How agricultural investors can lead the way to a 1.5C future
(and make a trillion dollars in the process)
While an increasing number of creative solutions to the climate crisis are cropping up, a deep-seated barrier persists: financial markets still lack a cohesive mechanism to reward good environmental outcomes and price in negative externalities. Put simply, humanity is getting better at generating technological solutions but what is missing are the frameworks and tools to channel investment towards these solutions in an optimal manner — and to do so at the rapid pace that is required.
After launching several technology ventures aimed squarely at tackling the climate crisis, such as in the energy sector via Mission Zero (closing the carbon cycle via direct air capture) or in the agriculture sector via P.E.S. Technologies (revolutionizing soil health science), it became clear that there is an entirely separate set of constraints that are limiting commercial approaches to climate solutions: those relating to financial markets, which still fail to fully incorporate negative externalities or reward positive environmental outcomes in investment decision-making or capital allocation. This led us to begin scoping commercial solutions that could help reorient capital towards a “Planet Positive Economy” through improved incentives, better risk pricing, or higher rates of return in key sectors like capital markets, insurance, carbon offsets, and institutional investing.
One industry that suffers disproportionately from misaligned financial incentives is agriculture. Six years after the Paris Agreement, the agriculture sector still represents 19% of global GHG emissions, including 75% of nitrogen oxide, and causes 80% of all deforestation and 86% of species at risk of extinction. Even though you might buy organic vegetables at your market, less than 2% of agriculture is organic (even in wealthy countries), while 20% is genetically modified, another driver of biodiversity loss. More than 130 billion tons of soil carbon has been lost due to farming, impacting the Earth’s biochemical cycle and causing negative climate feedback loops. This is why there are no climate models that limit warming to under 2 degree C without significant changes in land management practices, including in agriculture.
These are the sector’s results despite many agriculture tech (agtech) innovations and well-evidenced, profitable investment pathways to a decarbonized and net regenerative agricultural sector, one that would also ensure sustainable producer livelihoods and global food security — two other existential crises being exacerbated by the climate crisis. To illustrate an example of the investment opportunity, take regenerative farming — practices like no tillage, cover crops, multiple crop rotations, and no pesticides or synthetic fertilizer use. Regenerative farming needs to be expanded to 300 million hectares of row crops — or to about 750,000 to 1 million commercial farms — in order to generate a 22 billion tons reduction in carbon from both increased carbon sequestration rates (up to 400% higher than conventional row crops) and from reduced emissions. The transition to regenerative agriculture would require an upfront investment of about $100 billion, but regenerative farms would generate lifetime cost savings of $3 trillion, and earn owners a net profit of up to $200 billion — that’s a 200% return on investment! And this is only one of several rigorously evidenced approaches, such as improving rice production ($250 billion net profit), conservation agriculture ($100 billion net profit), and sustainable smallholder intensification (up to $300 billion net profit). These figures do not even include the $200 billion in potential additional revenue from soil carbon offsets by 2040.
Market system constraints underpin investor pain-points
So, if the technological solutions are available, and there are significant financial returns (literally in the trillions) to be made, what is causing the glacial pace of implementation? We took a first principles approach to solutions design, which meant identifying high-level constraints in not one but three overlapping systems: agriculture markets, financial markets, and carbon markets which are a key lever for decarbonization. In all three markets, we found that economic signals are simply not aligned with planet-positive outcomes. For example, in agriculture markets, consumers are unwilling to pay a premium for sustainably certified food or beverages; in carbon markets the cost and headache of producing soil carbon offsets is often higher than the value of the offset; and in financial markets, asset valuation techniques (multiples, comparables) haven’t been adapted at all to include the regenerative or natural capital value of agricultural assets.
Market structures themselves are also working against the agriculture sector, such as in carbon markets, which function well for simple renewable energy offsets, but which struggle to deal with the complexity of soil carbon measurement, permanence, and additionality, leading many compliance markets, afraid of quality control, to simply exclude agriculture offsets altogether. Financial markets have also been slow to adapt: governance and guardrails structures like regulators, ratings agencies, exchanges, and accountants have very modestly begun to include climate risk under the asset manager’s responsibility, but unless externalities (emissions, water pollution, soil health decline) are regulated, climate might still not appear material to most companies. ESG investment service providers can’t add a lot of value either, as ESG datasets mainly rely on inputs or process-based datasets (e.g. existence of policies, compliance with policies), and the measurement of real-world environmental outcomes like the positive or negative impacts of the business on climate or biodiversity are not available. Even where outcomes data is available — like on carbon emissions — the datasets mainly omit private assets, where the vast majority of agriculture assets are held.
Selecting some of these high-level constraints allowed us to generate a long list of potential approaches to solve for the gap in planet positive agriculture investment, such as companies providing sustainable land valuation, a sustainable commodities exchange or index, tech-enabled soil carbon estimation, regenerative outcomes-linked performance compensation mechanisms, or climate and biodiversity-adjusted financial statements. We tested some of our top hypotheses about potential approaches by interviewing more than 45 asset owners, asset managers, agribusinesses, consumer goods companies, and other experts to research more specific constraints by market actors, existing or emerging technological solutions, customer top pain points, business models, and routes to market.
Investors, lenders, and corporate actors highlighted challenges that prevent them from scaling up these types of investments, particularly as they related to three priority areas: 1) raising new funding or accessing new revenue streams; 2) meeting climate and nature disclosure requirements; and 3) strategy, goal-setting, and performance improvement.
- Raising new funding or accessing new revenue streams
There is huge demand for responsible investment opportunities that positively impact nature, and that present portfolio diversification opportunities. But investors haven’t figured out how to estimate the climate or natural capital impacts of new investment products or design strategies that align asset allocation with international climate or biodiversity goals. They are also completely missing out on the $200 billion soil carbon offset opportunity. For example:
“We are launching a natural capital fund in 2022, but we don’t yet have an investment strategy or an idea of how to create one.”
“We have a model to monetize forest carbon but are not yet able to monetize soil carbon, although we would like to do so.”
“We want to offer a securitized green bond, but we need to know the net GHG performance of our portfolio in order to offer this kind of product.”
2. Meeting climate and nature disclosure requirements
As new European regulations ramp up to encourage more alignment between the financial sector and real world environmental commitments (like the EU Sustainable Finance Disclosure Regulation, which applies to more than $37 trillion in assets under management), and as LPs start to align with global climate and nature reporting frameworks, asset managers are facing more detailed and science-based reporting requirements. For example:
“We expect the EU Sustainable Finance Disclosure Regulation (SFDR) to contain soil organic matter directives that we’ll need to meet, but we don’t have any method to track or report on this.”
“Our portfolio companies sometimes use different GHG emissions boundaries, so portfolio level reporting is difficult.”
“We want to align our climate reporting with the Taskforce on Climate-related Financial Disclosures and the Taskforce on Nature-related Financial Disclosures.”
3. Setting strategies and goals, and monitoring performance
Despite a flurry of net zero commitments from investors, very few have created operational pathways to optimize assets for both financial and climate outcomes. Even where some tools have been tried, investors are unhappy with the costs or data requirements to gain needed insights. For example:
“We use soil sampling to measure asset performance, but it costs so much that we only use it every few years.”
“We set a net zero target for the entire institution last year, but we haven’t identified a pathway to decarbonization for our natural resources portfolio.”
“Farm management tools are too data-intensive and have a long lag time to receive the results, we need something that is faster and easier to use.”
“We would prefer that investors shift their focus from risk management to impact measurement, this would help us as an agribusiness to invest in outcomes.”
A venture approach to scalable investor solutions for agriculture
You’ll notice that many investor complaints centred on issues relating to data availability, data cost, and data confidence, pointing to a huge unmet need for real-time, low-cost insights on the future potential and the current performance of agricultural assets. This makes sense: agroecosystems are not wind turbines or electric vehicles: reliably understanding their complex contributions to climate and natural capital outcomes requires enormous amounts of input data on weather, climate, soil, plant physiology, and other factors, and falls outside the area of expertise of financial institutions.
To identify opportunities to solve these constraints, we focused on researching rapidly growing technologies, including high resolution remote sensing imaging of land, machine learning/AI, and agroecosystem process models. When combined in novel ways, these technologies can generate agri-asset insights at a very high confidence level (meeting IPCC Tier 3 reporting requirements, the same as physical monitoring), but at a 50–70% lower cost than field measurement.
Innovators in the sector, such as Nori or CiBO Technologies, are deploying some of these technologies already to help farmers gain access to carbon markets. And, based on emerging evidence, we think these technologies can be enhanced even further to not just allow for point-in-time measurement but also to help investors to identify profitable pathways to decarbonized agriculture, design new sustainable agriculture finance products, and enhance returns with new revenue streams from carbon markets. This will in turn enable investors to attract and deploy the additional billions of dollars required to operationalize the regenerative and low-carbon agriculture transition.
Regenerative agriculture insights for investors, by themselves, present a significant commercial opportunity for providers, more than $400 million a year, by our estimate. In addition, these insights are the foundation for other more sophisticated financial instruments that could channel public market capital into climate transition agriculture, such as securitized sustainable agriculture debt products (e.g. REITs or CDOs), a natural capital bank, natural capital rated ETFs, soil-carbon backed lending, or other. Stackable commercial opportunities like these, where the same technology is deployed to different customers or is expanded to offer more sophisticated products is also an attractive business model. It may also offer synergies between Deep Science Venture portfolio companies, which could help us to achieve even larger scale, faster results in reorienting capital towards a regenerative, decarbonized agricultural sector.
We’re actively building a variety of solutions that will help agricultural investors to drive the sector towards planet positive outcomes on climate and natural capital, and we’re actively looking for partners and co-founders. If this is you, or if you’re working on related solutions, check out our open opportunities or send me an email at nicole@deepscienceventures.com.
