It's a common refrain in investment circles these days.
Carbon may be a dynamic new investment opportunity but the classic risk/reward dynamic still applies--even with game-changing, cap-and-trade legislation on the horizon.
“Capital in the U.S. is beginning to be mobilized into carbon funds, ready to be deployed once the President signs into law the requisite legislation,” wrote Environmental Finance editor Mark Nicholls, in his firm’s just-released 2009/2010 carbon fund survey.
The survey counts 89 carbon-related investment vehicles with assets under management of $16 billion. That's ten more funds and $3 billion more in capital than a year ago.
Though private equity and hedge funds have already begun placing their bets in the carbon space, its unclear at this point whether the old investment models are best suited to play a market that could hit $2 trillion in a few years times.
At this point. private funds are “emerging as the method of choice” for access, says Scott Furman, head of the environmental law group at the New York-based firm of Tannenbaum Helpern Syracuse and Hirschtritt, because it "enables the investor to share risk, diversify and rely on professional management,” he says.
The ideal carbon fund structure, however, may borrow some aspects from both private equity and hedge funds, creating a hybrid that could require some rethinking of asset allocation models that typically divide alternatives managers into private equity, real estate or hedge fund portfolios.
Because of the way carbon offsets projects are developed, most investors now approach carbon from a project finance perspective—often a private equity approach, with the closest model being a closed-end partnership to develop oil fields—versus creating a fund buying and trading the carbon commodity itself, a more typical hedge fund strategy.
For example, a project financing pool may approach a dairy farmer, help him build and manage an anaerobic digester to capture methane from his herd’s manure and turn that methane into green energy. The farmer sells the power to a utility for profit and generates carbon offsets as an additional revenue stream in the process.
Adding more farmers creates a portfolio of carbon offsets projects and the resulting carbon credits could then be traded.
Greg Arnold, managing partner at CE2 Capital Partners, says his firm now does both of these things, although not through one investment vehicle.
Founded in 2005, the firm’s first funds focused on environmental commodities, including European Union Emissions Trading Scheme carbon credits, renewable energy certificates produced by clean energy generation in many US states and carbon credits from a regional greenhouse gas organization, as well as nitrogen- and sulfur-oxide-related credits under the old acid rain mitigation cap-and-trade program.
“In these funds, we looked at everything that was investable,” he says.
But in their latest vehicle, CE2 Carbon Capital LLC, Arnold says they’re taking an asset management approach. “It’s a perpetual investment vehicle,” he says, adding that it’s not really a fund in the usual sense. “Think of it as an ‘extremely long-dated hedge fund."