FEATURE: Rising prices attract institutional investors to carbon markets in New Zealand, Australia

Rising carbon prices and improvement in policy certainty has started to attract more institutional investors to carbon markets in Australia and New Zealand.

While New Zealand operates a cap and trade emissions trading scheme on the lines of EU ETS, Australia is a hybrid market comprising of both voluntary and compliance markets.

The most direct route for exposure to carbon markets are carbon credits -- Australian Carbon Credit Units, or ACCUs, and New Zealand Units, or NZUs.

"2021 was the year investor interest in carbon assets globally really took off," said Blake Schaefer, partner at Environmental Commodity Partners LP, a US-based asset manager.

ECP in October entered a three-year carbon credit deal with Australia-based Olkola Aboriginal Corporation to buy ACCUs generated from its savannah fire management carbon project. These projects generate ACCUs by undertaking controlled burning to avoid emissions from fire in savannas in northern Australia.

However, investors are also taking the route of buying or jointly owning carbon projects, such as plantations, forestry projects as well as agricultural land.

"There has been institutional interest not so much on the ACCU market but in sort of real asset plays that can include complementary income streams from say ACCU generation," said Rich Gilmore, CEO of Carbon Growth Partners, a Melbourne-based investment manager.

Sydney-based investment manager New Forests and Canada's Alberta Investment Management in September 2021 agreed to buy Lawson Grains, one of Australia's leading corporate grain growers, with an aim to increase focus on soil carbon and native revegetation.

Projects

"I get an information memorandum every week or so focused on HIR (Human Induced Regeneration)," Gilmore said, referring to the project type that involves restoring native vegetation through land management practices.

HIR projects are the most capital-light way of generating nature-based ACCUs, Gilmore said, adding that they require significantly less expenditure and time before generating credits.

Platts, part of S&P Global Commodity Insights, assessed the price of HIR ACCUs at A$38.55/mtCO2e ($25.85/mtCO2e) and Generic ACCUs at A$37/mtoCO2e March 16. Market expects the price to rise further once the government implements tighter limits under reforms to Australia's emissions compliance scheme, Safeguard Mechanism.

Environmental plantings and forestry projects are also attracting interest from developers, both in Australia and New Zealand.

Firm NZU prices have led to a large number of forestry projects in New Zealand entering the emission trading scheme to generate credits.

Platts assessed the price of NZUs at NZ$67.60/mtCO2e ($42.15/mtCO2e) March 16. The price touched a record high of NZ$88.50/mtCO2e in November and while it has fallen since then, the market expects it to rise over the long term. As a result, NZUs and ACCUs continue to represent one of the highest carbon prices in Asia.

"Most of the projects are forestry based. You are seeing hundreds of millions of dollars going into planting forests for the purpose of absorbing carbon," said Paul Harrison, managing director at Auckland-based Salt Funds Management, which runs a carbon fund.

New Forests said in October that it had sold carbon positions from forests in New Zealand and was actively looking at opportunities to establish greenfield plantations for both timber and carbon production.

Nearly half of Australia is farms and to meet net zero goals, capital can be deployed at scale on the farmland through institutions and acquisitions, Gilmore said.

Melbourne-based Tiverton Agriculture Impact Fund has invested in a cropping asset of more than 6,000 hectares in New South Wales to develop a soil carbon sequestration project. The fund is also developing a soil carbon project in collaboration with aboriginal landholders on a nearly 1,000 hectares asset in Western Australia.

Returns

While Carbon Growth Partners is targeting a minimum 20% internal rate of return in its funds, Salt Funds said on its website that the average annual return since inception for its carbon fund was 17.5%.

"While we are seeing a number of index-based funds emerge, generally speaking, Carbon Funds with active management to limit volatility and outperform benchmarks will generate better returns," said Luke Donovan, partner, global carbon markets, at Sydney-based Apostle Funds Management

In New Zealand, the carbon value of $50/mtCO2e exceeds the timber stumpage value in many areas, New Forests said in a paper in December.

Barriers

Market participants said that the compliance carbon markets are policy-driven and hence uncertainty around new rules could inhibit investor interest.

Australia allowed project developers to exit ACCU delivery contracts with the government in early 2022, creating a glut of supply and momentary a fall in prices.

New Zealand's government unexpectedly adopted weak price settings for its ETS auctions in December, resulting in a slide in NZU prices. The government has also tightened the rules for overseas investors to buy and convert farmland into forestry.

"It was always there but it is now crystal clear that overseas investors cannot buy carbon forest without having to jump through a series of hoops," said Dan William, partner at New Zealand-based law firm Anderson Lloyd.

The market is also seeking some clarity around the interaction between voluntary carbon markets and compliance carbon markets, Gilmore said, referring to rules being negotiated under Article 6 of the UN-backed Paris Agreement.

"The more trust market participants have in those governments to remain consistent with the general policy direction, the more investors will be willing to expose themselves to those markets," Schaefer said.