A British investor launching a natural capital strategy is aiming for a strong risk-return profile by balancing investments in nascent markets like biodiversity with more assured sectors like renewable energy and afforestation.

Octopus Investments plans to close its first natural capital fund by year end and to allocate around 80% of the fund to revenue streams like afforestation through the Woodland Carbon Code and renewable energy, while the remaining portion will go towards more nascent markets like biodiversity credits and soil sequestration.

“What we’re trying to create is a larger portfolio effect on land that isn’t just carbon, isn’t just biodiversity,” said Alex Godfrey, investment director at Octopus Investments.

“It’s a mix of everything and gives investors sound basis points of return” in areas they are already familiar with like wind, solar, energy storage, and net zero property, he told Carbon Pulse.

The voluntary carbon market (VCM) is far from fulfilling its potential as a climate mitigation tool and “yet it’s undeniable no one gets to net zero without high integrity credits,” he continued.

DEMAND BURST

The investment house anticipates a burst of credit demand to arise from corporates running to meet their net zero targets, and wants to create high-integrity carbon removal credits to meet both its own corporate and fund-level emission targets and to sell to third parties.

“We’d probably only sell about 30% of the carbon from these assets as a revenue line” with the remainder kept back for value appreciation and to meet our own corporate commitments, said Godfrey.

Octopus Investments, sister company to renewable energy company Octopus Energy, launched its natural capital strategy last month with a UK focus and aiming for an initial fund size of £150-250 million.

The fund size is an acknowledgement of the UK’s limited land size and there are plans to expand globally over time, said Mike Toft, senior fund manager at Octopus Real Estate.

The natural capital strategy forms part of Octopus’s long-term goal to grow its assets under management from £13.5 billion to £50 bln by 2030.

Initial projects under the fund are likely to be in Scotland, with the team in advanced discussions there currently, said Toft.

“It’s impossible to eradicate carbon entirely from real estate development, so voluntary carbon credits are a key part of that solution” and Octopus has a vested interest in delivering the highest quality credits both for its own use and to sell to third parties, he said.

The investment house has yet to acquire any credits but expects to need them to reach its 2030 targets.

“We’re at a pressure point now to deliver credits” given corporate timelines to reach net zero are looming ever closer, said Toft.

FUND PREFERENCES

The fund will focus more on investing in afforestation projects under the UK’s Woodland Carbon Code (WCC) than the Peatland Carbon Code because the former generates carbon removals, as opposed to carbon avoidance with the latter, said Godfrey.

There’s been a lack of trading in WCC credits so far, he noted, but Octopus plans to “stimulate that trading and create those headlines” through making strategic moves in project development north of the border, he said.

The company expects the government-backed peatland and woodland codes to retain their market value better than on the voluntary market. When it comes to biodiversity, it will focus more on the voluntary biodiversity market rather than the government-backed biodiversity net gain (BNG) market, because the latter is unlikely to scale significantly, Godfrey said.

“We’re putting more salience on the voluntary biodiversity market, which is more nascent but we think will be bigger,” said Godfrey.

A land manager recently told Carbon Pulse that selling all BNG units from one large conservation project in England could take up to a decade, if they trade at all, with the current system unable to drive large-scale landscape recovery on its own.

The approximately 800-hectare Wendling Beck environment project in Norfolk is preparing to generate approximately 3,500 BNG off-site units to sell to developers.

However, pre-demand for units has not taken off, with developers offsetting the bulk of their nature impacts within building sites, while there is an excessive supply of BNG units, said the project lead.

Under legislation that came into force in February, developers in England must improve biodiversity by 10%. They must prioritise generating on-site units, before buying off-site ones if necessary, then purchase biodiversity credits as a last resort.

However, a hypothetical case study by Endangered Wildlife suggests that property developers should take advantage of the economic value of nature and integrate biodiversity into their projects, rather than offsetting their impact.

Biodiversity-positive action in a development of 32 luxury detached houses over an 11-hectare plot in Norway could increase net profit by €600,000 up to €8.7 mln, the case study suggested.

GROWING TREND

Land restoration company Oxygen Conservation also intends to capitalise on England’s burgeoning BNG market, in addition to the VCM, and other revenue drivers like ecotourism, regenerative farming, and property lets.

The company, set up by private investors in June 2021, told Carbon Pulse in February that it has so far deployed £85 mln to acquire 10 sites across the UK, from Cornwall up to Scotland, totalling around 30,000 acres.

Its first portfolio is expected to generate about 1 mln tonnes of CO2e reductions by way of the WCC, PCC, and BNG markets, depending on the validation process.

Credits sold under the UK’s Woodland and Peatland Code schemes were found to be some of the most expensive in the VCM, according to Ecosystem Marketplace.

Data released in Oct. 2023, saw the average price of British woodland units increase to around £25 in the first half of 2023, from £15/t in 2021, while peatland credits were around £24 in 2022.

REACHING HURDLE RATE

Using investments in established areas like renewables, low-carbon property, and ecotourism will help Octopus to get pretty close to the hurdle rate for investment before having to factor in returns from an unpredictable carbon price, said Godfrey.

“The fund allows investors to minimise their downside risk because they have exposure to land, wind, solar, etc., while upside risk comes from carbon, biodiversity and water as those markets play out,” he said.

The more nascent markets that Octopus intends to play in in the UK include biodiversity net gain, voluntary biodiversity, nutrient neutrality, enhanced rock weathering, biochar, soil sequestration for regenerative farming, and other existing or potential government codes of agroforestry, hedges, and saltmarshes.

The worlds of biodiversity and carbon are increasingly interlinked, with the UK Peatland Carbon Code likely to combine biodiversity credits with carbon from 2025, according to a draft by the International Union for Conservation of Nature (IUCN), which runs the programme.

The inclusion of biodiversity credits is significant as it could provide government backing for voluntary biodiversity credit standards, driving corporate investment in nature, at a time when demand in the nascent area is lagging due to lack of confidence.

There is also ongoing work to develop a government-backed Saltmarsh Carbon Code to address the fact the UK has lost about 80% of its carbon-rich saltmarshes over the past 200 years.

By Bryony Collins – bryony@carbon-pulse.com