INTRODUCING THE COUNTERACT CARBON CURVE TOOL

All good carbon removal projects share a few fundamental characteristics: manageable technology risk, clear revenues with quality offtake agreements, strong team track record, and a well understood cost structure. These factors determine whether a project gets financed and at what cost.

There is an additional dynamic that comes into play in carbon removal. While seldom discussed, it is crucial to making both development and investment decisions at this stage of the industry. This is the shape of the carbon sequestration curve and its interaction with a project’s cost of capital. Whereas the fundamentals of a project will influence the break-even carbon price, the carbon curve shape will affect the sensitivity of that price to the cost of capital.

The relationships between carbon curves and costs of capital are nuanced and dynamic. To make sense of them we are sharing our modelling tool and invite you to play around with it. https://carboncurve.tools.counteract.vc/

The tool is by nature simplified; it does not account for all the variables that confront real-life projects. But there are still many parameters in the tool that you can explore and learn from. You may begin to look at the economics of carbon removal pathways differently, depending on where your interests lie:

• For investors: you’ll see where there are conditions for early returns in CDR, and how they are affected by sequestration rates more than you might think

• For developers: you’ll see that while you can’t change the fundamental carbon curve, you can optimise for it through variables like capex and opex ratios that affect your cost of capital and ultimately your project’s viability. Or you can innovate to improve the shape of your carbon curve, which in turn changes the cashflow profile and hence the potential profitability of your project.

As the carbon removal industry continues to grow in a capital-constrained environment, clarity on financial structuring is more important than ever before. This is part of the reason we're inviting the industry to explore this simplified tool.

Our conclusions

From being intimately involved in many companies across a diverse range of CDR pathways, driving focused research and developing this tool, we’ve found that:

• The shape of the Carbon Curve is fundamental to a project’s cash profile and determines its financial viability at least as much as technical considerations

• Diminishing carbon curves carry a structural financial advantage. Revenues are pulled forward, meaning projects will pay less in capital costs per unit of capital spend. We cover this below.

• Increasing curves are disproportionately punished by higher cost of capital

• At this stage in the development of carbon removal pathways and projects where risks remain elevated and, hence, costs of capital are high, an optimal project type has low capex and follows a quickly diminishing curve.

• Capex-to-opex ratios are another important lever

• There are a few actions that be taken to reduce a project’s sensitivity to the cost of capital

  • Change your carbon curve shape and hence your future cashflow profile

  • Bring in additional revenue streams

  • Alter the capex/opex balance of your project

  • Innovate your financial structuring

This piece walks through each of these dynamics, with case studies to show what good and bad looks like across the main curve types and what can be done about it.

Definitions & Tool Parameters

First, some definitions of the parameters you’ll explore in this tool.

The Carbon Curves

These curves show the annual removal capacity of a carbon removal project over time.

Some projects remove more CO2 in their earlier years than later years, and some remove more in their later years. For others, the removal rate is either constant or non-linear.

Carbon curves relate directly to project economics, because the rate of carbon sequestration represents a project’s cash flow profile.

Diminishing Curve

Project types: Enhanced Rock Weathering, Passive Mineralisation (eg. from mine tailings), Ocean Alkalinity Enhancement

The rate of removal is highest in the earliest years of the projects and declines with time.

Increasing Curve

Project types: Afforestation, Reforestation, Revegetation - slow carbon accumulating projects.

The rate of removal accelerates over time: removal is back-loaded. Typical of forestry-based or other nature-based methods.

If operated long enough these projects can follow a bell curve (below). The timing of the plateau will depend on the type of forest and how long it takes to grow.

Bell Curve

Project types: Soil carbon, nature-based removal projects - rapid carbon accumulating projects

The rate of removal accelerates at first, plateaus, and then diminishes until it reaches an equilibrium where it is no longer removing additional CO2. Some projects, for example plantation forestry, might choose to end the project once the growth rate begins to plateau in order to keep the plantation growing at its most productive rates - therefore the increasing curve should be used.

Steady State Curve

Project types: Direct air capture, Biochar carbon removal, engineered projects.

Removal capacity is constant over time. Typical for engineered methods like Direct Air Capture, Biochar, or engineered mineralisation projects where removal feedstocks are being processed at a constant rate in a closed system.

WHAT CARBON CURVES MEAN: EXAMPLES FROM THREE CURVES

Many conclusions – or suggestions – can be inferred from this simplified tool. We will delve into a few of them based on our exploration so far.

1. Diminishing curve: The opportunity and challenge of enhanced rock weathering

➡ If all else is kept the same, projects with diminishing curves have a structural financial advantage to other curve shapes

Of the different curve types, the diminishing curve is structurally the most attractive to finance. Revenues arrive sooner, projects recover costs faster, and less interest is paid on capital. If all is equal, projects that follow a diminishing curve are the most profitable.

The result is projects can breakeven at a significantly lower carbon price and in addition have a higher tolerance for cost of capital. The graph below shows both clearly. You can recreate this easily in the tool and change some of the underlying parameters.

Enhanced Rock Weathering (ERW) projects follow diminishing carbon curves and are a useful example to show its effect on project economics.

ERW is a carbon removal method that involves crushing carbonate or silicate rocks and applying them to agricultural land. The rocks naturally react with CO₂ dissolved in rainwater locking that carbon in stable mineral carbonates, which takes place from over centuries to millenia. However the process can be sped up - or enhanced - to relevant timescales by crushing the rocks into fine powders to increase their surface area.

Carbon removal happens fastest in the earliest stages of ERW as the more reactive mineral surface dissolves and slows as the mineral weathers, hence the diminishing curve. Realising the advantage of the diminishing curves is entirely dependent on how fast the rock weathers. This is where sequestration rate or weathering rates come in (see definitions table).

Faster vs slower sequestration rates will result in significantly different cash-flow.

A faster sequestration rate means revenue comes faster, opex is paid over fewer years, and the project pays back its financing costs sooner. A slower sequestration rate on the other hand delays the revenue, extends the periods over which operating costs (such as MRV) and capital costs accumulate, and erodes some of the structural advantage that makes the diminishing curve attractive in the first place.

Choose a mineral that weathers mostly in one year versus five years and (all other factors equal, including cost of capital) your project will be significantly more profitable.

The weathering rate also influences an ERW project’s sensitivity to costs of capital. A project that weathers mostly in one year can remain viable at significantly higher WACC than one weathering across five years, because it pays back quickly and financing costs do not compound. At fast weathering rates, there is minimal difference in required breakeven carbon prices even at financing rates of 18% (shown below). So these project profiles are particularly attractive to carbon removal investors today when financing costs tend to be high.

We discussed in a previous blog why slow weathering is such a problem for the unit economics of ERW projects. However, as exemplified here, fast weathering can offer a real opportunity.

2. Increasing curve: structural challenges of forest carbon projects

Projects that follow increasing curves, on the other hand, face a distinct set of challenges that shape the way this class of projects are financed.

Nature-based carbon projects - ARR being a prominent example - follow an increasing curve in their early years. Trees take time to grow. Carbon sequestration is minimal at the outset and accelerates with time as the forest matures. (Of course we recognise that a forest’s value goes beyond just carbon sequestration, however we are focusing on carbon for the purposes of this tool.)

The consequence is straightforward but meaningful. Projects will run at negative cash flows for several years. Upfront costs are significant, while revenues are minimal. The breakeven point can be a decade or more into the project life as shown in the illustrative chart below.

This creates two financing challenges.

First, conventional debt on its own is largely inaccessible to forest carbon projects. A project that cannot generate meaningful revenue for five to ten years may struggle to service debt repayments. Because the investment returns are heavily weighted to the latter end of a project’s life, they are vulnerable to changes across that period: carbon pricing shifts, fires, policy shifts, or other changes. For traditional debt providers, these project risks can be simply too high.

Second, ARR projects are acutely sensitive to costs of capital. Because revenues are delayed, every percentage increase in capital costs will have a compounding effect on the breakeven price. This is illustrated by the chart below. As the WACC (discount rate) increases, the breakeven price rises sharply and non-linearly.

Taken together, these two dynamics mean that projects with increasing carbon curves face structural financing challenges that cannot be solved by project design alone. Rather, financial innovations have emerged to work around it.

The clearest examples are:

• Corporate carbon credit pre-purchase agreements

Rather than buying credits when they are issued, corporate buyers agree to purchase credits years before they are realised. Committing to a forward price, and in some cases paying for a portion upfront.

An injection of cash earlier in the project lifetime, and a contract for future offtake, will flatten and derisk the cashflow profile, enabling the project to be more bankable as a result.

• Concessional capital

Concessional capital –typical of DFIs, philanthropic foundations, or climate funds – can offer finance at below market rates. This can reduce the overall cost of capital that funds the project through its early, loss-making years.

Arising from the limitations of their carbon curve, ARR projects often depend on a blended finance structure, to support the challenging cashflow profile.

• Hybrid projects

The majority of forestry carbon projects are not pure carbon plays. Most operate mixed models, where revenues from commercial timber and carbon are combined, with carbon credits often offering some upside. ARR projects will deploy a mix of carbon and timber revenues. Most large-scale tropical forestry projects in Latin America and Southeast Asia blend avoided deforestation or reforestation carbon credits with sustainable timber harvesting to bring in more predictable - and financeable - revenue streams.

These examples of increasing curves illustrate something you can see throughout this tool: curves can be adjusted, but their fundamental shape - and what that means for project financing - is par for the course.

3. Capex to Opex Balance

The carbon curve is not the only variable that influences a project's sensitivity to cost of capital. The balance between upfront capex and ongoing opex plays an equally important role - and is also one that does not succumb to fundamental biology or chemistry.

The principle is simple and almost feels too trivial to write down, however the magnitude of impact is interesting to visualise. Projects that have higher capex will pay more in borrowing costs over the course of the project's lifetime, and therefore have higher breakeven carbon prices.

The steady-state curve illustrates this cleanly. With removal happening at a constant rate, for example in engineered projects like direct air capture (DAC) or biochar, any difference in breakeven price is driven purely by the project cost structure.

Whereas at low costs of capital the difference in breakeven carbon prices between high-capex projects is trivial, at higher costs of capital the difference is stark - as shown in the chart below.

CONCLUSION: HOW USING THIS TOOL CAN BENEFIT PROJECT DESIGN AND ECONOMICS

As companies start to build projects, their focus will inevitably be on proving deployment and gaining operational data. That’s right and necessary.

However, we think that having an awareness of the dynamics highlighted in this tool can influence decisions in project design that could materially reduce a project’s sensitivity to cost of capital, and enable investors to identify opportunities for earlier returns.

There are a few levers that can be pulled, and some forward-thinking companies are already implementing them.

1.Can you change the shape of your carbon curve?

You can’t change an increasing curve to a diminishing one: unfortunately we are still operating under the biophysical limits of each pathway. However, can you steepen or shift the curve to bring revenues forward and reduce the period over which capital costs accumulate?

We’ve seen innovations in both areas. Sometimes these decisions might come at the expense of capex but, somewhat counterintuitively, it might be worth it in the long run.

➔ ERW is attractive due to its fairly low capex and relative simplicity. However, as discussed earlier, the weathering rate of the minerals is crucially important for the commercial viability of a project. It might make sense to spend more upfront to increase your weathering rate.

• According to our model, at a 12% WACC and a carbon price of $140/tCO₂, reducing half-life from five years to under one year is worth roughly $50/tCO₂ on the breakeven price.

• We also found (and this took us a while to get our heads around) that doubling upfront capex from $50m to $100m to achieve faster dissolution can still result in a higher NPV. The cost of slower revenues compounds faster than you might intuitively expect.

➔ In the forest carbon space, you're fighting an uphill battle with the curve. But there are innovations working to pull it forward. Rhizocore is developing specialised, locally adapted fungal pellets that accelerate early tree growth and survival rates. Their primary customers are commercial timber operators motivated by maximising the forests yield, but the carbon economics benefit for the same reason. Living Carbon, who have just received $500m project funding from Octopus Energy Generation, has engineered trees with enhanced photosynthesis to increase growth rates directly. Both innovations are financially compelling not because they reduce costs, but because they accelerate revenue generation.

2.Bring In Additional Revenue Lines

Additional revenue streams will reduce dependence on carbon credit timing and shorten the payback periods, therefore directly reducing sensitivity to higher discount rates.

Biochar developers, for example, can sell physical biochar for soil improvement, or bio-oil for liquid fuel, sitting alongside carbon revenue. The more these secondary revenues can be contracted and predictable, the more financing value they carry.

3.Consider altering the CAPEX to OPEX Balance

Projects with higher capex to opex ratios commit more upfront capital and will therefore be more sensitive to capital costs.

In today’s financing environment,this creates pressure to find lower capex, higher opex projects. However, this might not be the most cost-effective project in the long run. When capital costs come down, higher capex:opex projects might be superior. Projects that are heavily opex dependent today may have fewer options to reduce costs over time.

One practical response is to outsource capex in the near term. Developers might lease equipment rather than purchase it, building production partnerships rather than building in-house capability - then bringing these operations in house when the project derisks and capital costs fall.

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While this analysis is lengthy (thanks for following to the end!), it covers just a fraction of the analysis you can undertake on your own with the Counteract Carbon Curve Tool. Whilst simplified, we hope it is useful in exploring some of the financing dynamics of carbon removal projects as this industry begins to scale. We have even made some investment decisions related to some of the findings that this tool illustrates, especially around the opportunity of realising early cashflows in the diminishing curve.

Please do share with those you think could find some use in it, and of course we’re always open to feedback and discussing our interpretation of the model.