Asset class: Nature – Part 1

Part I – Creating value through Natural climate solutions (NCS)

This is the first of a three-part article on how NCS has emerged to be a new asset class

Natural climate solutions (NCS), according to Bain & Co., “are ways to sequester carbon through conservation, restoration, and improved land management of the world’s forests, grasslands, and wetlands.” Given this ability to abate greenhouse gas emissions and comparatively low marginal costs, among other benefits, NCS is expected to be a key component in limiting global warming to under 2°C above pre-industrial levels, in line with the Paris Agreement.

“NCS could account for 37% of total mitigation efforts—about 11 gigatons of carbon dioxide out of the net 30 gigatons that need to be abated each year—while also delivering economic and social benefits, such as restoring ecosystems and securing the transition to low-carbon livelihoods for communities that depend on natural resources,” wrote Bain & Co, in a note published last month.

A new asset class?

The growth of NCS could provide a great investment opportunity for investors as well. Today, only about 2% of the total $632 billion deployed annually in climate capital goes towards natural solutions. The primary reason for the low investment levels could be owing to unfamiliarity with the asset class among investors as well as inherent price volatility in the carbon market. Experts, however, expect this to change soon, with institutional investors set to enter the market and help with the maturity of the asset class. Several emerging trends may be pushing NCS funding forward, in this regard:

The boom in voluntary carbon markets: The value of the voluntary carbon market grew by a staggering 190% to just under $1 billion in 2021. Carbon credits – a permit that allows the owner to emit a certain amount of carbon dioxide or other greenhouse gases – have seen a major upswing in recent years, both in terms of trade price and volume. Although volatility in carbon markets has crimped volumes (and prices) considerably,
Shared standards: Global carbon markets have often been hampered owing to a lack of consistent standards with which to measure carbon emissions. At the UN COP26 conference in November, countries joined hands to address this, establishing rules about accounting and transparency to help international emissions trading markets. Bain reports, “the Institute of International Finance’s Taskforce on Scaling Voluntary Carbon Markets is working on legal principles and contracts for carbon trading as well as a global benchmark for carbon credit quality.”
Technological innovation: Tech innovation to NCS has helped grow transparency, accountability, and trust, all factors initially limiting the growth of the carbon offset markets. For instance, Bain reports, “improved forest monitoring allows for more accurate baseline assessments and monitoring while reducing setup and operational costs. Global Forest Watch’s new global maps (offered free online) can now detail the emissions and removals of a 30-square-meter parcel of forest compared with previous models that could only estimate broad changes in forest carbon flux across countries.”
The flourishing ecosystem of players: New infrastructure, actors, and systems (including marketplaces, brokerage services, and technical service providers) are developing globally. Domestic voluntary carbon markets also are emerging, reports Bain, for example, at least five countries in Southeast Asia are developing or considering emissions trading schemes, which can be a precursor to local carbon markets.

Investment funds have been growing rapidly, with an increasing number of investors today showing greater confidence in this asset class. Over the past five years, about 50 new funds with a strong NCS focus have been launched – about 20% higher than the previous period, Of the approximate $50 billion worth of capital committed from these funds, at least a third comes from private investors. These investments, according to Bain, “are increasingly viable, no longer dependent on public grants or a spirit of philanthropy.”

(To be continued)