Rising Tides: The Science of Salmon Investing
An overview of ScootScience, ocean investment, and the blue economy
This is Part One of a Two-Part food and commodity inflation series. I wanted to intro Scoot as a solution, and will follow up with a broader macro piece on Friday!
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Disclaimer: This is a partnered post with ScootScience. As I’ve outlined in many of my pieces, we cannot have green energy policy without green energy investment - but I’ve never provided or discussed solutions beyond that. Scoot Science is building a tool called SeaVest that allows investors to understand the investability of salmon sites, incorporating sustainability and investment impact in order to benefit society (and the environment!).
The Rising Tides Moment
The importance of the E part of ESG
This piece will discuss the history of investing, with a focus on climate-related projects, and then discuss the importance of ocean investment and understanding ocean risk to grow the blue economy. There will be a focus on salmon farms, through both the lens of economic and ecosystem benefits, and how we truly can embrace the concept of ESG.
Risk and Reward
So let’s return back to the basics - but in a better way.
For anything to work, there has to be an element of risk tied to it. The first person to milk a cow was definitely taking a risk - but the payoff was large (in theory) right? This risk-reward dynamic is tricky. People want to be *compensated* for the risk that they take on - or else, it isn’t really worth it.
And financing risk is difficult too. Venture funds are sort of the in-between risk takers - they help founders milk cows (gross analogy, but hang with me) for upside in the produced milk.
It’s a balance of risk and reward - venture money goes into industries that seem to have a lot of potential upside (dairy) and the goal is to milk as many cows as possible - finance risk, to benefit from the reward.
A History Primer
Risk and reward is an ancient concept - and financing risk is also ancient. The very first venture funds were whaling companies - tying risk sharing and reward into investing in a unique way. Whaling expeditions were incredibly risky (nearly 30% of all boats were destroyed) and *someone* had to shoulder that risk - enter ~Financiers~.
Whaling was focused on creating matched incentives between owners, managers, and employees - the crew (and everyone, really) was paid on the profits of the voyage - no one got a salary, and everyone benefited from the same upside.
Investors would do “spray and pay” with different voyages - but the incentive model remained favorable to the whalers themselves. Knowing how the industry worked was very important to success, so investors used agents to decide which whaling captains to work with. As Avi Asher Schapiro writes:
They studied which captains had the best records, helped rich families spread their money between multiple whaling ships, hoarded knowledge about whale hunting grounds, and drew up profit-sharing agreements to incentivize crews to stay out at sea.
This led to the specialization of expertise - and the concentration, and eventual disbursement of large amounts of wealth. Since then, the VC space has evolved (hello, web3). But with over $60b invested in climate tech between 2013 - 2019, there is room for more investment in the oceans - for VC to return to its roots, so to speak.
Currently, most climate based investing is around mobility and transport, which is good (emissions have grown 71% since 1990!) but oceans are essentially absorption tools for the impact of climate change. Oceans take on the byproduct of land pollution - absorbing ~CO2 emissions (which have increased 4x since the Industrial Revolution). As the New York Times highlights -
"As the planet has warmed, the oceans have provided a critical buffer. They have slowed the effects of climate change by absorbing 93% of the heat trapped by the greenhouse gases humans pump into the atmosphere."
That’s why it’s important to invest in ocean - the word ocean is only mentioned twice in PWC’s “The State of Climate Tech 2020” - which seems low, considering how the ocean is 70% of the Earth’s surface and 80% of it is unexplored!
But how does one invest in the ocean?
Aquaculture is an ancient industry, but one that is relatively untapped in terms of investment opportunity. Seafood companies are stable - but relatively unknown in the world of Nestles and Unilevers, as Norwegian fund manager, Hogne Tyssoy, points out. But aquaculture and ocean based companies are interesting because of the (1) stability of cash flows that they offer and (2) the profitability of the market that they exist in.
For example, near-coastal salmon farms - have a production value of $17.1B, and have generated a compound ROCE of ~24% between 2009 - 2019.
Which is pretty solid!! Salmon farming is not only a relatively profitable investment opportunity, but it’s an impactful one too. Salmon companies allow for three very important things in a world that needs to go greener sooner, rather than later.
Improved environmental impact
A solution to ESGification
Investment opportunities to truly make a difference
But how do you tap into this space?
SeaVest as an Analytical Tool
ScootScience developed a tool called SeaVest that allows investors to invest in ocean industries - they aggregate data from over 3,000 salmon sites all over the world, and have built a model that helps investors understand the space better. Just as whaling VC’s needed agents to understand whaling - investors can use tools like SeaVest to understand salmon farming better.
SeaVest is about true impact investing - and has helped to refine a space where sustainability and returns can coexist. It’s a balance of risk, return, and impact, and helps to encourage investment in our ocean spaces. It offers uncorrelated returns and high yield opportunity in an increasingly yield hungry world.
A brief and very simplified version of the tool:
It takes into consideration environmental conditions of the ocean - (1) ocean temperature and (2) dissolved oxygen - to parse out what areas are the best balance of sustainability and suitability for investment opportunities.
As you can see in the graph below, Tasmiana’s suitability has suffered whereas Faroe Islands and Central Norway have improved.
Above the line means improved suitability relative to the long term average. (Sort of oversimplifed, but above the trendline, better investment opportunity).
The Farms Themselves
So the ocean itself is very important - but what about the salmon farms themselves?
Farms are a $4-8M investment upfront - going towards net pens, feed, services, crew, etc - and usually deliver a maximum annual revenue of $7-10M. The goal of the farms are to produce good and healthy (and happy) salmon - through two key cost levers:
Minimize feed cost per unit of growth - Basically, it’s healthy couponing but for fish. How can you make sure the salmon are eating the best possible food, at the lowest possible price?
Maximize the number of fish that reach weight - This circles back to feed cost minimization - making sure the fish are fed efficiently and effectively.
The fish operate within a three-year production cycle:
Fertilized eggs are grown in smolts
Smolts are then transported to sea-based pens for 1-2 years
Salmon are then harvested when they are between 4-5 kg in weight
It’s a process that has been perfected by a relatively family-controlled industry, and mostly concentrated in Central Chile and Southern Norway (~60% of farmed salmon supply).
So it’s a tightly knit industry, with geographical constraints, and a lot of opportunity for growth - meaning that the excess profits are a sign that the industry can and should see more investment - which could be investment in new sites or better management through different tools.
One of the most important points of all of this is that “financial success in salmon farming is fundamentally linked to impact success”. It is an industry that actually responds to *positive* incentives, where profit and change actually go hand in hand. It’s an investment opportunity, ESG improvements, and environmental progress - all in one.
As a note - farmed salmon (~2/3rds of all salmon sold) is definitely controversial.
It’s important to think about ecosystems - how salmon is farmed really matters, which is why sustainable farming is the main goal. Fish mortality is a big deal - and farms need to invest in the wellbeing of their fish. As with any part of the food chain, it’s important to ensure that it’s a cycle - that we aren’t depleting scarce resources from an increasingly resource scarce world.
As with anything there are costs and benefits - and we need to maximize the benefits. That’s why it’s really important to dive into the data of these industries, and to understand *how* sustainability works in the space (and how it can be further improved). Salmon farms are more than just “profits” - they are employers, communities, and stewards of the environment around them.
So there are five-six main routes of financing in pretty much everything. But salmon farming as an industry has a LOT of capital constraints.
Family matters: 80% of the top 50 salmon farming companies are family-owned.
A lot of consolidation has occurred in the industry over the past 15 years - but with more than 300 smaller scale operators operating sites, and the average age of company owners ~60 years old, there is plenty of room for the next generation of salmon farmers to step in.
However,, the families mostly finance through retained earnings - forced to keep money on hand. They have lots of cash - but there is a difference between having cash and being able to deploy it.
Growth equity: The oldest method in the book - list on a public exchange!
Salmon farms can list on the Oslo Bors exchange, giving them access to institutional investors.
The only problem with this is the general IPO pop (also the oldest method in the book) - when these companies list, they are still relatively small - meaning that once the initial interest goes away, all they are left with is regulatory headaches and trouble raising additional capital.
Debt - There are three (3!!) banks that lend to salmon farms. DNB, Rabobank, and Nordea. In-house expertise is important to set the price of these loans, which is why the lending pool is so small (going back to whaling VC yet again).
There is more room for more lending here - through green bonds (meeting those sustainability goals) or simply through the salmon farms having more optionality around commercial debt opportunities (competition breeds innovation, even in debt markets!).
(Re)insurance - This is a tool that helps lenders to isolate specific sources of credit risk.
Salmon farming is rather expensive for the insurers to insure because salmon farming is volatile - and they pay out more than they receive in payment, which isn’t great (from the insurer’s perspective) with 80% loss ratios (aka 0.80 cents is paid out for every dollar of premium, which is a lot). There is a lot of room for innovation here.
Private equity - The whaling VCs are back. Private equity hasn’t really worked in salmon farming - mostly because the ocean industry is ripe with information asymmetry. However, with the right information, there is a lot of opportunity for P/E firms to meet their goals within this space.
Bain (the giant private equity firm) went into the space in 2014, buying Nova Austral, a Chilean salmon farm operator. Turns out that Noval Austral was falsifying documents - so not a great investment - so lots of room to change that path as well.
There is capital constraint in the industry - and the five tools listed above don’t allow salmon farms to truly grow to the level that they could. There is room for more investment - not only for the salmon farms themselves to grow, but also for investors to benefit from capital appreciation in a very balanced risk-reward industry.
Let’s quantify the risk-reward. Check out this graph - it reveals the profitability and the sustainability of salmon farming (Norwegian Portfolio).
Compounded Return on Capital Employed: The Norwegian Portfolio delivered 24% ROCE, and 60% of all portfolios are better than that Norwegian average (offering the higher expected return for a given level of risk)
Annualized risk-return profiles of US/European stock markets - Salmon provided a higher risk-return performance than that of value stocks (in terms of (EBITDA/EV) and profitable stocks (measured by cash profits/assets) and in fact performed in the upper quintile of both European and US stocks
TRUE SUSTAINABILITY - Basically the greener the dots, the better - and the more that investors are *rewarded* with improved risk-adjusted returns while choosing more sustainable portfolios
This space has a low correlation with the rest of the markets. The volatility in the oceans is not like volatility in the markets - and salmon returns are not correlated with market returns.
Getting a bit more into the numbers, Scoot Science developed something called the Green Sharpe ratio to analyze the investment opportunity - diving into this balanced reward-risk relative to impact of different projects. Looking at the table below, it’s clear that salmon investing delivers a much higher Green Sharpe ratio - meaning that it delivers substantial reward relative to its impact.
So what is the impact?
Improved Environmental Impact
Salmon is a great alternative protein source to traditional meat options - it’s low impact, nutrient dense, and is not a vehicle for greenhouse gas production (@ cows). It’s quantifiable impact too, producing far less CO2-eq than beef, pork, and dairy products.
As you can see, farmed fish like salmon produces roughly the same amount of GHGs as eggs (and 80% of the GHGs of chicken) - providing a more sustainable protein option. The industry is actively working to make this more sustainable, through:
Improving mortality metrics - less salmon deaths, the better - and tech is making this easier to achieve
Improving the eFCR (economic feed conversion ratio) - making sure that food is efficiently used by the salmon (and for the salmon!) mitigates waste and cost
Improving the feed composition - Sustainable soy sourcing would reduce global annual emissions by 830,000 tons CO2-eq!
Essentially the goal is to make an industry that is truly green - and farms are already making active strides in order to achieve that. This helps make progress towards the broad concept of ~ESG investing~.
It’s no secret that there is a gap between the “environmental” part of ESG and the actual impact. Funds have mandates in place that encourage them to invest in companies that support the concept of “environmental social governance”, meaning that they are socially conscious - take care of nature, people, and the company itself.
The concept of ESG is great - we NEED more green energy investment, and we need to make sure those in power care about the world around them.
The only problem? ESG is more of a label than a literal - it’s a way to *meet* fund requirements, but it’s not really a way to *improve* the world.
There is a difference between mandates and meaning - and ESG is much more of the former than the latter. There needs to be something that fulfills both - that takes the $35.3T that has been funneled into ESG and applies it towards things that make true impact, versus things that are just a test to pass. Salmon farming is one potential option.
Environmental: Salmon farming is a way to actually match the E in ESG - to have a positive impact on the environment, rather than just crossing another number off for funds. A sustainable ocean economy is really important for a sustainable future - and salmon farms and other truly impactful industries are one way to begin building that.
Social: Salmon producers are incentivized to take care of the ocean, and are taking steps to improve nutrients and water quality for the fish. This ends up being a reinvestment in the world around them - healthier oceans, healthier salmon, and healthier ecosystem
Governance: Salmon farming also provides jobs - In British Columbia, the farmed salmon industry employs 7,000 people - an important cornerstone for remote coastal communities.
For a powerful example of all of the above - this is the First Nations for Finfish Stewardship, who are advocating for sovereignty over decisions related to farming in their waters. As they write in their report:
Salmon farming has lifted entire coastal Indigenous communities out of poverty, creating meaningful, year-round jobs for Indigenous peoples, providing opportunities for First Nations-owned business to supply the sector, and funding projects that increase the health and resilience of communities, as well as wild salmon.
This is both economic and ecosystem related - it’s about the First Nations retaining rights to make decisions about their territories, as well as environmental stewardship of the community. As highlighted in some of the numbers below - “salmon farming is a path to self determination and reconciliation for many First Nations in coastal BC”.
Quantifying that further, the UN has Sustainable Development Goals that help to evaluate opportunities and risks, and to make sure we don’t wreck the planet in the next five years. The salmon farming industry is built around several of these SDGs -
SDG 13: Climate Action - Farmed salmon is a low impact source of protein!
This is primarily measured through emissions intensity - level of emissions released per unit of activity. Most greenhouse gas emissions from salmon come from feed sourcing - with room for incremental improvement, and thus improvement in these metrics!
SDG 2: Zero Hunger - Aquaculture is an undertapped protein source that will help manage food price volatility and help solve for other seafood protein options
SDG 3: Good Health and Well Being - Salmon is more than just protein! It also has EPA and DHA sources, which supports overall brain health.
Salmon farming solves for each level of the ESG trifecta - and is actively improving upon each element of it, while meeting the goals of the UN SDG. It’s an interesting investment opportunity, and a way to *really* help the world in a sustainable way.
Salmon farms are above-market returns opportunities that are non-correlated to the broad market, while also providing support to an ecosystem that needs investment. Sustainability isn’t something that can be solved by simply snapping fingers - it will require investors and industries to collaborate on building a better future. And we can’t pretend that the world is going to solve this altruistically - humans are always gonna human. So salmon farming is one option for a balance - offering a lower environmental impact with a higher risk-reward opportunity - and building towards a better future.
The salmon industry is complicated - but it’s an important industry that is capital constrained. It is a low carbon source of protein, a stronger source for ESG mandates, and a profitable investment opportunity.
This is a rising tides moment. We have to start making incremental steps towards making our world better.
Look out for part 2 on the macro thematics for all of this on Friday morning!
Disclaimer: This is not financial advice or recommendation for any investment. The Content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.