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By Anthony Milewski (Chairman of Nickel 28 Capital
This article is part of a series on the carbon credit sector. Anthony Milewski, a contributor to 11 Ways To Make Money, discusses the impact of streaming businesses and the future prospects for the sector.
His earlier installments are available for investors who want to learn the basics of carbon credits.
Both as an investment tool and as a means to combat climate change, carbon credits are on the rise. The sector is constantly changing like any other industry that is experiencing rapid expansion. The most recent change is the introduction of streaming carbon credits.
Streaming is a business model that comes from the mining sector, which boasts more than a dozen streaming companies and royalty companies with a combined market cap of over US$50billion.
Franco-Nevada (TSX,NYSE:FNV), purchased its first royalty in 1980. However, the model didn't take root until 15 years ago when Goldcorp spun off Silver Wheaton. This is now Wheaton Precious metals (TSX,WPM,NYSE :WPM). Similar operations were launched later in oil and natural gas, following Wheaton's success.
Streaming is an agreement that a company (the streamer), makes in advance for the right to buy a certain amount of production. Producers receive an additional per-unit payment when they deliver on their contracted production.
Conceptually streams and royalties look similar. Both parties have a lot to gain. The streaming agreement is a significant cash advance for the producer and non-dilutive financing. These deals can usually be deferred revenue, and not debt. The streaming agreement does not require that the operation be managed differently.
Streamers are exposed to price appreciation and project growth upside as well as earnings, dividends, and have lower exposure to operating and capital costs.
These structural advantages have led to streaming companies in the oil, mining and gas sectors being valued at a premium. Streaming has also been able to be used as a popular financing option due to the possibility of value arbitrage, which allows for mutually beneficial transactions.
How will this work in the carbon credits industry? A typical scenario is that the streamer invests upfront in a project and then receives the right, at a discount, to purchase a percentage of the carbon credits that are generated by the project.
The amount of investment will determine how much the streamer can receive. The streamer could also share in the revenue sharing model with project owners. The credits can then be monetized by the streamer.
This is consistent with the way the streaming model has worked in the energy and mining sectors. However, there are additional benefits when the streaming model is applied to carbon credits.
First, the potential to increase the value of carbon offset credits. The value of carbon credits is often compared to gold, which is gold regardless how it is made. This is because there are many project-related factors that can affect the value.
Because every carbon credit equals 1 tonne of CO2e taken out of the atmosphere, but not all credits have the same impact on society and the planet. The United Nations has identified 17 categories including education, poverty, clean energy, and clean water that are all designed to contribute to a more sustainable future. Greater potential premiums are associated with projects that cover more area than others.
The second benefit is the price upside. The carbon credits industry, which has been around for less than 20 years, is still young and developing at an incredible pace.
Asset managers, especially those in the US are driving growth, along with consumers and government regulators. Already, legislation has been passed in several countries that requires companies to disclose climate risks. Recently, the G7 nations agreed that mandatory disclosures regarding climate-related financial transactions should be made.
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Many companies will either look to voluntary carbon markets for carbon credits to avoid the regulatory disclosures and pressures that come with it or risk serious reputational damage.
Next is diversification and project life. Carbon offset projects, unlike mining and oil and gas assets, have a guaranteed duration and are not subject to the same risks as extracting natural resources. You can often look at returns for as long as 30 years in some cases.
These investments are also free to generate cash flow, so the streamer can either redeploy capital or pay dividends to shareholders.
You should also consider the monetization benefit. Carbon project operators, who traditionally worked with small teams because they had limited funds, have had to spend more time selling credits to corporate buyers than focusing on the project. The streamer brings a professional sales team and marketing team to take over this role.
The industry's final benefit from the streaming model in carbon credits is undoubtedly its most significant.
Almost two decades into its existence, the majority of carbon offset operators have had difficulty raising money from mainstream corporate finance -- the same source that energy and mining companies have taken as a given over the years.
Carbon credit streamers have made it possible for corporate financing to be available to most project operators. Projects can now acquire upfront cash investments and stream income from the revenue share model. This allows them to execute development plans much faster, whether they are investing in local communities, expanding their geographic reach, or increasing the overall effectiveness of these carbon offset projects.
What is the future?
Canada's Carbon Streaming was the first streamer to be publicly listed in the sector. It's reasonable to assume that similar operations will launch if Carbon Streaming is a success, based on the history of Wheaton in the mining industry. This will only benefit the sector's development, as it will provide investors with more opportunities to profit and will allow corporate finance to make a positive impact on the drive towards carbon zero.
The voluntary carbon credits market will be undergoing many changes and experiencing significant growth. The arrival of proven business models such as streaming indicates that the sector is entering a new phase. This is something to be aware of.
About Anthony Milewski
Mr. Anthony Milewski has spent his career in various aspects of the mining industry, including as a company director, advisor, founder and investor. In particular, he has been active in the commodities related to decarbonization and the energy transition, including nickel, cobalt, copper and carbon credits. Anthony has served on the London Metals Exchange Cobalt Committee, which includes representatives from the largest mining and commodities companies globally, to represent the interests of the industry to the board of directors the LME.
Read more from Anthony Milewski:
OPINION — Cobalt’s 3 Month Price Hike a Sign of Things to Come?
OPINION — Should You be Positioning for Decarbonization? Part 1
OPINION — Should You be Positioning for Decarbonization? Part 2
OPINION — An Introduction to Environmental Commodities
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