Natural Capital – problem, victim and solution
“The farmer is the only person in our economy who buys everything at retail, sells everything at wholesale, and pays the freight both ways.” — John F. Kennedy
Agriculture – problem, victim, solution
Agriculture sits at the heart of the Net Zero 2050 debate, being part of the problem, victim, and solution. It is the second largest generator of greenhouse gas emissions. Agriculture must respond to the consequences of climate change both now and in the decades to come. More varied and extreme weather threaten the global food supply, already under strain from global population growth, as well as declining growth in crop yields and available land. Agriculture, through its stewardship of much of our natural capital, also offers solutions to climate change including the potential to sequester carbon in plant matter and the soil, and to preserve and restore biodiversity. Agtech and food tech offer potentially high returns in large and rapidly growing markets.
Burning down the house
Agriculture is part of the problem; the need for transformation & changing behaviours is clear. At 24% of global greenhouse emissions, agriculture combined with forestry and other land use ranks second only to the production of electricity and heat (source: IPCC 2014). Most of agriculture’s emissions are not from energy use however, rather from the management of soil and livestock. One third of the world’s soils are classified by the UN’s FAO as degraded, with agriculture a prime contributor. More broadly, it is estimated that the stock of natural capital per person has fallen by 40% globally in the last three decades, compared to a 13% increase in human capital and a doubling in produced capital in the same period (source: Dasgupta Review, 2021).
Agriculture under pressure
The consequences of climate change add to the pressure on agriculture. As well as responding to a changing climate, globalisation of pests/diseases and extreme weather events, agriculture must also manage the long term decline in the growth in crop yields. Growth rates have halved in the last 40 years and now sit below the rate required to meet expected demand in 2050. Agriculture must address the prior degradation of the very natural capital on which it depends & face growth demographic pressures, including population growth and expanding demand for protein from a growing middle class. Additional strains come from political pressure on immigration, and thus cheap labour, in key markets such as the US and UK.
In soil we trust
Agriculture, through more efficient and effective management of natural capital, is very much part of the solution. The total carbon sequestered in soil globally, for example, is three times the amount accumulated in vegetation and twice the amount in the atmosphere. It is estimated that if soils were protected and replenished globally, they could absorb 10% of the carbon needed to stabilise the climate (source: Nature 2020). Recent research finds that the relationship between increasing CO2 levels, plant growth and carbon sequestration in the soil is complex. Even small changes can make a difference. Cover crops on 15% of the world’s crop land would absorb between 1% and 2% of global fossil fuel emissions (source: Soil Biology and Chemistry 2020). As well as absorbing carbon, healthier soils can also mitigate flood risk from extreme weather events by acting as giant reservoirs and reduce the demand for fertilisers, the production of which adds to greenhouse gas emissions.
Natural capital – the bigger picture
The combination of government pledges and new regulations is focusing investor attention on climate change. Other, related topics are just as relevant to the investment process; these include pollution, the state of the oceans, and biodiversity. Natural capital describes the global stock of natural resources including soils, air, water, geology and living organisms. There are strong links between natural capital and climate change: reducing carbon emissions from agriculture by encouraging a switch from meat to fish risks further damaging the already fragile state of the world’s oceans. According to the UN FAO, 31% of global fish stocks are overfished (being fished at a biologically unsustainable level) while 58% are fully fished.
This interconnectedness will drive investor interest and investment opportunities in the broader natural capital theme. Issues include addressing (plastic) pollution, loss of biodiversity, and damage to ocean ecosystems. Ultimately, the ability to produce food and discover new pharmaceutical drugs, for example, depends on this. Agtech together with food tech span a range of technologies. Combined these can reduce agriculture’s impact on the environment & help offset the contribution of other sectors to climate change. They can mitigate the impact of climate change and other pressures on agricultural yields, while at the same time expanding food production to meet population growth and changing demographics. History is also clear. Farmers will adopt new technologies that work, regardless of near-term pressure on income. Indeed, adoption rates are accelerating. It took 25 years for tractor adoption rates to hit 80%, 19 years for hybrid corn and only 13 years for GM corn.
Agtech – a very large potential market
Agtech alone is a ca. USD250bn global market today, growing at 5% CAGR on our estimates. Key verticals are biotech, biologicals, precision or smart ag, robotics, vertical farming, aquaculture and the supply chain. Within the space some verticals are growing even faster. Robotics, for example, is expected to deliver a ca. 25% CAGR in the next five years and precision/smart ag a 10% CAGR. If consumer, regulatory and technical hurdles are overcome, we believe some of these markets could be 2-5x larger. Biotech, and gene editing specifically, is a prime example. The food tech opportunity offers similar dynamics. The cultured meat market is expected to become a USD13bn global industry by 2030 from nothing today (source: Eat Just 2021) while the nascent market for insect proteins in the west may reach USD5bn by 2030. VC investment reached USD30bn globally in agtech and food tech combined in 2020, 35% more than in 2019.
Investing in agtech is profitable
Traditional farming is characterized by low returns and volatile incomes in the short term. In contrast, agtech operators and suppliers enjoy mid-teen post-tax returns on invested capital while demand depends more on rising adoption rates than farmer incomes. The adoption of tractors post World War One and of GMO post 2000 provide a clear playbook. Farmers will adopt new technologies that deliver either increased yields or lower costs.