The case for voluntary carbon credits

I am always looking for the next big thing, and although I am often too early I have been lucky to have been right a number of times. In 2018, after Bitcoin started going into a bear market and I was working full-time in the crypto space, I started looking at other investment classes that could have returns. I then stumbled upon carbon credits.

A carbon credit is the right to emit one metric ton of carbon dioxide (CO2) or an equivalent amount of other greenhouse gases. There are carbon credits issued by governments for the so called cap-and-trade market and there is the voluntary carbon market, a market that is overseen by standard setting bodies but that is not regulated by governments. When I first started investigating carbon credits I was only looking at the regulated markets, but I didn’t like the structure of it. The reason is that these cap-and-trade credits are created out of thin air by governments and given away or sold to companies that can use them to offset their emissions.

The problem with that is first of all that these carbon credits are not based on real emission reductions, which doesn’t make any sense to me. But more important, governments can unilaterally decide to issue more credits if they feel that’s needed, or they have the right to cap prices. As an entrepreneur or investor you don’t want to be active in a market that can be artificially manipulated by governments. So although I saw huge opportunities I decided to stay away from it.

In early 2021 I met up with 2 very experienced Dutch guys who had been active in the carbon credit space since 2005, among others trading credits and putting large international carbon projects together and executing on them. They are real veterans and have seen it all over the past 17 years. They told me about their business and I told them about my plans to build a sustainable business in the carbon space. I also explained that I didn’t like the regulated carbon space and they convinced me to take a look at the voluntary market. I had always dismissed voluntary carbon credits, simply because I did not believe you can build a real business on something that is voluntary. But after talking to them in more detail all of a sudden a light bulb went off in my head and I realized that the voluntary market will be the future of carbon credits instead of the regulated market.

Let me explain that: in the voluntary market a carbon credit is only issued once a project or a company takes one metric ton of CO2 (or equivalent) out of the air forever. It is a very strict system and it’s becoming stricter every year. The credits are bought by companies that want to offset their current or future emissions. That is voluntary, no government forces them to do this, and that’s why I dismissed it for a very long time. But what I suddenly realized last year is that the role of governments is not as important anymore as it used to be.

Nowadays consumers and investors are determining what companies should (or should not) do. What that means is that even though companies are not obliged to offset their emissions by government regulations, they are still setting net zero targets because their customer and investors demand it. If this is hard to believe (which it was for me for a while), look at what happened in Russia after they invaded Ukraine. Most Western brands decided to give up all their operations there, from Louis Vuitton to McDonalds, and from Starbucks to Apple. They were not told to do so by governments, but they did this because their other stakeholders wanted them to do so.

Virtually every big public company in the world now has emission reduction targets and many corporations have publicly said that they will have zero CO2 emissions by 2030 or 2040. There is no legislation telling them to do this, but they still do it. Customers demand it and capital markets now charge higher rates for companies that are not trying to reduce their emissions. 

So how will they get to net zero? Of course you can reduce your emissions, but getting to zero is almost impossible for any company. Not just for natural resources companies like oil or gas companies, but also for large Internet companies a net zero footprint is not possible without a way to offset emissions that you can’t reduce. And that’s where carbon credits come in: for every metric ton of CO2 that companies emit they will have to buy voluntary carbon credits to offset them. Because these carbon credits are actual reductions of CO2 (unlike the regulated carbon credits that are issued by governments) they allow companies to keep on emitting some greenhouse gasses as long as there is an offset for these gases somewhere else. 

Last year we started a company called Climate 8 to enter the voluntary carbon credit market. Climate 8 invests in very large reforestation projects on degraded land. These projects take CO2 out of the air and Climate 8 gets the carbon credits for these projects. It’s of course a bit more complicated than that, but that’s the core of the business. To us the co-benefits of our projects are important. They include for example ten of thousands of newly created jobs in areas with not many job opportunities. But we also use forestry models that preserve native species and enhance overall biodiversity.

We partially sell these carbon credits forward to pay for our costs, but we also aim to keep them on our balance sheet because I believe the price of carbon credits will explode over the next couple of years. Carbon credits in 2022 remind me of Bitcoin in 2012: most people haven’t really heard of them yet and most people don’t see why this new asset class will become very important in the future.

My Bitcoin thesis played out, but is just in the early stages. Governments and Central Banks simply printed too much money, which will eventually lead to a breakdown of the fiat financial system. My belief is that this will lead to cryptocurrencies taking over the role of the current fiat financial system, most likely before the end of this decade. There will be a huge demand for Bitcoin, but the supply will be very limited, leading to exploding prices. 

For carbon credits I see a similar future. The climate crisis is already quite visible and will get exponentially worse every year. The heat waves in 2021 were bad and broke many records, but 2022’s heat waves are even worse. Droughts are hitting large parts of the world and only seem to get worse. Even stubborn climate change deniers are starting to see that there is more going on than just a natural phenomenon. The worse the climate crisis gets the more people will demand governments and companies to do something about it. The problem is that governments have not been able to do anything over the past 25 years since the Kyoto protocol was signed. I figured out years ago that they were useless to solve the climate crisis, but only since last year I understood that we don’t need governments if we use voluntary carbon credits.

The worse the climate disasters get, there more people will force companies to do something about it. Companies will realize that they may be able to reduce their emissions by 30-40%, but if they want to reduce by more than that they will have to completely revamp their business models, which is impossible for many of them. So they will have to buy carbon credits in order to satisfy the wishes of the public, there is simply no other solution for them. That means a huge increase In demand, while it will be much harder or more expensive to increase supply.

Climate 8 currently creates new carbon credits for less than US$ 10 (our cost price), because reforestation is relatively cheap. However, there is a limit to how many carbon credits you can create by planting trees, there is simply not enough land to do it and certainly not land in areas where trees can easily grow. So in order to fulfill demand, technical solutions to take CO2 out of the air are needed. Luckily there are good solutions for carbon sequestrations, such as direct air capture, but they are very expensive. It depends a bit on the scale of companies and of the sequestrations technology that they are using, but generally a price of $300-500 per metric ton (=1 carbon credit) is not unheard of. 

If we start to use carbon credits at scale to fight climate change we will need to use the technical solutions, there is simply no way around it. That means that in order to make these technologies feasible, the price of carbon credits has to at least cover the cost to generate them. But because investments of billions or possibly trillions of dollars are needed to pull this of, the market will not just want to break even on these projects. So possibly prices of $300-500 per carbon credit will be on the low side, and prices could go to the thousands of dollars per carbon credit. Companies simply need ttem to survive and the world needs them to survive as well, then almost no price will be too expensive.

Current voluntary carbon credit prices for nature based solutions are about $10 per credit, but in the EU the regulated market pays almost $100 per credit already. When I started looking at carbon credits a few years ago these EU credits were at $15. My expectation is that both credits will eventually be interchangeable, so the voluntary credits will have a similar price to regulated market credits. Most likely the voluntary credits will go up fast over the next couple of years to catch up, and likely EU credits will keep going up fast as well.

A return of 10X is the least I expect over the next couple of years for voluntary nature based solutions, but it could very well be 50-100X. That may seem over the top, but it’s the same as it was with Bitcoin 10 years ago. Nobody would take you serious if you would tell them that Bitcoin could go to tens of thousands of dollars, just like most people still don’t see that Bitcoin could easily go to a million dollars or more if it becomes more accepted as a reserve currency. 

The point is that you have to be able to think out of the box if you want to understand where carbon credit prices could go. I think the downside risk is fairly limited unless we completely give up on the climate, but the upside is extremely high. Maybe it won’t be a 100X return once more people start creating credits or if the cost of creating technical solution credits would fall quickly, but I am pretty certain 10-20X will be on the lower side of the returns that we will see.

And that’s why I believe that Climate 8 is making a smart decision to keep as many of its credits on its balance sheet in the future, just like we did with Bitcoin mining company Hut 8. We may eventually tokenize some of these carbon credits, but for now the focus is on getting our first projects up and running and close the financing for these projects.

Climate 8 is a private company that is mainly funded by the management team. We are not raising funds for equity in the company, so there are currently no investment opportunities for outside investors. However, we do have a mailing list for people interested to invest once we open up to accredited investors or to the public.

Note: this is my personal opinion and not investment advice. I intentionally simplified some numbers, but the core is the same. Do your own research before you invest.