Carbon Growth Partners targets 20% IRR from carbon markets

Mispricing across voluntary carbon markets offers strong returns potential for investors looking to support the pathway to net zero.

Carbon markets investor, Carbon Growth Partners (CGP), is betting on an imminent correction in the price of carbon credits to bridge the gap between impact and for-profit investing.

Following stronger-than-expected demand for its debut fund, Carbon Growth Opportunities Fund, recently the firm launched a second vehicle focussed on investments that contribute to a global reduction in CO2 emissions.

“We aim to be dedicated investment managers in what most people call the ‘voluntary carbon market’ (VCM) - but we consider to be the ‘verified carbon market,’ because in our view, emissions reductions aren't voluntary,” founder and CEO, Rich Gilmore, told FinanceAsia.

Gilmore said his team is excited to be at the leading edge of this investment trend, adding, “I think there's a pretty fair consensus that decarbonisation and dealing with climate change is the biggest and most important thematic for the next 30 years.”

Carbon credits allow firms to invest in projects that contribute to a reduction in global carbon emissions, as part of their transition to net zero. One carbon credit usually equates to a one-ton reduction in carbon dioxide emissions.

Credits can be traded on mandatory carbon markets, such as the EU Emissions Trading System (EU ETS), or on VCMs, such as Singapore’s AirCarbon Exchange.

A former trader and later director at non-profit, The Nature Conservatory, Gilmore established Carbon Growth Partners at the end of 2020.

"We had three objectives for the business.... First and foremost, to generate financial returns for investors; to deliver positive impact for people; and to accelerate the decarbonisation pathway, providing highly trusted, high-integrity carbon offset solutions for companies to complement their own decarbonisation activities.”

The firm targets an internal rate of return (IRR) of over 20%, which defies the common perception that impact investing is tied to concessionary returns.

Gilmore explained that this target is achievable because of the current macro and market mispricing of carbon credits. He expects the price of these assets to rise exponentially, before 2030.

“Credits are currently trading in the international market for between $2 and $30 a ton, but research by McKinsey, EY and others, shows that the pricing required for us to meet the [Science-Based Target] of a 1.5-degree [limit in global warming] is conservatively around $100 a ton, and even up to $300 a ton,” he explained.

One cause for this relates to structural constraint in the future supply of carbon credits, which is yet to be factored into market pricing.

“Every year, we're generating about 200 million carbon credits and using about 140 million, so there's a perceived surplus of carbon credits, with about 500 million carbon credits issued to date that haven't yet been used for a corporate offset.”

“But by as soon as 2030, we’ll have about 2 billion of known demand from companies, based on existing public pledges to reduce emissions…. That's a 10-fold increase in supply of offsets that will be required over the next seven years,” Gilmore said.

He explained that a number of other elements – from biophysics to politics and community – will restrict the ability to create enough credits to meet demand. “Even if the price of carbon credits went from $5 today to $50 tomorrow, this won't make a tree grow any faster.”

Moreover, he noted that current technological limitations will mean that firms cannot achieve net zero based on decarbonisation efforts alone, particularly in high-emitting sectors.

“If you're an airline, for example, some of your investment will go into sustainable aviation fuels. But for the next couple of decades, a lot of that decarbonisation is going to have to come in the form of carbon offsetting.”

Broader appeal

As a general partner (GP), CGP invests about 80% of raised capital in the primary carbon credit market, meaning that the firm buys carbon credits directly from projects and project developers; the remaining 20% is deployed across the secondary market, for carbon trading.

The firm’s first fund raised $100 million, against an initial target of $10 million, within just two fundraising rounds in the space of three weeks, Gilmore said. The fund reached a final close in October 2021.

The second fund, the Carbon Growth Fund, is Cayman-domiciled, open-ended, and has a two-year lock-up period. The fund achieved a first close of $30 million in November last year, and is hoping to raise an additional $20 million in coming months.

“Ultimately we want that to get to $100 million by the end of this year, and to a total of $200-250 million in about a year from now,” Gilmore told FA.

Singapore-based impact investor, Silverstrand Capital announced in October 2022 that it had made a $10 million commitment in the second strategy, but Gilmore is confident that the fund will also appeal to a broader type of investor.

He told FA that the firm is increasingly in conversation with mainstream institutional investors who, due to fiduciary duty, tend to make allocations based purely on financial grounds.

Due to the nascency and size of the market, he said that there have been challenges for such investors to allocate to carbon assets at scale, but this is shifting.

“Many [institutional investors] are already participating in compliance markets for carbon. The European carbon market, for example, turns over hundreds of billions of euros per year and has a number of institutional investors participating in it,” he said.

Greenwashing concerns

Gilmore cited Audi, Apple, Microsoft, Amazon, Air France, EasyJet and McKinsey as examples of household names that over the past month had made use of the type of carbon credits that CGP invests in. Oil and gas companies have been active in VCMs for many years, he added.

Shell last year announced that it expects its own corporate demand for carbon offsets to reach 120 million tons a year, by 2030

“Shell has also announced publicly that it's investing between $450 and $500 million a year in upstream projects to buy and get access to credits now, because they are concerned that by 2030, there won't be enough credits at affordable prices to meet their set commitments,” Gilmore shared.

But the use of carbon credits has attracted critics. In the absence of unified international regulation, some question the legitimacy of carbon markets. An investigation earlier this year found that rainforest offset credits certified by the world’s largest standard setter, Verra, did not equate to genuine carbon abatement.

Additionally, some suggest that companies may view the use of carbon offsets as a way to legitimise continued emissions.

“I think we're spending a little bit too much time on the on the arcane nature of the accounting, instead of the outcome that is being delivered,” Gilmore said.

He believes there is “no evidence” that companies are using carbon credits to continue business as usual.

“Offsets are only credibly usable as part of a holistic decarbonisation strategy, but they are absolutely essential…. We have to do everything, everywhere, all at once, and this includes a massive increase in climate finance and carbon offsets.”

He shared his expectation of a continued proliferation of standards in the market, but a convergence in methodologies and types of project that are deemed eligible for carbon offsets.

Future of CGP

Looking at the months ahead, Gilmore’s priorities include fundraising for Carbon Growth Fund, with a focus on commitments from Asia.

“We’re seeing a lot of interest in Asia, and we've been spending time in Hong Kong, Singapore and Tokyo. The reception here has been very positive.”

While unable to disclose names, he said that the fund expects to announce a number of high-profile limited partners (LPs) in coming weeks.

Concluding the discussion, Gilmore underlined the importance to address the carbon market opportunity, both from a financial as well as climate change perspective.

“We think there's a very significant time-limited opportunity in the mispricing of the market, because once carbon credits start to be repriced…they're not coming back,” he said.

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