It Might be an Avalanche of Money...

Brace yourself - this is about to get controversial.

Three times in the last two months, investors that I deeply respect have told me about a new emerging market that they believe will become the investment opportunity of a lifetime…

I heard it once, and rolled my eyes.

I heard it twice, and became curious.

Three independent times… I began to dig.

I am talking about the Carbon Emissions Industry.

Now, before you hit “delete” on this email - here is my standpoint. I am an investor. I am not a climate scientist or weather expert. My job is to spot an avalanche of money and put myself in front of it. I have gotten this right a few times, and it has changed my life: Plant based food companies in 2018, crypto in 2019 and gold stocks in 2020.

I do not know if the carbon market is an avalanche yet, but I am trying to find out.

I have been digging in and I urge you to read this and form your own opinion.

Here is what I have learned about the carbon credit industry.

Carbon credits are a free market approach to reducing carbon emissions and thus combating climate change.

Why is this controversial?

It is controversial, because half of the internet does not believe in climate change - therefore the “problem” being “solved” does not exist, and the industry is based on fantasy.

The half that does believe, likely feels that making money off of climate change is immoral and corrupt.

So the captive audience is quite small… for now.

I understand. And I, as well, am skeptical.

However, I make an effort to explore the ideas that I am skeptical of, especially if I see a wave of money moving in that direction.

The money is moving.

What is the Carbon Credit Industry?

Earth currently emits 50 billion metric tons of carbon dioxide into the atmosphere on an annual basis. The major emitters are massive industries like utility companies, shipping and transportation.

In 2015, 192 countries signed a legally binding international treaty known as the Paris Agreement, with a stated goal of becoming a carbon neutral planet by 2050.

At a super high level, airplanes release carbon, trees absorb carbon. At present we are releasing 50 billion more metric tons of carbon than the world is absorbing. The excess 50 billion tons of carbon is what climate activists point to as the cause of global warming.

Now, I need to point some things out.

This is far from perfect science. There are valid reasons why climate change is hotly debated - but partisan loyalty is not one of them. The climate is infinitely complex, and analysts' ability to forecast just about anything is repeatedly terrible.

I personally believe that extreme climate change activists are equally as incorrect as staunch climate change deniers.

As per usual, the truth likely lies somewhere in the middle.

I am not here to debate climate science. I am here to follow the money, and money leaves clues…

Clues, like BlackRock Inc. - the world’s largest asset manager with over $10 Trillion in assets under management.

In several recent letters to shareholders, BlackRock CEO and Founder Larry Fink, has outlined his firm's plans to push his portfolio companies to match the Paris Agreement climate goals of achieving net zero emissions by 2050 - meaning the companies in BlackRocks portfolio must have a strategy in place to become carbon neutral. This will guide the firm's capital deployment process in the future, and may lead to the firm divesting from companies that fail to engage in carbon reducing strategies.

This is important - nothing is a static event - everything is part of a trajectory. Some trajectories are subtle and insignificant, others become massively consequential.

If a small investment fund did this as part of an Environmental, Social, and Governance marketing campaign, I would write it off as insignificant. When the world's largest asset manager does it? It could be a waterfall moment - investment funds will follow the leader.

Raising capital is competitive. If adding a carbon neutral strategy to the business plan increases the availability of cash - companies have a compelling incentive. I love the goodness of human nature, but change is created through incentives. Without them, we don’t change.

Another clue:

The Securities and Exchange Commission is soon going to require every public company in the United States to disclose their climate risks - the risks will be qualified into three “Scopes”.

Let's make it real with an example: Coca Cola.

For a company like Coca Cola:

Scope One emissions are the direct production of the beverage - energy and waste.

Scope Two is the supply chain - the procurement of the sugar, the coca leaves, the bottles.

Scope Three is the lifetime impact - in Coke’s case we are talking about plastic bottles and aluminium cans that end up in landfills and oceans and remain for thousands of years.

Why is this significant?

Media.

Remember, the media thrives on keeping the public angry at something. In a few years, this information will be reported by headline hungry media companies as a way to assess the impact of the world's biggest brands.

I assure you, we will uncover some surprises. We can expect energy, utility companies and shipping companies to lead the way in emissions, but inevitably there will be some surprise offenders.

What if a household brand like Starbucks, Lulu-Lemon or Whole Foods ends up way off the charts compared to their peers?

It will happen, this is information they have never had to disclose before. It is easy to claim sustainability when you are not having to prove it. That is about to change.

An immediate media backlash will erupt, finger pointing at the “evil corporation”. Consumers will respond accordingly.

Now look, no-one has more disdain for mainstream media as I do - but like it or not, they still carry influence. The last 18 months is an undeniable testament to that. People still react to headlines.

Fear of public shaming will incentivize companies to ensure they are not on the emissions “blacklist” by building carbon neutral strategies.

For many - it won’t be possible to reduce their emissions, so they will rush to fund projects that absorb the equivalent of carbon that their operation is emitting. If they are absorbing as much as they are emitting, they are net zero.

The easiest way to fund carbon absorption is through purchasing carbon credits.

What is a carbon credit?

A carbon credit is created by the absorption of one metric ton of carbon from the atmosphere.

Example, trees absorb carbon. So planting trees increases carbon absorption. If a company plants enough trees to absorb one metric ton of carbon (and this is where I question the accuracy of the science) they are rewarded with one carbon credit. They can now sell this carbon credit to Coca Cola, or any other company hoping to offset their emissions and become carbon neutral (net zero).

Remember, access to money and favourable public sentiment are the incentives for companies to fund carbon neutral strategies.

Right now, one carbon credit can be bought for roughly $10.00 USD. (The price of a carbon credit varies depending on the project that created it, more ambiguity…)

A bet on the carbon credit industry is a bet that the demand for these credits will grow faster than they are created, therefore raising the price. Basic supply and demand economics.

An example of Carbon Credit Creation

A hypothetical village in Indonesia is debating on selling a parcel of old growth rainforest to a palm oil company. The plans are to clear cut the forest and develop a palm oil plantation.

Wildlife will be displaced and the ecosystem will be destroyed, but the palm oil company is willing to pay $50 million to purchase the land - and build a community centre for the locals. In addition, they will provide 500 jobs to the community. The politicians will look like heroes for growing the local economy.

The land might be worth more than $50 million, and the economic life of a palm oil plantation is only 30 years, after which the jobs will disappear, but the government will take the deal, because there are no other offers for the land, and the community needs the jobs. 30 years of jobs for a community in abject poverty is a deal you take.

Forest conservation companies have tried to convince the community to decline, and that a sustainable ecotourism industry is the better plan, but the conservation company doesn’t have the financial resources to help get the industry running, and the speculative income from tourism doesn’t compete with the guaranteed jobs from the palm oil industry.

In addition, the government officials have been offered board seats at the plantation with passive salaries, so they lead the charge onboarding the community and take full credit for attracting investment into their little village. They will be heroes.

By the end of the plantation's life, the advocating politicians will have retired. The new leaders will be blamed for the loss of jobs, and they in turn will blame their shortsighted predecessors. They will promise to make their community great again, but without any offers from industry, poverty returns.

Is there a better way?

I am not sure, but this is the promise of the carbon credit industry. In the event that a natural habitat is slated for destruction, a conservation company can earn carbon credits by preventing the loss of habitat - one credit for every metric ton of carbon absorbed per year.

So in the above case, the forest conservation company now has the financial means to compete with the palm oil plantation’s offer. If they purchase and protect the rainforest, they will earn carbon credits that they can in turn sell to public companies that need to offset their emissions. They now have the financial resources to play the game.

Because the forest conservation company is now a for-profit business, they are highly incentivized to convince the locals to take their deal over the palm oil plantation.

The palm oil company will offer $50 Million plus 500 jobs… it is up to the conservation company to come up with a more attractive offer.

The forest conservation company can't offer the jobs? They will need to get creative. This is why the free market approach is the best solution. Entrepreneurs are more effective than politicians. I will bet on Elon Musk over Joe Biden any day.

It does not mean the locals will take the new offer - but it does mean they have options - and leverage. Whereas previously there may have been one bidder on the land, now there are two. That $50 Million parcel of forest just went up in price. Great for the locals.

Protecting rainforests slated for destruction is one example of how a carbon credit can be created. There are reclamation projects, carbon absorbing technologies, ocean protection, etc.

A key point - no-one gets credit for something that is already protected - so for example, California can’t suddenly cash in on Yosemite National Park.

Simply put, you need to plant a tree that wasn’t there, or protect one that would otherwise be chopped down.

The rush in demand for carbon credits will fuel a rush to create a supply. For profit conservation companies will need to raise capital quickly, and scour the globe for sensitive habitat they can save. They will need to fund the reclamation of lost habitat, and build technologies that can absorb carbon from the atmosphere.

They will do it, because they can sell the carbon credits they create for a profit. Incentives work.

I have spent many years of my life in very remote parts of the world, where wildlife populations are abundant and you can still drink from the rivers. I am not sure the extent of our impact on climate change, but I am very aware of what we stand to lose if we don’t take care of the natural habitat.

I have also seen this rodeo before - an emerging market and the tell tale signs. I follow the money. It’s my job as an investor to spot the avalanche and get myself in front of it. When I’ve gotten this right my life has changed. I do not know if this is an avalanche yet - but it is starting to look like one.