post “Who Pollutes Pays” on December 8^th discusses the negative externalities or costs imposed polluting companies on the unfortunate public.  Few shareholders like seeing the dent in profits from regulators trying to get producers to cover their true costs of production.  Thus analysis tends to focus on the negative side of things.    There is potential for positive externalities as well, wherein the general public receives for free some benefits from the way a company goes about turning out its products. 

Consider a forestry company that grows trees, which by their nature absorb carbon dioxide in the atmosphere.  The company will eventually harvest some of the trees and sell the lumber and wood chips.  In the meantime, the trees soak up carbon emissions that lead to global warming and climate change  -  a carbon sink.  Everyone, not just customers, benefit from the trees. 

It is possible for the forestry company to receive compensation for its carbon sink by-product as a ‘carbon offset.’  In the vernacular of economists, the positive economic externalities are internalized and monetized.  Carbon markets have sprung up to bring together producers of carbon offsets (the sellers) to others that need to make up for the carbon they produce and cannot entirely eliminate (the buyers).

The first carbon offset programs were established under the Kyoto Protocol.  These markets arose out of compliance to national or regional regulatory schemes for carbon emission reductions.  California adopted a cap-and-trade program in 2006, and has since become one of the largest carbon markets in the world.   

Voluntary markets soon followed, but remain highly fragmented.  California’s Climate Action Reserve (CAR) is among the most successful and has been officially recognized by California’s Air Resources Board to serve as an Offset Project Registry.  CAR has been proactive in working with private business to reduce carbon emissions.  For example, in September 2020, CAR issued a Soil Enrichment Protocol detailing methods for farmers to invest in sustainable management of agriculture lands.  The protocol guides farmers in creating carbon offsets by increasing soil organic carbon storage as well as decreasing net emissions of greenhouse gases.

The value in a carbon offset is too promising for investors to overlook.  Agriculture, forestry, renewable energy, landfill gas capture, and repurposed fossil fuel infrastructure are among the sectors and projects that have potential for monetizing the positive externalities of carbon reduction.  How can carbon offsets help boost profit margins?  How much capital can be raised through the sale of carbon offsets?

It might be effective to follow the smart money.  BP Plc (BP:  NYSE) has recently invested $5 million in the parent of forest carbon management company Finite Carbon, a self-styled carbon offset developer.    Finite Carbon is involved in over four dozen carbon projects covering three million acres.  The company claims these projects have generated over $500 million in revenue for the projects, giving value to carbon offsets that rivals lumber as a projects.  The trend has interesting implications for countries like Brazil that is struggling to build its economy on slash and burn practices that are destroying its ecology.

Too often investors have focused exclusively on the costs to polluters from environmental regulation or from pollution taxes.  Astute investors must begin scrutinizing business plans and project proposals with the income potential of environmental responsibility in mind, specifically the production of carbon offsets.    

 

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.