Carbon neutrality – myths and reality

How will the countries and the companies of the world achieve their very ambitious carbon neutrality targets? Craigmore Partner, Josef Nagel separates the myths from reality.

“The Great Reset” is an idea advanced by Klaus Schwab, founder of the World Economic Forum in Davos. One of its goals is no less than a rapid post-pandemic overhaul of economic systems, business models and societies. I would argue that the Great Reset has been turned into a political panacea.

The corporate world, governments, and entire economic blocks (such as the EU) are trying to outperform each other with ambitious PR and impressive announcements, “we will decrease our carbon footprint by 50% in 2022” or “we will become carbon neutral by 2030” or “the EU aims to be climate-neutral by 2050 – an economy with net-zero greenhouse gas emissions”. Microsoft will be (or rather, I would suggest, is aiming to become) carbon negative by 2030, and by 2050 Microsoft has promised to remove all the carbon the company has emitted either directly or by electrical consumption since its beginnings in 1975. I fully support setting ambitious goals to drive outcomes but note that leaders who fail to achieve their goals by a wide margin risk losing the support of the people, and, more importantly, risk losing sight of the goal. Now is the time to stop and consider dispassionately how these goals will be achieved. Is there a risk that everyone assumes that they will have a monopoly on the tools to achieve net zero and beyond?

Many companies and, indeed, economies have been slow to react to increasing pressure from consumers, shareholders, pension contributors, the voting public, and schoolchildren to get their act together and introduce measures to reduce their carbon footprint. Some have taken the easy-way-out by simply delegating their corporate responsibility to the end-consumer, Lufthansa and Air New Zealand for instance offer the ability to off-set emissions from your flight at check-out. For a few extra dollars you can fly across the world guilt-free.

The world is trying to embrace a “new normal” in which climate protection is society’s collective mega-challenge, but we do not wish to give up many parts of our comfortable lives. I raise my eyebrows when reading resolutions by UN climate conferences, policymakers such as the IPCC, and political parties aiming to limit global warming to 1.5°C – written and passed like an average corporate governance resolution. PR implies reaching net zero CO₂ emissions globally around 2050 and concurrent deep reductions in emissions of non-CO₂ forcers. The question remains, collectively, how are we going to achieve these goals? Let’s think about it.

The Numbers

Let’s look at the reality and the facts. Global man-made CO₂ emissions in 2019 were 33 billion tons. The graphic below shows emissions by source.

Source: iea.org/data-and-statistics

Don’t get me wrong, we should all welcome the numerous initiatives and announcements (and occasionally actions) to avoid and reduce GHG-emissions, but my impression is, this is where the public debate often ends. Even if the direct carbon emissions of one activity is reduced by, say 50%, that still leaves 50% remaining to compensate or sequester. The only natural and immediately available way, at least for the time being, is in the management of land – with TREES at the forefront.

The world requires an additional 900 million hectares of new forests (the size of the US), preferably immediately, to sequester our existing and future CO₂ emissions. Instead, we are currently deforesting about 10 million hectares every year! There are obstacles to reaching the 900-million-hectare target but all of us, including those of us with the financial means to influence outcomes, can make significant contributions.

Today, the most efficient, cost-effective method of capturing carbon and reducing atmospheric CO₂ is to increase the global biomass of trees or woody vegetation (researched by ETH Zurich). This can only be achieved by both reducing harvest volumes and the clear-felling of existing forests; AND by re-planting trees and establishing new, greenfield forests on land which was previously forest, often cleared many generations ago. There are various ways to achieve set targets and create incentives.

We fight the war on greenhouse gas emissions on two distinct fronts. The first is the reduction and avoidance of future possible emissions by emitters and the second is the actual sequestration of carbon from the atmosphere:

1. The reduction and avoidance of CO₂ emissions

• CO₂ emission reduction goals are defined by each country. Those who have signed and stood by their commitment to the Paris Agreement are obliged to do so
• These goals are then supported by regulation, typically either in the form of an ETS (Emission Trading Schemes) and/or taxes on emissions
• This, and public pressure and perception, incentivises the reduction of a portion of emissions at a company level

2. CO₂ Sequestration

• Today, the only cost-effective method of capturing carbon is land-based. Forestry, grasslands and wetlands all capture carbon from the atmosphere. The best way to facilitate and incentivise this is to establish trading platforms for “Forest Verified Carbon Units”. A prerequisite for all such voluntary (or mandatory) market projects is the additionality and permanence of the emission reduction (i.e. through additional biomass).
• There is currently no other viable way to sequester CO2
• The annual growth rate of forests determines the additional volume of CO₂ sequestered annually.There are currently two prevailing kinds of Emission Trading Schemes:
  Regulatory or compliance markets are created and regulated by mandatory international and regional carbon reduction schemes such as the European Union’s Emissions Trading Scheme (EU-ETS), and the New Zealand Emissions Trading Scheme (NZ-ETS). There are 21 Emission Trading Systems Worldwide (as of November 2020), which actively contribute to the sequestration of carbon and incentivise a reduction in emissions.

Voluntary offset markets function outside of the compliance markets and enable companies and individuals to purchase carbon offsets/certificates on a voluntary basis. The voluntary market is currently experiencing an enormous boom – independent auditors verify the eligibility of all projects and certify them.

The available supply of off-set credits or units under these schemes is currently low. Demand is increasing and looks set to explode. As an educated reader, you will appreciate the basic laws of supply and demand govern what might happen next.

It is also important that the market and purchasers understand that there are various definitions and therefore differences in the quality and effectiveness of the different types of certificates. ‘Forest Verified Carbon Credits’ are a good example of this. ‘Forest Verified Carbon Credits’ are issued for projects that sequester CO₂ rather than just reducing emissions.

‘Forest Verified Carbon Credits’ must comply with standards that are certified by recognized institutions (e.g. VCS, Gold Standard, BUND, CCB Standards, GFG-Energy, etc.) to ensure that the certificates actually originate from effective climate protection projects. Critically these standards ensure one credit is not sold many times.

I believe the Verified Carbon Standard (VCS) which is part of the VERRA organization has a good chance of becoming one of the prevailing standards. Currently it is the most widely used and accredited standard worldwide for compensating GHG emissions. VCS accounts for many of the transactions in the international global voluntary market, and therefore has a significant relevance for the market, especially afforestation or avoided deforestation. Under VCS there are different methodologies for optimizing CO₂ storage in forests.

Suitable methodologies are selected for certain areas and confirmed by VERRA. The area is then certified by independent third-party auditors. The CO₂ certificates generated (1 ton of stored CO₂ = 1 carbon certificate) are registered in an account with VERRA and can then be sold at market prices or retired by emitters to off-set emissions.

Most of the existing standards use similar methodologies to calculate the effective CO₂sequestration and there might be various efforts underway at national or international levels (e.g EU). However, to make a serious impact we need to put our energy into the development of a global carbon standard supporting a global marketplace! In the future, there should be no loopholes to arbitrage different standards and markets.

What is the fair price of carbon?

Basic economic theory tells us that the fair price of a product or service is where supply matches demand. Now, in our case, this suggests that the fair price is the one which is needed in order to restore carbon equilibrium, or even return to a world with CO₂ levels prevailing in, say, 1960. In reality, there is no fair price at the moment since supply cannot meet the steep surge in demand. Actual prices for carbon credits whatever the precise underlying features are often non-transparent and can vary from €5 to around €50. In New Zealand, revenue from the sale of carbon will pay for the cost of land and the cost of planting forests in approximately ten years. This is a result of the well-functioning emissions trading scheme pricing carbon.

I am confident that prices will continue to increase, and my hope is that at some point we will have a global carbon credit market where emitters pay to off-set their footprint and forestland owners sell their credits (instead of the local only markets we have currently).

New Zealand Carbon Price History

Source: Craigmore

Farm and forestland are the real ESG investment

In a world where interest rates are zero or below, financial markets will increasingly be driven by ESG outcomes. The investment community can now choose from a growing range of funds, ETFs and alternative strategies. Amongst this smörgåsbord of ESG opportunities it is very hard to separate the wood from the trees. The challenge for investors is to ensure they fully understand sustainability and the outcomes of each investment decision. Natural capital offers a unique opportunity to reduce the greenhouse gases in the atmosphere.

To conclude – some thoughts on the future

The Great Reset in the context described above will reinforce a massive push towards a Net Zero World, including further support for e-mobility and renewable energy production by society and politics. The Green New Deal will lead the European Union into the new era; I expect to see the Biden Administration doing the same in America, beginning with the renewed commitment to the Paris Agreement.

We will see more creative ideas from policymakers such as carbon taxes. Both carbon taxes and carbon offset-markets must lead finally into increased forest biomass.

The difference between carbon taxes and an organized market for carbon offsets is simply on the cost side.

Whilst carbon taxes are collected by the state and then (possibly) re-allocated to forest owners to incentivize them for further reforestation or conservation measurements, organized carbon offset funds find their direct way from the emitters to the forestland owners, and if correctly structured, with a high degree of market efficiency.

More importantly, an increasing number of initiatives will lead to an emergence of new regulated carbon credit markets. I expect these will often be driven by voluntary projects where real money changes hands between emitters and producers of Forest VCUs. As these markets continue emerging the significance of forestry for sequestration and carbon off-sets will be more widely understood and result into more afforestation programs. Managed forestland will be taken out of production for approx. 30 years and certified for credits based on their additionality mentioned earlier.

National efforts mean well but will usually not have the desired impact, greenhouse gases don’t know any borders. We need efficient programs spanning entire continents (e.g. Europe or North America (both the US and Canada) or Asia) which support massive increases in forest-based biomass. This requires global coordinate on a scale largely unseen.

The eco-systemic role of our global forests beyond its carbon sequestration function (such as water, erosions protection, etc.) will be increasingly recognized and inevitably monetized as well. With it, the awareness will grow that right now, today, forestland was one of the most undervalued asset classes of our time.

Press the Reset Key and watch it!

With warmest regards for the festive season!

JJ Naegel

About: Josef Naegel is a Craigmore Partner and a founding partner of GlenSilva GmbH. GlenSilva is an investment advisor to institutional clients, including family offices, on timberland, biomass plantations and farmland investments. Josef sits on Craigmore’s Forestry Investment Committee, having worked with Craigmore for seven years.