Market Cap: $ 301M
Shovel-stocks readers know about the upcoming commodities super cycle and my bullish view on uranium, copper, lithium, manganese, niobium and other raw materials.
Recently I discovered a new type of commodity, which is heavily leveraged to the secular trend of clean energy and has inelastic demand.
On Oct 31st 2021 political leaders of the west met for COP26 in Glasgow, to discuss how to secure achieving the goal of global net-zero by mid-century and keep 1.5C degrees within reach. Their self indulging discussions aimed to further feed their preferred narrative, but the politicians were confronted with the harsh realities of our modern world being built on fossil fuels. As expected, the outcome of COP26 is that it was one big nothingburger filled with blah-blah-blah. Coal will still be an essential energy source for many years and companies will buy carbon credits left to right to offset their carbon emissions. Carbon neutrality will likely be the new criteria big companies strife to fulfill in order to be added to indexes, get a valuation bonus and adhere to potential regulation.
There are multiple ways to play the carbon credits theme: invest into carbon capture technology companies, trade carbon credits directly or buy an ETF like KraneShares Global Carbon ETF. However, I found a low risk high reward way to take advantage of this trend: Carbon Streaming Corp - a royalty company focusing on carbon credits.
Structure
Macro view
What are carbon markets?
Supply side
Demand side
What are royalty companies?
Carbon Streaming Corp overview
Projects
Management
Share structure
Risks
Conclusion
Macro view
We are in the middle of an energy crisis unfolding in Europe, which will very likely be soon showing its ugly face in the USA and in other areas of the world. The climate politics of the leaders of the west are leading to unintended consequences that further accelerate into a vicious circle. Big oil companies are forced into unprofitable wind farm projects and discouraged to drill to advance their oil reserves. This in turn leads to an oil supply crunch and rising oil prices.
The big push towards renewable energy sources like solar and wind is disconnected from reality. On the one hand, many minerals are needed for the construction of wind turbines and solar panels. On the other hand, to mine these elements a lot of energy is needed in the form of fossil fuels like oil, cancelling out any CO2 benefit that was hoped to be achieved in the first place. In addition, the amount of copper needed for offshore wind turbines voltage cables is mind boggling. The picture below says it all.
Source: Twitter
European and US politicians are pushing for new car sales being limited to electric vehicles (EV) and signal the end of the internal combustion engine, to be able to say "we gave our best shot to fight climate change". This is based on the logic that every 4.6 tonnes of CO2e removed from the atmosphere is the equivalent of removing one average passenger vehicle for a year (Source: EPA). Even when taking this at face value and not taking into account emissions of the battery supply chain and assuming 1 EV equals removing one CO2e emitting vehicle from the fleet, the math still does not add up.
With 4.2M electric cars, China has the highest EV adoption rate. Applying the above metrics of 4.6 tonnes CO2e times 4.2M would equal to only 19.3 Mt CO2e being removed in China due to EV adoption. However, cement production is responsible for 4-8% of worldwide CO2 emissions and for the production of every tonne of cement one tonne of CO2 is emitted. China produced 2.377 billion tonnes of cement in 2020. This would translate to 2.377 billion tonnes of CO2 being emitted annually.
This example clearly visualizes that the push towards EV, while well intended, will only be a drop in the bucket in terms of decreasing CO2 emissions. The governments will have to find other solutions to be able to meet the climate goals set by the Paris Agreement.
Source: Carbon Streaming Corp
Moreover, the pressure is not only building directly from the environmentalist side, but also from financial regulators.
The Financial Stability Oversight Council (FSOC) has released a new report on Climate Related Financial Risk, & identified climate change as an emerging and increasing threat to US financial stability. Among other things the report mentions that the Securities and Exchange Commission (SEC) has begun to evaluate its disclosure rules and requested public comment on ways to improve climate disclosure. Based on this development, I expect carbon footprint to be a company metric that will be monitored by the SEC.
As mentioned in the intro, the political leaders are only interested in feeding the narratives that benefit their own agenda and not actually interested in doing something to reach climate goals. Most of them did not even hide this fact and used the time at COP26 for an undeserved rest & relaxation.
Source: The mirror UK
What are carbon markets?
Based on the numbing realty check above, did you ever ask yourself how a big company like Google can become carbon neutral in a relatively short time frame? Google reached carbon neutrality in 2007 by purchasing carbon offsets to offset their emissions.
There are two types of carbon markets: compliance and voluntary. Please find a description of both below.
Source: Carbon Streaming Corp investor presentation
"Typically, a carbon credit represents one tonne of carbon dioxide (“tCO2”) or the carbon dioxide equivalent (“tCO2e”) of another greenhouse gas that is prevented from entering or being absorbed from the atmosphere." Carbon Streaming annual information form
The Paris Agreement clearly is not enough to reduce carbon emissions and the gap between the carbon goal and the emissions that occur if we continue the status quo is widening. In addition, the longer nothing happens, the steeper the slope will have to be to hit 2030 emissions targets. Carbon credit markets offer a solution for this problem. It is a solution that does not include waiting for politicians to act, but rather let market mechanisms offer incentives to corporations, to reduce their carbon footprint while also supporting carbon offset projects. In addition, the gap between the red and the green line in the image below offers an opportunity for speculators.
Source: Katusa Research YouTube channel
When speculating on a commodity it is important to assess the supply demand situation.
Supply side
Over 4,600 carbon offset projects are currently listed in the 4 largest voluntary carbon credit registries. However, according to corporations like Shell, there is a massive supply / demand deficit developing. They expect a supply shortage by 2024 and go even so far as saying that the "top-five Big Tech companies could cause a supply shortage in carbon credits in 2025, if they opted to buy only removal credits to cover just their scope 3 emissions"
There are carbon capture technologies that could support in removing CO2, but these technologies are in their infancy and hold technology risk. The way to go are carbon offset /sequestering projects - but they are limited and have various cost points that may make them more or less attractive for companies or developers to pursue.
"The table below shows the steep cost curve associated with carbon sequestration activities, which includes natural carbon sinks and CCUS that reduce net emissions by removing carbon from the atmosphere. The table depicts carbon abatement potential as a result of prospective sequestration technologies." Carbon Streaming Corp
Source: Carbon Streaming Corp annual information form
Similar to other commodities like uranium, the carbon credit price is below the cost curve. The big potential to have an impact is for example with cement & direct air capture, but higher carbon prices are required to fund innovation & breakthroughs to progress these activities.
Demand side
Of the 5,300 NA & Eur companies with over a billion market cap 9% have released a plan to offset their carbon emissions. As the carbon footprint will most likely become a metric the SEC requires public companies to report on, as discussed above, more companies will follow in their footsteps. This could also influence valuations of companies and shareholders would push companies to achieve carbon neutrality.
Further demand drivers:
The Net Zero Asset Managers initiative, which includes BlackRock, Vanguard and 218 others, managing $57 trillion of assets are targeting net-zero emissions by 2050 across all their holdings.
Climate change is the #1 ESG issue for assets managers in the U.S.
The number of S&P 500 companies publishing sustainability reports has grown from 20% (2011) to 90% (2019)
Source: Carbon Streaming Corp
In the Q3 2021 earnings release from Hecla Mining, a big silver producer, I found a concrete example of what we will see more of in the future.
"we have taken the next step by investing ($ 200K) in carbon credits that allows us to be net zero for our 2021 scope 1 and scope 2 emissions. We will continue our focus on reducing emissions as well as investing in credits in the future."
Source: Hecla Mining Q3 earnings release
Demand for Carbon credits is growing fast. The Advisory Board of the Task force for Scaling Voluntary Carbon Markets is a new governance body, comprised of a majority of independent members. It is set to transform the voluntary carbon markets by setting a global benchmark for carbon credit quality. The task force is estimating that demand for carbon credits could increase by a factor of 15 or more by 2030 and by a factor of up to 100 by 2050!
Source: Carbon Streaming Corp
Economics sometimes seem complicated but its formulas include relationships that are very straightforward. A shortage in supply, coupled with high demand leads to a higher price. The average price estimation for carbon credits by 2030 is currently at $101.
Source: Carbon Streaming
When speculating in a commodity, I am looking for low or decreasing supply and steady or increasing demand. The ideal scenario is a supply demand deficit, that is ignored by all market participants until it is too late and they cannot close the supply demand deficit gap in a timely fashion. The best deficit is the one where the demand is inelastic. All these characteristics seem to be present in the carbon credits market. The question is how to put this speculation into action and which vehicle is the best to play this? In my point of view a royalty company offers the best risk reward here.
What are royalty companies?
Imagine you are part of an up and coming music band eager to have your first #1 hit. A major label contract can greatly increase the chances of this happening. The major label will offer you a contract where you get a certain amount of advance money to produce the album, shoot music videos etc. In return the label has the option to benefit of a steady royalty stream later, should your music be successful. "Royalties are the sums paid to rights-holders when their creations are sold, distributed, embedded in other media or monetized in any other way".
This financing/business model is also quite common in the commodities sector, as companies developing a mine often times need alternative routes of financing and sell a certain percentage of their future supply to royalty companies. The benefit for the royalty companies is that they get access to a future, secure revenue stream without any operational risks or -costs. Should the energy costs for example increase because of a supply shock in oil prices, this will not matter to the royalty company. They also are diversified through having access to many royalties, making them independent of any one specific project. Should the price of the commodity increase, the share price of the royalty company is leveraged to this increase. If the company expects the price of the commodity to increase in the future that is a perfect scenario, as they can buy rights to a commodity now for cents on the dollar and sell them later at a massive premium.
Franco Nevada is one of the most successful gold royalty companies ever. Founded in the mid 1980s, the two founders managed to grow the business from a $ 2M market cap to $ 1.2bn in the peak, when Newmont acquired the company. The Franco Nevada founders had realized early that searching for gold offers no compelling risk/reward and that owning a royalty claim enables the owner to earn 1-2% right off the top of the gold producers revenues. In my mind royalty companies are the ultimate picks and shovels play and should also perform very well in an inflationary environment. They have minimal to no input costs and are leveraged to the price of the commodity.
There are many startups in the field of Carbon capture. Elon Musk even sponsored a competition around carbon capture technology with $ 100M last year and stocks like Aker Carbon capture are listed on the Oslo Stock Exchange. However, all of these have one thing in common: They hold high technology risk, as it is impossible for an investor to know which of the companies will be successful. In those scenarios where I cannot calculate the probabilities I prefer a picks and shovels plays approach and choose a company like Carbon streaming corp, as they have a range of projects and will acquire more along the way.
Carbon Streaming Corp overview
When Doug Casey mentioned in the below video that Carbon Streaming Corp is one of his biggest single investments, my interest was peaked.
Source: YouTube
I had heard about carbon credit trading here in Germany and was vaguely aware that one can trade the credits even as a retail investor. However, I wasn't aware of the different investment vehicles that offer better risk/reward than trading carbon credits directly.
I researched the topic further and found videos by Marin Katusa (important to note: I'm not affiliated with Katusa and I'm not a KRO member), which I used as starting point to deep dive into the company and the carbon credits market.
Who is Carbon Streaming Corp and what do they do?
Carbon Streaming is an investment vehicle that is bringing the royalty streaming model to carbon credits. Investing in projects that generate voluntary and/or compliance carbon credits is the focus of Carbon Streaming's business model and the way they offer their shareholders direct exposure to carbon credit markets.
"A carbon credit stream is a contractual agreement whereby the stream purchaser makes an upfront payment (in the form of cash, shares or other consideration) in return for the right to receive all or a portion of future carbon credits generated by a project or an asset over the term of the agreement." Carbon Streaming Annual Information Form 2021
How their streaming agreements will work can be seen below.
Source: Carbon Streaming Corp
The typical projects Carbon Streaming invests in also have Co-Benefits like protecting endangered species or providing tangible benefits to the communities in the project area. An example of a Co-Benefit is the land that one of their project protects would've been otherwise used for a palmoil plant. This means the land would've been deforested to make space for the plant.
The types of carbon credits Carbon Streaming has access to also include blue carbon credits. These credits are attributed to projects protecting coastal and marine ecosystems. "Studies suggest mangroves and coastal wetlands annually sequester carbon at a rate 10 times greater than mature tropical forests. They also tend to store carbon for a longer period of time as much of the carbon is stored below water in organic rich sediment or peat" Carbon Streaming investor presentation.
Carbon Streaming is aiming for investment returns of 15% or higher, which is higher than typical streaming returns in commodities sector. Blue carbon credits & credits with Co-Benefits will most likely attract a premium. With their premium portfolio of carbon credits, Carbon Streaming is able to sell the credits to entities wanting to offset their carbon emissions. Companies like Gucci, Delta airlines and PwC are examples of The Rumba Raya project credit buyers. With the outlook that carbon credits prices are expected to increase massively, Carbon Streaming provides pure leverage to the expected carbon credits price increase.
Current portfolio of projects
Below I shared an overview of Carbon Streaming's current portfolio of projects.
Deal pipeline & outlook
According to Carbon Streaming they are "targeting to have completed investments that have the potential to annually deliver for up to 30 years:
20M carbon credits by year-end 2021
50M carbon credits by 2023
100M carbon credits by 2025"
The current voluntary market price (Nature Based Carbon Offset) is $ 13.43. In Europe the regulatory (EU ETS) price is 84.35 €.
"EU ETS – is the European carbon credit contract which is exchange traded. It is a Futures contract for the purposes of trading and delivering EUAs (European Union Allowance). One EUA allows the holder to emit one tonne of CO2 or C02 equivalent greenhouse gas."
Especially in 2021 the EU ETS has risen dramatically and is in a parabolic move upwards.
Source: carboncredits.com
Market experts expect, based on the movement seen in regulatory prices, the voluntary price to be close to $50 in the future. When calculating the value of their targeted carbon credits portfolio, one has also to consider that Carbon Streaming would be able to ask for a price premium due to the nature of their credits described above.
A back of the napkin calculation using a $ 50 credits price would result in:
100M credits in 2025 = at least $ 5bn market value (assuming dilution of 15% = $4.25bn)
At current market cap of $ 301M this would imply a potential of at least 14X. I think the real upside is even larger but would calculate with this conservative number to be on the safe side.
Additional commercial highlights published in Carbon Streaming's recent shareholder update:
Carbon Streaming expects to receive up to 7M Verra registered REDD+ carbon credits in the first half of 2022 from their existing carbon credit streaming investments into the Rimba Raya and Cerrado Biome projects.
The Company has been experiencing strong demand at premium prices for the credits the Company expects to receive in 1H22.
REDD+ 2021 vintage carbon credits are currently trading for an average of US$13.72/credit.
This year the voluntary carbon credit market has exceeded US$1 bn as of November 9, 2021.
Management
Justin Cochrane is the CEO of Carbon Streaming Corp. He is the brainchild behind the idea to build a streaming company involved in the carbon credits markets and put together the management team and financing. He has many years of professional experience in the commodities sector and has been involved in multiple royalty companies like Nickel 28 Capital Corp, Cobalt 27 Capital Corp. and Nevada Copper Corp.
His insider ownership of NETZ according to sedi.ca dated Dec 12 2021:
272,000 common shares
100,000 options
100,000 RSU
272,000 warrants
744,000 in total equates roughly to 0.9 % of the fully diluted share capital. I usually don't like such a small direct ownership of shares at a microcap company. A higher insider ownership usually ensure the CEO's and shareholders interests are aligned. The topic is further discussed in the share structure section.
On the board there are multiple directors with royalty experience. Two examples are:
Board of directors: Saurabh Handa CFO for Metalla Royalty & Streaming Ltd., a TSX-listed and NYSE-listed precious metals royalty and streaming company.
Advisory board: Sean Roosen, Executive Chair of the Board of Directors of Osisko Gold Royalties Ltd and founding member of Osisko Mining Corporation. When further looking at the share structure, I saw that Osisko Gold is also +10% shareholder of NETZ.
Share structure
NETZ listed in 2021 on the NEO exchange via a reverse merger.
Fully-diluted Share Capital: 80.7 M
Cash: $108.6 M
Debt: nil
Osisko Gold is invested in NETZ and owns 11.66% of the fully diluted share count.
The overall share structure looks good to me except one attribute that I like to see at the companies I invest in: The insider ownership seems to be only 4%. I found this small insider ownership unusual for a microcap that recently went public. However, it could have something to do with the way they finance the projects and equity in form of shares they offer the project developers. This could be the reason they have hold back a certain amount of shares. It would definitely be a topic to ask management about, should I get the opportunity to speak with them in the future.
As NETZ plans to list on the NASDAQ or NYSE in H1 2022, a 1:5 reverse stock split was completed recently. I expect institutional buyers and big ESG funds to enter after the US listing is completed, as it offers them more liquidity than the current NEO listing.
Risks
Every opportunity involves risks. Some of the risks I see with Carbon Streaming Corp can be found below.
They are very early stage in their company lifecycle and only just started to acquire projects. If a few of them don't work out, they cannot offset the lost carbon credits with other projects.
Even though Carbon Streaming are the first movers, new entrants are coming to market fast and could drive prices for projects up. Examples of new entrants planning to go public in 2022:
EB Tucker (Metalla Royalty, Nova Royalty) is involved in Carbon Neutral Royalty Limited https://www.carbonneutralltd.com/
Base Carbon is another 2022 planned NEO listing
Voluntary carbon credit markets could get substituted by something else
Dilution: Further needs to raise capital in order to finance projects.
"The demand for, and the market price of, carbon credits can be adversely affected by any number of factors, including the implementation of lower emission infrastructure, an increase in the number of projects generating carbon credits, invention of new technology that assists in the avoidance, reduction or sequestration of emissions, increased use of alternative fuels, a decrease in the price of conventional fossil fuels, increased use of renewable energy, and the implementation and operation of carbon pricing initiatives such as carbon taxes and ETSs. There can be no assurance that carbon pricing initiatives or compliance or voluntary carbon markets will continue to exist. Carbon pricing initiatives may be subject to policy and political changes and, may otherwise be diminished, terminated or may not be renewed upon their expiration" Carbon Streaming Annual Information Form
Low insider ownership: Could lead to decisions not in line with shareholder interests.
Conclusion
Rating: Bullish
In conclusion, I think Carbon Streaming is a great way to play the carbon credits market at a very compelling risk / reward profile. With "ESG assets on track to reach $53 trillion" and Energy politics leading to near inelastic demand for carbon credits, I expect major money flows into NETZ in 2022 and onward.
Carbon Credits expected to be in supply / demand deficit soon
Demand for carbon credits could increase by a factor of 15 or more by 2030 and by a factor of up to 100 by 2050!
Carbon Credits prices forecast to increase
NETZ has access to blue carbon credits & Co-Benefit projects -> ability to ask for price premium
NASDAQ listing in H1/2022
More projects acquisitions to be announced soon & big project pipeline
Will grow in tandem with the general commodities super cycle, as commodity producers need to be net neutral. However, most of them have no other choice to reach this than buying carbon credits
Great inflation hedge due to asset lite business and no input costs
Management team with experience in royalty streaming businesses
Osisko gold is a significant shareholder
14X potential from current level
I started a position in NETZ (currently roughly 1% of my private equity portfolio) and will scale in over time. The NASDAQ listing should be a short term catalyst as will be additional acquisition announcements, plus headlines around the carbon topic. Expect further money flows from ESG funds into Carbon Streaming once NETZ is listed on the NASDAQ and a higher market cap above $ 1bn is reached.
If EB Tucker's Carbon Neutral Royalty should go public in the near future, it might be valuable to have an active account with Freedom24, an online trading platform that offers a wide variety of instruments: shares, ETFs, stock options at US, EU and Asian markets.
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Carbon streaming is also part of the "Picks and shovels plays" wikifolio, which is traded on the German Stock Exchange. Sign up here for free to learn more about wikifolio:
Sources:
Doug Casey mentions Carbon Streaming Corp https://youtu.be/vSBk0iOD1Fs
Up to date carbon prices: https://carboncredits.com/carbon-prices-today/
The War on Carbon: The most misunderstood commodity on earth: https://www.youtube.com/watch?v=jiFxPEqBcno
Financial Stability Oversight Council (FSOC) report: https://home.treasury.gov/news/press-releases/jy0426
Carbon credit prices: https://carboncredits.com/
China cement production https://www.worldcement.com/asia-pacific-rim/05102021/fine-china/
Carbon Streaming investor presentation https://www.carbonstreaming.com/investors/presentations/
Annual Information Form https://www.carbonstreaming.com/_resources/financials/AIF-June-30-2021.pdf
Disclaimer: This blog post is purely my personal opinion and is not financial advice. Please do your own research, before taking investment decisions. I am long Carbon Streaming Corp. Investments in securities and other financial instruments always involve the risk of loss of your capital. The forecast or past performance is no guarantee of future results.