Carbon Markets - Nascent and Faced with Growing Pains, Why Should VCs Care? (Part 2)

This is part 2 of a 2-part series covering our views on the carbon credits market. The articles are co-authored with Khushbu Topandasani.

*The original article appears on *Medium.

In our on-going fight against climate change, carbon offsetting should not be the first line of defence. While it is important to invest in decarbonisation levers — including renewable energy, sustainable farming, electric vehicles and others — it may simply not be enough due to various factors such as technology readiness, economics and investor interest, regulatory incentives and enabling infrastructure. Carbon offsetting is therefore an essential piece of the puzzle in attaining our goal of achieving net zero.

In Part 1 of this two-part series, we established a case for why the voluntary carbon markets (VCMs) play an important role, especially by catalysing the funding of natural climatic solutions projects such as reforestation and mangrove restoration (NCS). In this article, Part 2, we discuss specifics of where investment opportunities lie within the carbon markets tech stack, and why we decided to invest in Indonesia-based carbon technology platform Fairatmos.

So What? — Identifying and evaluating investment opportunities

It’s nascent and a potential mess. Should Southeast Asia based VCs care about the nature based carbon market? Well, going by the market signals, I think most certainly so.

Why?

Firstly, economically VCM makes sense. VCM credit prices are expected to continue trending up in the foreseeable future. Currently, the global average price for carbon offsets is approximately US$3 per tonne. Due to rapidly growing supply shortage, VCM credits are expected to cost significantly more in coming years. Bain & Co has previously projected the increase to reach US$17 per tonne by 2030, more than 5 times the current price. Furthermore, if we try to reach the Paris Agreement targets without a breakthrough in direct carbon removal, the demand may even cause the carbon credit price levels to further escalate to above US$50 per tonne [29].

Secondly, our Southeast Asia region is in a unique position from the supply perspective. Although the region covers only 4% of earth’s land surface area, it comprises six of the world’s 25 biodiversity hotspots, is responsible for 15% of the world’s fish production, and harbours one of the world’s most extensive seagrass beds, coral reefs and mangrove mass [30]. Consequently, the region is in prime position to be a major global supplier of nature based carbon credits.

Thirdly, demand for VCM credits is expected to grow, driven by national level net zero commitments, corporate pledges and shifting consumer sentiments. Eight of ten Southeast Asian nations have set net-zero targets [31]. More large regional corporations have stepped up to make climate pledges — the likes of Singtel and Sempcorp have endorsed the Task Force on Climate-Related Financial Disclosure (TCFD) framework and made commitments to become net-zero emissions by 2050 [32] [33]. Amongst the consumers, Southeast Asia based Millennials and Gen Zs — who will be in their prime earning years within five to eight years — are generally more willing to pay extra for environmentally friendly brands than their Gen X counterparts. For example, in Indonesia, 76% of Gen Zs prefer to buy environmentally friendly brands. This is at least 20 percentage points higher than in other segments of consumers [34].

Carbon offsetting is an essential piece of the puzzle in our fight against climate change, though, as mentioned earlier, carbon offsetting should not be the first line of defence. Thus given the above trends, it is of our view that the VCM market, including the nature based segment, holds significant promise despite its infancy and the cloud of uncertainty surrounding it.

The NCS Carbon Market Tech Stack

So, where do VC investment opportunities lie specifically? They can come from various parts of the Carbon Market tech stack as illustrated below.

From the supply perspective, NCS carbon credit projects typically originate from large and smallholder land owners and communities. Tech-enabled solutions broadly fall into two main categories:

• Project Development — Currently, the carbon credit project origination processes — from conceptualisation to project design document development — are typically manual and undertaken by consulting agencies. This in turn implies a high barrier of entry from both the cost and time requirements perspectives. Startups operating in this space have the opportunity to leverage digital tools and third party data sets to increase efficiency, transparency and reduce costs. This can potentially pave the way for long tail supplies, for example from smallholder farmers, to be unlocked in a significant way. Unique access to supply, ease of use of workflow tools as well as unparalleled domain expertise are critical success factors that will potentially set great startups apart from others in this segment.
• Measurement, Reporting and Verification (MRV) of Mitigation Actions — According to the World Bank [35], MRV enables the measurement of the amount of greenhouse gas (GHG) emissions reduced by a specific mitigation activity over a period of time. MRV seeks to prove that an activity has actually avoided or removed harmful GHG emissions so that actions can be converted into credits with monetary value. Through the use of sensors, satellite imagery and workflow tools, MRV startups can potentially enhance the level of transparency and information integrity of the carbon credits market. To scale well, companies in this space must find the right balance between data resolution and coverage.

On the demand side, startups have the opportunity to address private sector demand from both the enterprises and consumers.

• Institutions — In order to develop sound net zero strategies, enterprises must first take stock of their scope 1, 2 and in some cases scope 3 carbon emissions across their supply chains. Startups in this space may inform enterprises of their carbon emission posture by harmonising and analysing a complex range of internal and external data sources. Others make actionable recommendations on possible mitigation strategies, as well as provide carbon offsetting options to the enterprises. Carbon accounting startups can potentially develop a strong moat by positioning themselves as leading specialists for certain sectors, use cases or geographies. Those offering carbon offsetting options must be ready to curate a wide variety of projects in order to suit the different types of enterprise net zero strategies and narratives.
• Individuals — Climate conscious individuals may be interested to track, reduce and offset their own carbon footprint. In addition, they may also seek to support brands that are perceived to be climate positive or at least climate neutral. Similar to other consumer facing businesses, startups in this space must develop cost efficient and extensive distribution channels as quickly as possible in order to scale sustainably.

Lastly, underpinning the carbon markets are:

• Carbon registries — Carbon offset registries issue credits based on defined certification protocols, keep track of available offsets in the marketplace, and when offsets are purchased registries are responsible for tracking the retirement of credits to ensure that two purchasers cannot claim the same verified carbon reduction [36]. While the voluntary market is currently dominated by carbon standard providers such as the likes of Verra and Gold Standard, startups that aspire to bring disruption to this segment can potentially do so by focusing on methodologies, project categories and geographies that are not well covered by existing standards.
• Market mechanisms — By connecting the supply and demand drivers, carbon credit marketplaces, trading and auction platforms as well as brokers ensures that there is liquidity to the carbon market, in turn encourages funding to the carbon project. A variety of players — from traditional placement agents to tech-enabled platforms — already exist globally. Scale and reputation will be key success factors for startups in this segment.

Introducing Indonesia as a prime country for NCS & our investment into Fairatmos

“Since climate change is a global problem, it doesn’t matter where you reduce emissions. It makes sense to reduce emissions where it’s cheapest and easiest to do them” said Anja Kollmuss, a Climate Policy Analyst and Affiliated Researcher with the Stockholm Environment Institute [37].

While the demand for carbon offset is significantly growing, the supply of legitimate carbon projects is lacking due to limited know-how, cumbersome certification process and not to forget, a steep cost structure.

Various pain points that exist in the market today will inevitably lead to an increase in prices of carbon credits. It is therefore important for countries who are blessed with rich natural resources and biodiversity to build up their carbon supply base with proper processes and governance to ensure seamless global trading.

It is to no surprise that Indonesia has a prime geological position. Firstly, the country has the second largest global potential to provide low-cost, natural climatic solutions for decarbonisation [38]. The country also stores about 66% of investable forestry carbon stock in Southeast Asia — the highest in the region [39].

These conditions provide a fertile ground for companies such as Fairatmos to strive. Fairatmos aims to create a supply side focused carbon credits ecosystem, with Indonesia as its initial target market. By leveraging technology to streamline project due diligence processes and access the global carbon markets, the company aims to democratise carbon project viability and monetisation for smallholder farmers, communities and other project developers.

“Fairatmos will empower 40k+ communities and contribute to 300 Mt GHG emission reduction globally by developing an inclusive platform to engage small & medium organisations to start, fund and trade carbon offset projects,” says Natalia Rialucky, Chief Executive Officer.

Vertex Ventures Southeast Asia and India (VVSEAI) is proud to announce our participation in Fairatmos’ recent Seed financing round. We believe the company is well poised to contribute to, and capture significant value from, the largely untapped nature based voluntary carbon market in Indonesia, which is expected to reach US$3.2 B in 2030.

Summing it up

ClimateTech is certainly not a silver bullet in the fight against climate change — we not only need technological innovations but also concerted efforts and decisive actions across society and the economy. Similarly, carbon offsetting should not be the first line of defence in our efforts to drive decarbonisation.

However, just as the ClimateTech solutions can potentially move the needle in reversing the rising global GHG emissions, the carbon credit market holds significant promise as a critical tool kit in this fight.

As tech investors, we remain optimistic that our collective journey toward a greener economy offers interesting opportunities for innovative ClimateTech and carbon market companies, including those from Southeast Asia.

If you are a company with an innovative business model or technology in this space, feel free to reach out to us at https://www.vertexventures.sg/apply and we would love to hear your pitch.

Glossary:

GHG: Greenhouse Gases

MRV: Measurement, Reporting and Verification of Mitigation Actions

NCM: Natural climatic solutions

Scope 1/2/3: Scope 1 emissions are direct emissions from owned or controlled sources. Scope 2 emissions are indirect emissions from the generation of purchased energy. Scope 3 emissions are all indirect emissions (not included in scope 2) that occur in the value chain of the reporting company, including both upstream and downstream emissions.

TCFD: Task Force on Climate-Related Financial Disclosures

VCM: Voluntary carbon markets

References

[29] Bain & Co, Southeast Asia’s Carbon Markets: A Critical Piece of the Climate Puzzle

[30] https://www.straitstimes.com/singapore/environment/south-east-asias-biodiversity-worth-3-trillion-a-year-in-economic-growth-jobs-report

[32] Singtel, Empower every generation to Accelerate Climate Action

[33] https://www.sembcorp.com/en/sustainability/climate-action-plan

[34] Mckinsey & Company, What makes Asia−Pacific’s Generation Z different?

[35] World Bank, Carbon markets: Why digitization will be key to success

[36] https://carbonbetter.com/story/carbon-offset-registries-2/

[37] https://www.vox.com/2020/2/27/20994118/carbon-offset-climate-change-net-zero-neutral-emissions

[38] Boston Consulting Group, Vertex Analysis, Carbon Credits.com

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