GUEST POST: A Deep Dive Into Carbon Credits and How We Can Protect Earth’s Lungs
Matt Hayden and Andrew Hurst from Sea Purity Investments join us to discuss their carbon projects.
In today’s edition of the Guest Perspectives series, we will be expanding on our Carbon Markets manifesto and doing a deep dive into forestry credits. We are joined by two investors who have much more in-depth knowledge on the subject – Matt Hayden and Andrew Hurst from Sea Purity Investments. Today’s Guest Perspectives post will follow an interview-style format. Without further ado, we are excited to introduce Matt and Andrew!
Introducing Sea Purity Investments
Sea Purity Investment Portfolio[1]
Sea Purity Investments is a family office that employs a fundamental, multi-strategy approach to investing, focused on producing positive absolute returns while beating the market over the long-term. Investments cover the spectrum in both public and private growth companies, operating across multiple sectors, income generating assets, and alternative funds. Assets are split 50/50 between funds and direct investments.
Matt Hayden & Andrew Hurst
Matthew Hayden (Matt) is an active investor through his family office, Sea Purity Investments. Matt’s started his career as a licensed broker and in 1996 transitioned by founding Hayden Communications, an investor relations firm focused exclusively on servicing small-cap companies. Following this, he and Ted Haberfield built what would become the North American division of MZ GROUP, a subsidiary of the largest global independent Investor Relations Firm.
Andrew Hurst is an Associate at Sea Purity. He came from Cue Health Inc in San Diego, a biotechnology device startup, where he was heavily involved in the company's scaleup as they transitioned to a Good Manufacturing Practices production environment. Andrew assists with the management of Sea Purity’s venture portfolio. Andrew graduated from Yale University's chemical engineering program in 2018 and worked on a novel waterproofing textile treatment in the Pfefferle Lab group.
Deep Dive into Forestry Credits & Outlook
To set the stage, can you tell us about the types of projects you have worked on?
We currently have two investments in larger-scale REDD+ forestry projects in Brazil. At the highest level, we are taking at-risk sections of the rainforest and putting a figurative fence around them. As part of this process, we are protecting that property for a minimum of 100 years. In addition to the environmental impact, these projects bring a number of community benefits to the residents of those areas.
Can you walk us through what the process looks like?
First, you have to secure the land through a long-term lease. This usually involves approaching adjacent landowners and discussing the revenues they would bring in if they were harvesting the trees, using the land for pasture, etc. Land-based carbon projects like these typically receive credits over a thirty-year period, so you project those revenues over 30 years and strike a deal with the landowner where they agree to encumber the land and not use it for agriculture or development. In return, landowners get a cut of revenues from the sale of carbon credits that should be roughly equivalent to the value that would have been extracted over 30 years. That lien – if they were to sell the land – transfers to any new purchasers of that land, and any new buyer must accommodate the prior commitment.
Then, you hire a services team to do the pre-feasibility work. You need to understand the scope of the project, what challenges you may encounter, and whether there's a case to be made for an emissions reduction in the project area at all. Hiring a consultant can be quite challenging; you have to ask, “Who has bandwidth, experience operating within the project's area, and is qualified to work on my project's chosen third-party standard?” These groups are in such high demand – rarely the one you want is available right away.
Next, you have the formal Project Design Document (PDD) and community involvement. This is where you describe in writing what exactly is being done in order to protect each parcel according to the standard methodology set by the registry for each project. This document can be thought of as analogous to a fund's prospectus, and it includes a very explicit description of where the project is, who owns the land, and how carbon stocks in each part of the forest are quantified. As you are working to file the PDD, you are working on community engagement with the project in and around the project area. Part of our mission is educating local populations on why it’s so important to protect the lungs of the earth. Another part of our mission is creating local jobs. This includes hiring forest rangers on the ground and creating a monitoring function. As we are generating carbon credits and protecting the land – people get to see in real-time the actual benefit to the community. In this capacity, we are really starting to get local government support, as well as support from a couple of local NGOs. Lastly, there is a 30-day public comment period on all new PDDs before work starts on evaluating the land. During this time members of the local community and the voluntary carbon market can pick apart the assumptions and methods laid out in the PDD, so it's essential for every aspect of the project to be extremely polished. Lazy projects can and do get halted in this step every year.
Once you strike the deal, you have to make sure it is adhered to. That includes the physical protection of the land by forest rangers and fences. In addition to physical protections, it’s critical to have legal protections. You need good legal teams on the ground to deal with title issues and claims--in many jurisdictions, you will run into these types of issues much more often than one would think!
Next, there is the ongoing measurement of how carbon stocks in the forest are doing. The goal is to answer the question, "Do the assumptions made in the PDD on carbon entering or leaving the forest during the course of the year remain true?" Each year, the parcel is assessed in its entirety by chartering an assessment, flying over, and sampling on the ground. You have to physically guarantee the property and the inputs and have the credits verified by a third party. Hiring a verifier is also challenging – in addition to finding a verifier with the willingness and bandwidth to work on the project, you also have to find someone with geographic expertise here, too. The same validator with expertise in Indonesian REDD+ projects may not have the same ability to read through a chain-of-title dispute in Brazil. Once all the manual work is done, and the conditions of the registry's standard are deemed to have been satisfied according to your validator, carbon offset credits are finally released ("issued") by the registry to the project owners, and owners can begin selling into the market.
That sounds like a lengthy process! What stage are y’all at now?
We are expecting our first round of credits shortly, so we have been talking with a lot of potential buyers.
In general, for anyone looking to invest in projects like this, you also need to be developing relationships during the process we’ve just laid out. This helps you understand how premium (or not) your own offsets are going to be in the overall market. It also helps you build a strategy for what your hold period should be and what your appetite will need to be for taking risks off the table. If you own a project or some cut of a project for its entire life, there are companies that know they will need to purchase offsets on a recurring basis for a long time, and you may work out a longer-term deal where that company agrees to purchase year-over-year for 5-10 years, with step-ups in pricing along the way. There are a variety of structures possible to see liquidity from these projects, and it's important to start establishing those relationships well ahead of your first issuance.
Now, let’s talk about outlook. Do you see there being a carbon credit “gold rush”?
New buyers are coming to the market every quarter as companies are issuing emissions reduction goals. These projects are expensive and time intensive (at least ~18-24 mo. start-to-finish), and there is still a feeling among many buyers that there is not enough to cover the rising demand.
This narrative has been going on for two years now – a massive run on carbon prices because there isn’t enough for corporates to cover their goals. However, if you look at current buying activity relative to the backlog of projects with carbon issuances pending, there is still a huge surplus in the market, so the real story is a little more complicated. While there is certainly demand, there's no way the story is as straightforward as, "price will go up."
One thing that isn’t talked about is state-owned carbon projects. Some regions are nationalizing their own carbon stocks. Governments are steadily starting to insert themselves in the carbon value chain, and some are even putting these plots of land together themselves with a much lower cost basis and higher scale than can be achieved by private developers. It’s hard to know how this will affect pricing since there's so much potential supply, though that supply may be seen as somewhat lower-quality.
How do you see the carbon markets evolving in the aftermath of the IRA?
The IRA hasn’t really impacted our work to date. It does give subsidies to groups in the US doing things like industrial carbon capture and grants funding for direct air capture, but we deal primarily with REDD+ credits in Brazil.
The one that companies in the voluntary carbon markets get excited about is the SEC’s climate disclosure proposal. Getting good data on scope 3 emissions, even just looking at Tier 1 suppliers, is an enormous lift for companies. Companies are going to have to meet the demands of the SEC, and there's a chance that institutional investors start to take the numbers reported in that disclosure into account when making investing decisions. It remains to be seen what will become of the proposal since the final action by the SEC is yet again delayed.
Understanding that most of your current work is in Brazil, have the results of the election impacted your outlook at all?
We believe this is a net positive for mankind. This incoming president has openly stated his goals for conservation, but this is going to take a while to get into place. If you are a project developer looking at a project in Brazil, your assumptions on deforestation possible in the area may be changing, meaning you may not be able to claim as much credit for protecting a plot of the forest as you once were.
On the flip side though, now the state itself is invested in furthering the preservation of rainforests. You always have to look at these things and see both sides.
For our projects, this may have a limited impact because we are so far along.
Do you think the Science-Based Targets Initiative will be successful in pushing for only removal offsets counting towards net-zero goals? What will this mean for REDD+ credits?
At some point, it’s likely. The idea that corporate buyers prefer these nature-based solutions (which have largely been deforestation avoidance projects to date) really comes down to two things: volume, and the ability to market the "co-benefits" of the project. Before nature-based solutions, people were buying offsets from other projects like large solar plants. These plants could produce enough tonnage to get it done at the time. That same idea--availability of inventory--is probably the main reason why forestry offsets are important right now for these buyers. It comes down to how can we get the most tonnage through at a cost basis that makes sense. In addition, many companies have used the idea that by protecting a given mangrove forest, grassland, or rainforest, they are also protecting important biodiversity while at the same time reducing their carbon footprint. This narrative of co-benefits has been important in solidifying buyers' preferences for nature-based offsets over other types.
Eventually – I think one way or another – market preferences and narratives will shift. Just as it shifted from renewables to forestry, it will likely shift away from avoided deforestation. Not anytime soon, however. There aren’t enough projects at a scale that could produce the tonnage to cover obligations.