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By Anthony Milewski, Chairman of Nickel 28 Capital
This is the latest in a series of articles on the carbon credit industry. In this instalment, INN contributor Anthony Milewski considers the arrival of the streaming business model and how it might affect the sector.
You can read his earlier instalments, written for investors seeking to understand the fundamentals of carbon credits, in part one and part two.
Carbon credits are growing fast, both as a tool for combating climate change and as an area of investor interest. Like any industry undergoing rapid expansion, the sector is changing, and the most recent of these changes is the arrival of streaming in the voluntary carbon credits sector.
As a business model, streaming comes from the mining space, which has over a dozen streaming and royalty companies sporting a collective market cap of more than US$50 billion.
The model first surfaced when Franco-Nevada (TSX:FNV,NYSE:FNV) purchased its first royalty in the early 1980s; however, it didn’t really take hold until about 15 years ago, when Goldcorp spun out Silver Wheaton, which is now Wheaton Precious Metals (TSX:WPM,NYSE:WPM). Wheaton’s success led to similar operations being launched in the mining sector, and then later in oil and gas.
Streaming is based on a contractual agreement whereby a company (the streamer) makes an upfront payment in return for the right to purchase a portion of production. An additional per-unit payment is received by producer as it delivers on its contracted production.
Conceptually, streams and royalties are similar, and the upside for both parties involved is considerable. For the producer, the streaming agreement means significant upfront cash proceeds and a non-dilutive form of financing; these deals can typically be accounted for as deferred revenue and not debt. There is also no requirement to change how the operation is managed.
The streamer gains exposure to price appreciation and project expansion upside, as well as earnings and dividends, while enjoying reduced exposure to capital costs and operating costs.
As a result of these structural advantages, streaming companies in the mining, oil and gas sectors have typically been valued at a premium. Additionally, the opportunity for value arbitrage to create mutually accretive transactions has allowed streaming to become a mainstream financing alternative.
So how will this operate in the carbon credits sector? Well, a typical scenario would be as follows: The streamer makes an upfront investment into a project, and in exchange for that upfront investment, it receives the right to purchase a certain percentage of the carbon credits generated by that project; it does so at a discount to the current market price.
Depending on the size of investment, the streamer may receive anywhere up to 100 percent of the carbon credits that are that are created from the project, with an associated revenue-sharing model with the project owner. The streamer can then monetize those credits on the market.
All of this is in line with how the streaming model has operated in the mining and energy sectors. There are, however, additional advantages when applied to the carbon credits industry.
The first is the ability to directly increase the value of credits produced by a carbon offset project. Compared to the mining sector, where, for example, gold is gold regardless of how it is produced, the value of carbon credits can vary dramatically depending on a variety of project-related factors.
This is because while every carbon credit represents 1 tonne of CO2e removed from the atmosphere, not every credit is equal in its impact on the planet and society. The United Nations has listed 17 categories, including poverty, education, clean energy and clean water, which are designed to help achieve a more sustainable future. The more areas a project occupies, the greater the potential premium.
The second advantage is price upside. With less than two decades under its belt, the carbon credits industry is still relatively young and is developing at a tremendous pace.
Growth is being driven by asset managers, particularly those in the US, as well as by consumers and also by government regulators. Legislation has already been introduced in a number of countries that require companies to disclose climate risk, and recently the G7 nations all agreed that “mandatory climate-related financial disclosures” should be implemented.
Faced with such pressures and regulatory disclosures, many companies will look to the voluntary carbon markets to purchase carbon credits or risk significant reputational damage.
Next on the list is project life and diversification. Unlike mining, oil and gas assets, carbon offset projects have guaranteed durations and do not have the risks that come with extracting natural resources. In many cases, you can be looking at returns over as much as 30 years.
In addition, these are free cash flow-generating investments, which means the streamer can redeploy capital into new investments or pay a dividend yield to shareholders.
There is also the monetization advantage to consider. When it comes to the work of monetizing credits, carbon project operators — which traditionally run with small teams due to limited funds — have had to spend time marketing and selling those credits to corporate buyers instead of focusing purely on running and expanding their project. With the arrival of the streamer comes a professional sales and marketing team that can take over and excel in that role.
The final major benefit that comes with the arrival of the streaming model in the carbon credits sector is undoubtedly the most important in terms of industry-wide impact.
Over its nearly two decades of existence, most carbon offset operators have found it hard to raise money from the mainstream corporate finance world — the very source that mining and energy companies have taken for granted over the years.
The arrival of carbon credit streamers means that corporate financing is no longer closed off to the bulk of project operators. The potential to acquire upfront cash investments, together with the stream of income from the revenue-share model, means projects can execute much quicker on development plans, whether that’s investing in local community projects, expanding their geographical reach or essentially increasing the overall effectiveness and impact that these carbon offset projects have.
What does the future hold?
The first publicly listed streamer to enter the sector is Canada-based Carbon Streaming (OTC Pink:OFSTD). Based on what happened in the mining sector once Wheaton established itself as a valuable enterprise, it’s reasonable to expect similar operations to launch should Carbon Streaming prove a success. This can only be for the good when it comes to the development of the sector, as it will give investors more exposure to potential upside and it will help the corporate finance world to positively impact the drive towards carbon net zero.
With so many changes, and so much growth occurring, the voluntary carbon credits market is in for a very interesting ride. However, the arrival of well-proven business models like streaming indicate the sector is transitioning into a new and exciting phase, and it’s certainly one to watch closely.
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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