Natural Capital as a concept was rarely talked about until a few years back when it burst on the scene in two respects. Partly as a result of the requirements of the emerging Environmental, Social and Governance (ESG) frameworks of businesses, and partly as Professor Dieter Helm's writings started to get the ear of a government planning both a post Brexit rural policy, and a response to climate change. Very rapidly since then it has become a regular feature of most conversations involving rural land use and its economic value.
However, even although the term natural capital is widely thrown about it can mean lots of things to different people, and often conjures up images of greenery and nature, but what is it really?
It is really an economic concept, and it is about recognising that the product of natural processes has an economic value to society. It is not necessarily green, or indeed benign for the climate. For example, oil can be considered a natural capital, as are minerals even the nasty radioactive ones. The output of agriculture and forestry is also a type of natural capital as are renewable resources such as wind and sun.
What people are generally meaning when they are talking about natural capital in a green sense is the concept that natural capital arising from ecological processes has an economic value. The value of natural capital in agricultural and forestry output is well understood, and those markets are well developed. Similarly renewable energy and its economic value has become more developed in recent years. The latest in the evolution of natural capital is bio-diversity and the market for nature based solutions.
The simplest way to look at this is that largely since the start of the industrial revolution the modern economy has been based on massive exploitation of the natural environment. It is not difficult to see this in the vast consumption of natural resources or damage to the ecological environment. However, that cost to nature, if you like, has never been fully recognised on the balance sheet. Imagine if that was now put right, and a deficit account created to show the true cost of nature, the balance sheets would look quite different. It is these costs that businesses are being challenged to put right, and this is the funding gap or costs to restore nature.
The challenge to put this right is coming from the Environmental, Social and Governance (ESG) frameworks of businesses driven in turn by demands of their customers, investors, and government. Businesses are having to address that notional negative deficit on their balance sheet and demonstrate that they are environmentally sustainable either through their operations, or through offset. In other words, if they cannot tread lightly, they have to pay someone else to undertake that nature restoration for them. That is where the market then emerges for nature-based solutions and things get interesting.
The principle is quite clear, but the markets themselves are less so.
The offset carbon markets in the UK rest on two voluntary codes. One is the Woodland Carbon Code, and the other is the Peatland Carbon Code. They are fundamentally different though, one is about sequestering carbon in woodland, and the other is about reducing emissions from degraded peatland by restoring them. Peatland will also capture carbon but at a slower rate. It is the reduction of emissions that has a massively positive effect. Both these markets are voluntary, and rest on voluntary codes. They are also aimed at the offset market for buyers that are unable to reduce their emissions in their industrial processes. By voluntary, we mean that they do not have a statutory or regulatory base. This means that they also lack a certain degree of price transparency and can lack standardisation of investment model.
The nature-based solutions markets, that rest on biodiversity, are even less well developed. In England there is a requirement under planning law to offset any negative impact of bio-diversity in development, but that the position is less prescriptive in Scotland. Unlike climate change there are no regulatory targets for businesses on bio-diversity and so these markets lag behind the carbon codes. It is worth observing that if targets were set for businesses for bio-diversity (and not just decarbonisation) it would really propel this market.
There are also some challenges in satisfying these markets. To be effective, and investable, nature based solutions have to be verifiable and of scale. Almost by definition measuring bio-diversity is incredibly difficult and developing an investment model that is scalable is a challenge. A corporate investor looking for a nature based solution to invest in will not want to deal with a raft of landowners with various small projects. Instead it will want to engage with a project or cluster of projects of scale, and in a model that is measurable and verifiable.
This presents a challenge to develop an investable model to take these products to market and make the connection between businesses looking to invest, and landowners willing to "sell" nature-based solutions. There are some businesses that have already, invested directly in natural capital assets, or indeed have undertaken projects of their own. DEFRA and Scottish Government also both have programs underway to develop an investment ready model to prepare for the evolution of these markets. In Scotland the scheme is FIRNS - The Facility for Investment Ready Nature in Scotland which supports a number of initiatives to develop this market.
There are of course some who question the fundamental validity of these offset markets on two grounds. One is that they are effectively a kind of derivative market. It is not really trading a tangible asset, but rather a measure of movement from one measure of natural capital to another. No one buys the carbon or the bio-diversity – but just the delta between the starting position and the point when it is measured, which is in turn translated into units or tokens. The second objection that some people have is on ethical grounds. They argue that these initiatives to sequester carbon or improve bio-diversity should be undertaken as well as eliminating emissions and environmental damage rather than as an offset.
Whether you see these markets as the emperor's clothes or a coat of many colours (albeit mostly shades of green), undoubtedly for the next few years these natural capital markets are set to feature strongly both in the rural sector and the boardrooms of many businesses. The challenge for both is to build the supply base and investable model so that the money can be invested, and that nature, and in turn the environment we all live in, can truly benefit.
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