A CDR demand flywheel
a donor advised fund for CDR & financial leverage for philanthropic carbon investors
This article was originally published in Notion in Spring 2023
tools and leverage
Let’s assume you have some money that you want to use to dramatically scale up the CDR market. That’s your primary goal. You could start an AMC like Frontier. You could set up a volume guarantee vehicle. Both good!
But in the case you’re a maximalist like me: what about a donor advised fund? For those unfamiliar with donor advised funds (DAF), have a look there, but it’s a common tool in American-style philanthropy: “A donor-advised fund is a private fund administered by a third party and created for the purpose of managing charitable donations on behalf of an organization, a family, or an individual.” It’s not particularly novel, but usage of DAFs is growing quickly in the slow moving world of philanthropy. In 2020, assets held in DAFs was ~$150B.
Think of it like a philanthropic holding company. You can donate to it like a regular non-profit and get a federal income tax deduction. Once your money is in the DAF, you can’t get out. But, you can use that money to donate like normal, or to invest, make a return(!), reinvest(!!) in whatever you want, all without tax implications (!!!). Debate over whether or not this is a good thing is outside of scope here. It’s a tool, we’re exploring what it might be like to use it to influence the CDR market.
Let’s take Frontier’s ~$1B AMC as a model. In Frontier’s case, they spend $1B buying carbon over a decade, lead the market, and are generally the most influential force in the market to date. Amazing leadership and tons of PR, technical, scientific, and market leverage. But, for better or worse, not much financial leverage. You might assume that they end up spending $1B at ~$150 a ton (all said and done), which is something like 6.6M tons of CDR over the period of the fund, say, 10 years. Those tons are made available to the companies paying into Frontier, and they get to use those millions of tons to count as progress towards their carbon commitments.
What might a CDR DAF look like?
But, what if you had instead made charitable contributions totaling $1B to a DAF that has the explicit goal of scaling the carbon market?
🔥 Please note - I’m going to exaggerate the DAF’s behavior to highlight the risks and opportunities. I haven’t thought about it enough to argue this is a net good, I’m just saying it can be done and is worthy of consideration.
First, the corporations could deduct these donations from their tax liabilities (yes this already happens and is legal, afaik). The effective corporate tax looks like it’s 13-16%. Not sure it’s a safe assumption, but if you assume the donors to our DAF would have paid taxes on $1B, but instead avoided them via donating to the DAF, you’re up +100M). Theoretically, that means you now have $1B in a DAF and $100M in your bank account.
Next, let’s say you used the DAF to buy carbon from the top CDR suppliers. You converted your $1B into contracts for 5M tons of CDR during the 2023 and 2024 calendar years. I want to highlight that you don’t have the carbon yet. You only have the contracts. And, you had to pay a bit more ($200 a ton) because you’re getting it all done fast. Now, from a simple “impact” perspective, you’ve increased the demand perceived by CDR companies by ~4x by compressing your purchases from 10 years down to 2 years.
Now, you’re not offsetting any emissions, or removing any historical emissions, so you don’t need to actually take delivery of the carbon. Remember, the goal is to dramatically scale the carbon removal market, so whatever allows you do to that best is what you do. So, you sell the contract for the carbon removal to another buyer. On one hand, you want to sell the contract as quickly as possible, freeing you to turn your money over, so there is a priority on speed. On the other, you want to retain as much of your principal as possible, or grow it, so you want to sell it for a much as possible. A healthy tension, but one that should be prevent the DAF from hoarding CDR and trying to squeeze the rest of the market.
As soon as you sell your forward contract for CDR for cash to a corporate, you turn around and do it again. Let’s make do a little napkin math here. If you’re Frontier, you’re getting 100M out the door every year for 10 years, making for $1B of net demand. If your DAF can resell half of its contracts every year, and reinvest the money in new forward contracts, then you’re putting out $500M every year, meaning 5x the impact.
As far as I know, this is ~similar to how financiers of solar projects work. They find and fund a project, generate a long-term PPA which yields a fixed rate of return. Then pension funds and other deep pocketed investors come through, and buy up the PPA, returning the cash to the financier for another crack at the solar development market. Run this back, but set up a DAF and focus on the CDR market, and use forward contracts as your PPA. Now, we’re skipping a step here - to get to PPA level, you’d also need to organize an offtake contact. I’m going to ignore that for the moment, but it’s important.
Some additional notes - please add q’s, and I’ll get to them if I can.
Downside
The downside scenario is that your DAF buys carbon, and then isn’t able to resell it. In that case, it’s basically an AMC where the donors can’t technically use the carbon the DAF bought to offset their emissions. But, it’s not a regulated market, so I suspect no one would blink if they did, and I don’t see any real ethical issues. The donors bought carbon with philanthropic dollars, and catalyzed production of CDR.
Upside
The upside scenario is really significant. I suspect the early days of this would involve a fair bit of tool building, so the DAF’s ability to turn projects over and return capital might be longer than optimal. But in the best case, you can turn a $1B into multiple billions of impact, dramatically increasing the speed with which the CDR market reaches scale on the supply side. To do this, you’d need:
tools to deliver carbon forwards with confidence
public consensus that buying carbon forwards is a reasonable (or necessary) behavior
increasing volume of corporate demand for carbon removal
What to buy?
How do you decide what to buy? You could build your own climate team, as many corps are doing, and make the decisions yourself. Or, you could take a more passive and capital efficient route and simply agree to buy some multiple (on the same terms) as a market leader, say Frontier, leveraging their expertise. For Frontier, the DAF is leverage on their investment. To the DAF, Frontier is outsourced diligence.
Demand q’s
But, don’t you have to sell the carbon to make the flywheel spin? Yes, you absolutely do. The velocity and leverage of this plan is based on increasing demand over time. However, an investment vehicle like this also has the change to 1) prove that this is a good trade, driving others to enter the space, 2) deliver real pricing data to market players, 3) test and scale the tools needed for making these trades, and 4) make it easier for more corporations to buy CDR (those who have annual budgets and don’t want to provide long term contracts). As with all flywheels, momentum will accelerate IF it works.
Only DAFs?
Couldn’t you do this outside the context of a DAF? Yes! A demand flywheel concept like this would work for PE, hedge funds, investment banks, etc. I don’t want to convey that selling forward contracts for carbon is a new idea. Major financial players are jumping into NBS extremely quickly now, with this explicit business model. However, if the primary incentive is profitability, the investor will going to be trying to extract maximum profit from the transaction. I view that optimization as ultimately rent-taking, and thus not likely to maximize impact on the carbon market - they might buy and hold long term, for example. On the other hand, DAFs provide both tax and incentive shelter for mission oriented work that is carried out via market instruments.