managemnet company strategy managemanet A Game Plan for Funding Carbon Offsets

A Game Plan for Funding Carbon Offsets

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The most common types of carbon offsets are natural-based offsets such as forests. Unfortunately, while emissions remain in the atmosphere for about 1,000 years, possibly longer, a tree can only sequester carbon for its lifetime of 10o or so years, which means that a forest planted as a carbon offset must be maintained with trees replanted at least ten times to match the emission it offsets. Most businesses are reluctant to raise capital in this way, but such projects can be (and have been) financed through perpetual bonds, which represent attractive investments for investors such as university endowments with very high liability streams that will arrive in the future. The use of financial instruments such as perpetual bonds will make a sufficient amount of capital available to offset producers, which will stimulate production and the creation of spot markets for offsets that can be fully and reliably recovered. against emissions.

In September 2015, a curator from Yale’s Beinecke Rare Book and Manuscript Library traveled to Amsterdam to collect the past 12 years’ worth of interest on a bond issued on May 15, 1648. In issuing the bond, the borrower, an autonomous Dutch water authority, promised to pay interest to the owner. forever. The money from the bond sale is used to pay for an infrastructure project that protects against sea level rise.

Such perpetual bonds could prove useful in today’s fight against climate change by enabling the financing of projects that remove and store carbon forever. Carbon offsets can be used to offset carbon-emissions debts (or E-liabilities), thereby helping businesses and other organizations achieve net-zero goals. Perpetual bonds can also support efficiency improvements area markets to remove offsets, spurring their production and their use.

Perpetual bonds can help resolve an important mismatch between the duration of many carbon offsets and the duration of the E-liabilities they will incur. As we noted in our July-August HBR print article, “Accounting for Carbon Offsets“E-liabilities from greenhouse gas emissions pose a particular challenge to financial markets because the emissions produced today are expected to remain in the atmosphere for more than 1,000 years, a period longer than than typical financial liabilities. For that reason, we established the need for offsetable carbon-emission assets (E-assets) that also have no definite duration.

Some E-assets such as carbon capture and storage through underground mineralization clearly meets this criterion, but such E-assets are currently uncommon. Nature-based offsets (NBOs) such as virgin afforestation programs are now more widespread, often with shorter durations from limited (unfilled) lifetime of forests (possibly less than 100 years). The issue, then, is whether NBOs can be used to offset E-liabilities: if they can’t, then most of the offsets for offsets currently provided are only down-payments against long-term emissions liabilities.

For NBOs with an indefinite duration, the issuer must commit to managing the underlying (forest) property in perpetuity – that is, replanting the forest as its trees naturally decay. or be destroyed by disease, fire, etc. To finance this operation, the offset provider needs capital not only to buy the land and plant trees but also to provide predictable costs forever. In other words, they must invest part of any capital they earn in an endowment fund, the returns of which can go to finance forest management so that carbon remains unchanged (defined as, say, 1,000 years, a reasonable scientific estimate. how long the carbon emitted today will remain in the atmosphere).

In addition, because of the indefinite commitment, an issuer that wishes to qualify some portion of its current (or “found”) liquidation offsets as immediately and fully nettable against of E-liabilities of the buyer must allocate a separate (very large) portion. of his available earned offsets against future carbon sequestration commitments.

All this means that the providers of capital to the producers of NBO offsets can expect a relatively low return on their investments, even if distributed forever. Individual offset buyers (usually for-profit businesses) do not find it attractive to tie up their own capital in this way. But such an investment can be attractive to institutions that need endowments to cover predictable future debts, such as universities and churches. The investment will take the form of a perpetual bond – such as that issued by the Dutch water authority – or of preferred equity with a fixed dividend. Ordinary equity is probably not suitable for financing unlimited duration offsets because investors usually want a guaranteed return for tying up capital in perpetuity with limited upside.

Consider, as a hypothetical example of how a perpetual bond approach might work, an indigenous tribe in Canada that wants to sell nettable E-assets from a virgin forest that it will plant on its land and manage forever. To do this, it must raise capital to develop and maintain the forest. The tribe can issue a perpetual bond and put some of the capital into a perpetual financial endowment. The tribe uses interest from the endowment to pay for forest management costs. As the offsets from the forest become “realized” – that is, trees that mature and sequester carbon – the tribe can sell some of these E-assets to cover costs, including interest. in perpetual bonds.

Let’s say 20 megatons of CO2 equivalent (MtCO2e) of the offsets from the existing forest trees “taken” this year and will be for the next 100 years, but the trees must be replanted at least 10 times to be nettable against 1,000 years that E-liability . To distribute the risks of this commitment, the tribe can sell 2 MtCO2e of this year’s offset as “seen” forever (ie, 20 Mt divided by 10).

If there are enough producers of NBO offsets and enough demand for them, nettable offsets can be sold in a liquid market, which distributes future forest risks among different offset buyers and helps of the tribe to meet the obligations of interest. The buyers of the area next year will be different from the current year, and, in fact, the buyers of the area hundreds of years from that will probably be very different, but together, by contributing to the interest costs of perpetual bonds, they share a high series of risks with NBOs. . The scheme will be profitable for the tribe as long as the income from spot sales of nettable offsets and from endowment returns exceeds the costs of interest on the bond and the ongoing costs of managing the forest.

Presumably, no one 375 years ago expected Dutch seawall-management bonds to pay interest today to a New England university library 3,500 miles away. Likewise, we cannot predict how financial markets will evolve to meet the needs of managing emissions liability. But the path outlined here suggests a viable market solution to reduce the long-term consequences from today’s carbon emissions.

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