Background: I’ve spent the last few years learning about climate change. Recently, I thought of a new model to finance mass reforestation and long-term (100+ year) forestry stewardship. I’m calling it “Evergrow”, a play on the word “evergreen”. In investment management, evergreen funds are funds have have no end date, so the idea of an evergreen vehicle that develops and owns forests seems appropriate.
One thing most people don’t realize about climate change is our reliance on the widespread rollout of negative emissions technologies in the next decade. The rollout of these technologies is even baked into the Intergovernmental Panel on Climate Change’s forecasts of global temperature rises over the next century. Unfortunately, these technologies don’t exist yet at the cost or scale necessary to meet our needs.
Meanwhile, we have an effective, affordable, and proven carbon capture and sequestration solution at our disposal today. They’re called forests. Forests are incredible carbon sinks. Every second, the trees and plants in the world’s forests are breathing in CO2 and turning it into biomass through photosynthesis. By some estimates, forests sequester up to 45% of the world’s carbon stored on land. Unfortunately, we’ve significantly depleted the world’s forests to clear space for housing and livestock, and make wood products and palm oil. Forest depletion is a one-two punch on climate change. When we remove forests, we both (i) release the carbon that forest was sequestering into the atmosphere, and (ii) lose that forest as a source of further sequestration.
An obvious thought would be that we should immediately plant lots and lots of trees. This idea has recently gotten the endorsements of a scientific paper in Science, the Nature Conservancy, and Marc Benioff (to name a few). But there are 3 challenges with naive tree planting as a strategy to combat climate change. First, not all trees are created equal when it comes to their ability to sequester carbon: they grow and sequester carbon at very different rates, depending on species, climate, geography, and more. Second, we have a short window to address climate change. What are the mechanisms for us to mobilize capital and labor toward mass reforestation, and how quickly could we do this? Third, we need to make sure that the forests we plant sequester carbon permanently (or for an arbitrarily long time). It’s no use to plant a trillion trees only to see them lost again to logging, urban development, and fires.
Some have put their hopes in the emerging markets for carbon offsets as a means to finance mass reforestation. On a quick scan of California carbon offset projects, most of them involve forests. However, these projects seem to rely on California’s “improved forest management” protocol, which involves harvesting fewer trees from commercial timberlands vs planting entirely new forests, the latter being far more impactful on carbon emissions. I suspect this is because of the way many forests are owned.
Historically, most commercial forests were owned by industry – e.g., a sawmill. In the 1990s, institutional investors began allocating large sums of capital toward commercial timberland investing. Now, most commercial forests are owned by investment vehicles, whether private funds or REITs. Weyerhauser, the largest timber REIT, has a market capitalization of over $22B at the time of writing. The problem with this model of ownership is that it requires forestry owners to generate cashflow within a predetermined amount of time. A fund manager typically has a 10-year window in which to make and realize a return on their investments. Public REITs have even shorter horizons, as they’re held to a quarterly dividend number by Wall Street investors.
As you might expect, these investor timelines are much shorter than those of a natural forest. It takes a Douglas Fir tree over 100 years to reach its peak growth rate, which is roughly proportionate to the rate at which it sequesters carbon. Meanwhile, the average age of harvest for a Douglas Fir tree in a commercial forest in the Pacific Northwest is around 40 years. These mismatched timelines also prevent investment in reforestation, because investment managers don’t have time to wait for newly planted trees to grow. For example, to obtain certification for a carbon offset under California’s reforestation protocol, a forest owner has to promise not to harvest any trees for at least 30 years, representing a mandatory hold period three times longer than the lifespan of a normal investment fund. Note that the problem isn’t that the underlying forests aren’t appreciating in value; it’s that investors need liquidity before the trees have reached their natural maturity. Generally, the only way to turn paper gains into realized cashflow from a forestry asset is to harvest the forest for timber. Putting it together: we’re cutting down the world’s forests to meet investor expectations on IRR, because “you can’t eat paper”.
Permanent capital for reforestation
How can we simultaneously (i) invest in planting new forests, (ii) own those forests for a very long time, and (iii) provide liquidity to investors without harvesting those forests? There’s a company that’s figured this out. Replace “forests” for “companies”, and you’ve got Berkshire Hathaway.
Berkshire Hathaway is Warren Buffet’s permanent capital vehicle for investing in businesses. Berkshire generates capital by selling reinsurance, and uses this capital to invest in businesses that appreciate in value over time. Because Berkshire itself is publicly traded, equity investors in Berkshire have liquidity independent of Berkshire’s underlying assets. This gives Berkshire the ability to hold assets for a longer duration than most other investors, because they don’t need to sell their investments to generate cash to return to investors. Indeed, Warren Buffet said his favorite hold period is “forever”. I’ve always been fascinated by this model, because it frees you from the typical 10-year fund lifecycles that most fund managers are constrained by while also giving investors liquidity when they need it. I think we can copy this model to create a permanent capital vehicle to plant, manage, and own forestry assets for the truly long term. Here’s how.
First, we acquire the right kind of land. The right kind of land in this context is: (i) not currently in use, (ii) not currently forested, (iii) located in climates favorable to carbon sequestration, and (iv) remote and unlikely to become targets for urbanization or housing development in the foreseeable future. Practically speaking, this means deforested or otherwise unproductive and remote tracts of land in the Pacific Northwest, the northern United States, and Alaska. Next, we plant trees and other native species on the land, and forecast how much carbon our forest will capture and sequester over the next 100 years. We can use this forecast to generate and sell carbon offsets in the California carbon market, which in turn generates capital. Finally, we use the capital that we generated from selling offsets to repay our land acquisition and planting costs, leaving a small surplus to cover ongoing land maintenance costs and invest in acquiring more land.
This model takes advantage of the carbon offset markets established as part of California’s cap-and-trade program, which was recently extended until 2030. The California carbon offset market has 3 features that make it reliable: (i) a relatively high price on carbon offsets, currently around $15/ton, (ii) a price floor on carbon offsets with inflation and appreciation baked in, guaranteeing a sustainable price in the future, and (iii) a robust set of buyers and other market participants.
Like Berkshire, we structure our company as a corporation, not a fund or a REIT, allowing us to hold our forests for an indefinite time period and retain and reinvest surplus cash. We take this company public as soon as possible, so that equity investors in the company get liquidity whenever they need it, freeing the company from the need to return cash to investors by harvesting timber. Instead, the company grows by acquiring more land and planting it, and the company’s assets accrete in value each year proportionate to (a) the appreciation in value of the underlying land, plus (b) the growth of the timber on top of the land multiplied by the price for timber. This kind of company can be compared to a publicly traded closed-end mutual fund, where the company’s value is (roughly) equal to the value of its assets minus its liabilities (“Net Asset Value”, or “NAV”).
In order for our company’s NAV to incorporate the growth in the value of the timber assets in the forests, the company would need to at least plan to have a harvest at some point in the future. Without this, investors could not reasonably ascribe economic value the company’s timber. So how is this different from the timber investment funds described above? The key is in duration. There is nothing wrong with harvesting timber from forests if done sustainably; the trick is that in giving investors liquidity on demand, we can afford to make large up front investments in reforestation and wait 100+ years for our first harvest, at which point our trees will have hit their peak growth rates. This is something a traditional timber fund or REIT simply cannot do. It also has the added effect of aligning our investment horizon with the rate of carbon sequestration in our forests, as trees that are young and fast growing sequester carbon at a faster rate than older, mature trees.
Three questions and some rough math
- Can forestry assets earn a good rate of return? Yes. The National Council of Real Estate Investment Fiduciaries Timberland Index has produced an annualized rate of return of 12% since 1986. While this is slightly lower than the S&P 500 (~15% since 1986), timber has two advantages over traditional equities: it’s generally not correlated with the stock market, and it’s less volatile. There is also good reason to be bullish on the future prospects of both forest land and timber as investments given the emergence and growth of carbon markets and cap-and-trade programs in dozens of countries around the world. Finally, I believe that the capital from carbon offsets described above should work like free or low-cost leverage in the model, similar to how reinsurance float does for Berkshire, and thus produce a corresponding bump in IRR. For reference, Berkshire has returned just under 20% per year since inception.
- How big can this be? At 500 trees per hectare of forest, to reach the goal of planting a billion trees, you’d need roughly 2 million hectares, or 7,720 square miles, which is about the size of New Jersey. Assuming (conservatively) 100 tons of carbon sequestered per hectare, these forests would sequester 200 million tons of carbon and generate $3B in capital from the sale of carbon offsets at today’s price in California of $15/ton. If you budget $1,250 per hectare to acquire, plant, and maintain the land, you’re left with a NAV of ~$2-3B that appreciates at 12% per year plus a surplus of $500M in cash to reinvest. Meanwhile, to get to a trillion trees, you’d need 2 billion hectares, or 7,720,000 square miles, which is slightly less than the size of Australia. While the world’s carbon markets are currently too small to absorb this large of a reforestation-offset project, it’s not unreasonable to suggest we might get there soon given the scale of the climate crisis.
- Where do we get our initial capital to acquire and plant the first tracts of land? The ideal state would be to collect capital from selling offsets before the first project is planted, negating the need to raise much if any capital to start. Unfortunately, it takes 2-3 years from project inception to carbon credit certification in California. One option would be to sell carbon credit futures at a discount to today’s price. This is not without precedent; the first carbon offset futures sales took place in California in 2019, with Shell as the lead purchaser. Another option would be to create a pool of buyers of offsets who contribute their capital in advance in exchange for a share of future offsets. Finally, landowners themselves could contribute their land to the company in exchange for equity in a tax-free 1031 or 721 exchange. The attractiveness of this proposition increases when the company goes public, as then the landowner would trade a single, illiquid asset for a diversified and liquid interest in a pool.
So in short, the master plan is:
- Buy land.
- Plant trees, sell carbon offsets.
- Use that money to buy more land, plant more trees, and sell more carbon offsets.
- While doing the above, hold the assets in a public company to give investors liquidity. Own the trees forever.