Evergrow Questions 19-22: “Have you thought of X?”

Background: I’m exploring an idea called Evergrow, and wrote up a list of 30 questions relating to the idea. A full list of Evergrow-related posts is here. Answers to questions 19-22 are below.

Q19: Can we move the market for offsets? At scale, how large of a producer of carbon offsets would the business be? How large is this relative to existing production? Are we so large that our production has a material influence on supply (and thus potentially pricing?)

It’s difficult for any single company to move CCO prices given the price floor on CCAs and the projected shortfall in CCOs over the next decade. That said, it stands to reason that rising supply and constant or falling demand will put pressure on prices. As discussed in previous questions, I think there is equal if not greater reason to believe the CCO market will increase in the future with, e.g., new compliance markets getting set up and the exhaustion of IFM flush opportunities.

Historically, the largest single CCO producers are developers like Bluesource Forest Carbon Partners, and Finite Carbon, who together have produced in the low tens of millions of CCOs in the last 7 years, a rate of roughly 2-3M CCOs/year. Assuming 50-100 CCOs per ha per year, we would be among the largest CCO suppliers at approximately 50,000 ha.

Q20: This vs conventional timber investing: What is the relative value of the carbon offset income stream vs the value of the forest asset? As an investor to what degree am I excited by the carbon offset income stream vs the long term appreciation of the underlying forestry asset?

Based on today’s prices, I would rather be a timber company than a CCO company. However, if the markets for CCOs evolve such that CCOs become more valuable than the sale of timber, then that would change. Given the long timelines involved in reforestation, we don’t have to choose until much later. Until our trees mature, we are in the business of selling CCOs, and using this cashflow as leverage on our equity to finance reforestation. Once our trees mature, we can either delay our harvesting to continue selling CCOs, commence harvesting and become a pure-play timber company, or do some combination both. This optionality is a major advantage in the model. Existing timber companies generally can’t sell CCOs in respect of their existing holdings because there is no additionality. And existing carbon developers generally don’t own the land or trees. We are hedged and ready for whichever direction the market goes.

Q21: Alternate models of land acquisition: If part of the theorized value capture is being able to hold forestry assets a longer duration, why not simply directly acquire those forestry assets from those “shorter duration” holders, and capture that temporal arbitrage without needing to plant trees? Alternatively, we partner with landowners – e.g., “Airbnb for reforestation”?

It’s my understanding that in most cases, State law requires that timberland owners replant trees that they harvest. As a result, you cannot get CCOs under the CA Forestry Projects for this replanting, because it was already mandated by law and thus is not “additional”. Acquiring this land from timber owners would come with the same restriction, thus making it not suitable for the Evergrow model.

The partner vs buy model is interesting to me. Pros of partnering vs buying: no up-front capital needed to buy land, no ongoing costs for property taxes. Cons of partnering: less control (maybe?) around the future of the land, need for long-term partnership agreement to ensure long-term access and compliance with regulatory obligations may be complex to negotiate and costly to administer. Also, I think it’s important to own the trees or at least the commercial/harvest rights to them given how valuable they are, and I’m not sure if there’s any other way to do this other than by owning the land as well. Last, purchasing land is well understood, with comps. It may be easier to just find land that is undervalued and pay for it vs invent a whole new structure of land use. For these reasons, I lean buy vs partner.

Q22: Lobbying/future regulatory developments: Do we engage in regulatory capture by lobbying for stricter environmental standards (and thus demand of carbon offsets)? Does this company have an enemy/group with diametrically opposed interests? What do the major political parties say about this topic? What would the passage of the Green New Deal imply for the model?

I wouldn’t exactly call it regulatory capture, but generally, Evergrow benefits from the enactment of cap-and-trade systems that include the use of offsets. The relationship between Evergrow and other pieces of environmental regulation – e.g., stricter environmental standards – is not as straightforward as it may seem. While I am personally supportive of this kind of regulation, widespread emissions abatement could put downward pressure on CCA and thus CCO pricing.

The Green New Deal called for a carbon tax as opposed to a cap-and-trade system. I happen to believe cap-and-trade systems are preferable to carbon taxes because they allow the market to allocate resources to the lowest cost of abatement (vs imposing a flat charge across the board). Cap-and-trade also has the advantage of being – at least, historically – a bipartisan policy, with substantial Republican support in the 90s and early 2000s. For this reason, I think we are more likely to see the imposition of more cap-and-trade systems than carbon tax schemes over time.

The fossil fuel industry and other large emitters (e.g., heavy industry) tend to oppose any form of carbon pricing but also support the use of offsets in such systems. Detractors of cap-and-trade systems and offsets call this “pay to pollute”. What often gets ignored in the public debate on carbon pricing is that the companies under cap-and-trade mandates are the ones who supply the economy with basic goods and services like fuel, electricity, and transportation. These companies tend to operate on low, commodity-like margins, and thus pass on the costs of any carbon pricing onto consumers. Therefore, I believe that it’s important that we allow these companies to lower their emissions in a way that also doesn’t produce price shocks for consumers, because such shocks could erode public support for increased climate change measures in the future. Offsets are an important mechanism in achieving this goal.