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Emissions Trading and the Transfer of Risk: Concerns for Farmers

By: John Bennett and Dave Mitchell

Endorsed by:

Saskatchewan Soil Conservation Association

Box 1360

Indian Head, SK S0G 2K0

(306) 695-4233; Fax: (306)695-4236

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Manitoba-North Dakota Zero Tillage Farmers Assoc.

7 - 31 Street

Brandon, MB R7B 2J6

(204) 727-5355

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Alberta Conservation Tillage Society

RR 1

Red Deer, AB T4N 5E1

(403) 343-3172

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Innovative Farmers of Ontario

6650 Boxall Rd., RR#2

Port Stanley, Ontario N5L 1J2

(519) 769-2443

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Pacific Northwest Direct Seed Association

Box 4262

Pasco, WA 99302

 

Introduction

Agriculture can make two contributions to lowering greenhouse gas (GHG) concentrations in the atmosphere: it can reduce emissions from fossil fuels, fertilizers, and livestock, and it can remove greenhouse gases from the atmosphere with biological sinks. If markets are to provide the incentive to make the soil sequestration of carbon happen, it is necessary to understand the differences between these two contributions, and to design markets that address these differences.

Markets for emissions trading have the potential to benefit both greenhouse gas emitters, by lowering the cost of reducing emissions, and farmers, who can increase their farm income by adopting Best Management Practices that reduce emissions and remove GHGs. However, there is also a real possibility that the kind of emissions trading system that may develop will not adequately protect the interests of farmers. This paper takes a critical look at some possible options for an emissions trading system, paying particular attention to the possible transfer of risk to farmers, and then proposes one possible emissions trading system that could better protect farmers from an unjust and overly heavy burden of risk.

Emissions trading is increasingly gaining attention in the agricultural sector. In October 1999, GEMCo (a consortium of Canadian utilities and energy companies) struck a deal with Iowa farmers for the purchase of 2.8 million tonnes of CO2 equivalent emission offsets. (McConkey et al. 1999: 160). More and more frequently, farmers are being approached with similar offers of money in exchange for adopting farming practices that reduce overall emissions of GHGs as well as practices that sequester or remove atmospheric CO2. Farmers must only agree that emission reductions or the carbon that becomes sequestered under their crops "belongs" to the buyer. Unless farmers take the time to understand the risks they are being asked to assume, this offer can be just what it seems: too good to be true. GHG removals with soil sinks can be very useful as a "bridge" to meet short term GHG targets and to allow emitting industries the time they need to implement permanent emission reductions. However, markets for carbon sinks must not be a mechanism that transfers the liability of emissions from emitters to farmers and land managers.

A Word on the Terminology

When speaking of emission reduction credits (ERCs), it must be noted that there are important differences between credits that represent GHG emission reductions and credits that represent GHG removals from the atmosphere. These differences will have important implications for determining the price for which the credits are sold:

Emission Reductions mean only that a lower level of GHGs are being emitted than was previously the case. Significant amounts of GHGs, it must be remembered, are still being emitted.

Removals refer to the actual removal of GHGs from the atmosphere. Biological sinks are currently the only method at our disposal to actually reduce the growing levels of GHGs in our atmosphere.

The distinction between these two methods of generating ERCs reveals some important implications for the price of the credits. It must be remembered that while in the case of reductions the price need reflect only the cost of reducing emission levels (though cleaner-burning fuels, increased energy efficiency, fertilizer management, manure management, and so on). For removals, the price must reflect both the cost of removing the GHGs from the atmosphere and the cost of maintaining the sink - presumably for as long as global warming is a problem. Farmers should keep these factors in mind when deciding whether to sell their GHG removals, and for how much.

Virtually all farms would have some level of GHG emission and most have some options that would reduce these levels. Let us represent this as shown below.

emissions trading graph 1

To illustrate we assume emission levels would remain reasonably constant but at time A the farmer implements a fuel consumption reduction and reduces emissions by 10%. Later at time B the farmer implements a fertilizer management practice that reduces N20 emissions 10%. The farm has now reached a 20% reduction. If the emission target were 6% the farmer would have a surplus of 14% to sell in an emission reduction market. The 6% target can change however, varying the surplus with it. The scientific community is adamant that a Kyoto target of -6% will not address the urgency of global warming. If public opinion follows the scientist's lead, so will the politicians. Thus, a prudent farm manager should recognize the 'moving target' for emission reduction and not sell off all the surplus credits.

Next let us assume that this same farmer adopts Best Management Practices (BMP) with reduced or zero tillage and continuous crop production that would remove CO2 from the atmosphere and sequester it in soil as organic matter, creating a sink. GHG removals would be the greatest in the early years and would level off as the sink becomes saturated (McConkey et al., 2000). This graph shows that GHG removals are the greatest shortly after the management changes. Eventually the sink will fill and gains in sequestered carbon level off. Farmers must also realize that this sink can quickly be eliminated by returning to tillage.

emissions trading graph 2

If we superimposed these two graphs we would create an annual farm carbon account as shown below.

emissions trading graph 3

The challenges of emissions on the farm will remain long after the benefits of sequestration have leveled off.

The GEMCo deal

As was mentioned above, in October 1999, GEMCo made a deal with IGF (a U.S. crop insurance provider) to purchase 2.8 million tonnes of carbon offsets from farmers in Iowa. The exact details of the deal are confidential; however, it is useful to look at what is known about it, since the deal may set a precedent for other such agreements. First, it is important to note that the deal is based entirely upon speculation: "The GEMCo deal to buy sequestered carbon in Iowa is based on the assumption by GEMCo that there will be credit for early action in the U.S. that then gives monetary value to any sequestered carbon before 2008" (McConkey et al. 2000 162). This assumption that governments will attach monetary value to carbon sequestration largely depends on the acceptance of agricultural land as a carbon sink that can be counted against emissions in the Kyoto Protocol. If the Kyoto Protocol is ratified without the inclusion of agricultural sinks, then there is very little incentive for emitters to pay farmers to sequester carbon, since there will be no credit for this sequestration. It is hopeful that governments would nonetheless encourage the use of agricultural land to sequester carbon, since regardless of carbon accounting it will help to minimize global warming. However, in such a case the price for carbon credits from GHG removals would likely be quite low, and the credits purchased through the GEMCo deal that are based on GHG removals would be of little or no value to the buyer as an offset against emissions.


It should be noted that the GEMCo-IGF deal, in addition to both emission reductions and GHG removals also, identifies biofuels. The GHG removals address 1) shifting from intensive to minimum or no-till farming methods, 2) adopting better crop rotation and/or soil conserving methods, 3) planting woodlots or other environmentally appropriate perennial vegetation on marginal land and using the biomass as a biofuel or for storage of carbon for a long period. The emission reduction component could include reduced fuel usage associated with the GHG removals as well as fertilizer and manure management. This manure management includes installing appropriate digesters and other equipment to burn methane generated from animal waste and using animal wastes to reduce nitrogen fertilizer use. The third component includes burning crop residue or sustainable managed wood waste to replace fossil fuel use on the farm as well as utilizing excess biomass to produce ethanol.

Two elements of this deal are of particular interest for the purposes of this paper, and both have to do with the question of risk. The first is the price of carbon, which is highly uncertain, since it is based entirely upon speculation in a commodity of ambiguous value. Farmers who sell their carbon now for the prices GEMCo is offering may lose out if the real price of carbon turns out to be substantially higher. On the other hand, if agricultural sinks are not included in the Kyoto Protocol, then the price of carbon would probably be much lower, at least until some means of crediting farmers for sequestering carbon in their soil is developed.

The second element that surrounds sinks is the question of permanence and flexibility. McConkey et al. (2000; p. 161) suggest that the deal allows "reasonable flexibility for the participating farmers," since there is nothing requiring farmers to maintain the specified land management practices indefinitely. "After having been paid for the Certified Emission Reduction Credit (CERC), the farmer has no obligation to continue any particular practice" (McConkey et al. 2000). If this is true, it would mean that the emission reduction is only temporary, and that the burden of risk is therefore placed on the buyer, who would presumably have to offset any lost carbon by sequestering the same amount (or reducing emissions by the same amount) somewhere else.

However, it is not clear at this time if the burden of risk has in fact been placed on the buyer, or if the question simply has not been addressed. If a buyer meets his emission quotas in any given year with the help of sequestered carbon ERCs purchased from farmers, then that year balances out - the farmers sequester X tonnes of carbon, and the polluters emit X tonnes of carbon. However, if a few years later a farmer is forced to till his or her soil, it is unclear exactly who would be responsible for the carbon emitted. The polluters are likely to argue that it is no longer their obligation, that the farmer's sequestration in the past balanced their emission, and that any obligation was cancelled out at that point. If the emitter succeeds in shirking responsibility for the maintenance of sinks - that is, if there are not clear mechanisms in place to assign responsibility - then that responsibility may fall to farmers, simply by default.

Let us now look more closely at the nature of the risks involved in an emission reduction credit market which treats GHG removals interchangeably with emission reductions.

Two Sources of Risk

Price Risk

If farmers sell their carbon now for $3 per tonne, they are in effect gambling that the price of carbon will not drastically increase in the future. If this happens, and they find that, for one reason or another, they need to buy back some of the carbon which they had earlier sold for a much lower price, they may be forced to buy it back at the new higher price. For their own security, farmers must ensure that mechanisms are in place to prevent this from happening, or they can become locked in to land management practices that may cease to make sense at some point in the future.

The problem here stems from the fact that any current attempt to set the price of carbon will be based purely on speculation. It will be determined, first, by the level of public concern over global warming, and second, by the cost of reducing emissions. These costs, which in turn depends upon such factors as the inclusion or lack of inclusion of sinks in the Kyoto Protocol, influence the level at which governments set emission caps (the higher the emission cap, the less industry will have to curtail its emissions to meet it, and the less those measures - and, consequently, carbon credits - will cost), and the severity of any emission taxes or permits that are imposed. It is only once the Canadian government commits to its Kyoto target and implements a plan to achieve it that a consistent, agreed upon price for carbon credits will develop.

That does not mean, however, that carbon prices are likely to remain stable over time. McConkey et al. (2000) point out that while agricultural land offers almost immediate offsets of emissions, new technology will eventually be developed that will accomplish significant emission reductions. "This could mean," they speculate, "that the value of offsets could be greatest in the near future and decline with time as new technology becomes available that reduces emissions." However, this scenario fails to take into account the fact that 6% reductions is only the first hurdle of our efforts to curb global warming. Emission reduction will likely become more and more strict, requiring further and further emission reductions. In either case, farmers would be advised to put off selling their carbon until a market-based price of carbon is established, or at least ensure that if they sell their carbon now, measures are in place that will guarantee that they will not have to buy the credits back later at greatly inflated prices. By taking precautions farmers can ensure that the burden of risk does not fall too heavily on them, the sellers - that it is shared to some extent with the polluters who buy their credits.

Permanent vs. Temporary Agreements

In order for a market for emission reduction credits to develop, buyers must be assured that the credits they purchase are reasonably secure. That is, the credits must represent a fixed amount of carbon that will be sequestered for an agreed upon period of time. If the carbon is released during that time, then the credit it had generated becomes worthless, and must either be purchased back by the farmer or simply written off by the buyer as a bad investment. If buyers doubt the security of the credits for sale in a market, the price they are willing to pay will be significantly lower than would otherwise be the case.

If the credits represent a permanent sequestration of carbon (as opposed to credits that expire after five or ten years, causing the buyer to have to repurchase them or to buy others), then they will likely require a legal mechanism such as a conservation easement to guarantee this permanence. Conservation easements are permanent and legally binding agreements to maintain certain land management practices (in this case, zero or minimum tillage and continuously cropped). Because they are permanent, they are tied to the land itself, and not to the landowner, which means that a transfer in land ownership also involves a transfer in easement obligations to the new owner. If the easement is seen as a liability, then this could depress land values for any land that is held under easement.

For farmers, there are important implications of permanent agreements to sequester carbon, which are perhaps best demonstrated by looking at two basic facts about soil carbon sinks:

  1. Sinks become saturated. When a sink is created after a carbon-sequestering land management practice is adopted, soil carbon begins to accumulate. However, under any given land management practice, soil can only hold a certain amount of carbon. Thus, as carbon accumulates in the soil over ten or twenty years, the total soil carbon level approaches a new equilibrium, which means that eventually no new carbon credits are being generated. At this point, unless some additional carbon-sequestering land management practices are adopted, the sink is effectively "full," and therefore ceases to be a revenue generator (unless long-term incentives for the farmer to maintain the sink are included in the agreement) and becomes simply a liability. There is a cost associated with maintaining the sink, as well as with establishing it.
  2. Carbon sequestration is reversible. If a farmer sequesters twenty tonnes of carbon in his soil over fifteen years after switching to zero-tillage, the bulk of this carbon can be released in only a few years if he reverts to conventional tillage and summer fallow, or in the face of drastic weather conditions. This would effectively render any credits the farmer has sold for sequestered carbon worthless, meaning he would likely have to buy the credits back from the original purchaser (or buy an equivalent amount from another source) if there is a need to till the soil to remain productive.

When these two basic facts are taken into consideration, it becomes very clear that farmers need to think long-term when deciding whether or not to permanently sell the carbon in their soils. Some of the possible long term implications of permanent agreements are as follows:

  1. Permanent agreements likely bring short-term revenue and long-term obligation. Once a sink is full and the farmer has been paid for the carbon that has been sequestered, he or she is left with only the obligation to continue the carbon-sequestering land management practice, perhaps indefinitely, unless the contract includes some mechanism for the farmer to be compensated for maintaining the carbon sink.
  2. Permanent agreements reduce future land management flexibility. If the agreement includes the signing of a conservation easement, then the current and subsequent land owners are obligated to maintain the sink in perpetuity. If the agreement is enforced by some other mechanism, then any subsequent change in land management practices requires the farmer to buy back the credits, perhaps at a higher market value.
  3. Permanent agreements reduce farmers' options for total accounting. If governments look at total farm emissions (which they must if total GHG emission levels are to be accounted for), and if farmers will be expected to reduce their overall emissions to a set quota, then it must be remembered that at some point farming will cease to be a net sink, and will become a net source, since soil sinks will at some point become saturated, while farm operations will continue to generate GHG emissions. Once the carbon sinks are full, no more carbon is being sequestered, and farmers become net emitters of GHGs, and subject to required reductions. If farmers have already sold the carbon they have sequestered in their soils, they will have to meet these quotas in other ways, or perhaps pay taxes or fines on the GHGs they emit.

For all of the reasons mentioned above, a system that employs or implies permanent agreements imposes serious limitations on farmers, and places an unfair burden of risk upon them. Temporary agreements, on the other hand, represent an alternative to legally binding long-term contracts.

Carbon Banking: An Alternative System

If carefully designed, temporary agreements can more equitably distribute the burden of risk between farmers and emitters. The key is to see them not as a permanent transfer of carbon from farmers to polluters, but as a lease or loan, designed to ease the burden of emission reductions, to be paid back once the industries have their more permanent (and more expensive) measures in place. To follow the banking analogy further, consider the creation of a sequestered carbon bank, which could be run nationally or internationally. Land managers such as farmers or foresters could contribute sequestered carbon to this bank - the bank's "capital." This sequestered carbon could then be leased or loaned on an annual basis to an emitter to allow them to achieve a short-term emission reduction target. Then, once the emitter has implemented the necessary reductions to his operation, and can show that they have exceeded emission reduction targets, the excess credits (principle) can be returned to the sequestered carbon bank. Such a system would provide an incentive for the farmer or forester to create and maintain the largest sink possible, without transferring the risk of permanence from the emitter to the land manager. This loan or lease would not be a substitute for emission reductions - it would simply provide a much-needed window to allow industry time to adapt to stricter regulations.

For the farmer or forester, who is managing an unpredictable biological process, this "carbon bank" lease-loan system would limit exposure to the risks of permanence. Once a base line carbon level is established, any GHG removal and storage in a sink would have some value for as long as the sink is maintained.

If the sink is lost, for example by fire or disease in the forestry sector or by tillage in the agricultural sector, the land manager would forfeit only the right to loan or lease the value of the sink. Still using the bank analogy, the land manager would be obliged to "withdraw" the principle of his or her sequestered carbon account certified in the bank.

This sequestered carbon bank would also effectively address the issue of price risk for land managers. Currently Canada's Kyoto target is 6% reductions below 1990 emission levels (UNFCCC, 1997). Environmentalists will point out that this is woefully inadequate in terms of actually reducing the GHG levels in the atmosphere. As public concern over global warming increases, so will the pressure that is brought to bear on governments, which in turn will lead to higher and higher targets for emission reductions. The more important the issue becomes, and the harder it becomes to meet new emission reduction targets, the greater the value of mitigation tools. A loan or lease arrangement for GHGs sequestered in biological sinks would address price variability, since it would be reviewed and revised at the end of each term.

Biological sinks are a valuable one-time opportunity to address GHG concerns. Any market system must recognize that sinks are the only GHG removal tool at our disposal. A broad based market system for emission reductions would establish the value of the sequestered carbon "principal," and any loan or lease rate could be negotiated using this value and the agreed upon term. The potential returns of sequestered carbon would add value to land for as long as the sink was maintained. This is in stark contrast to the potential liability a farmer who sells his sequestered carbon permanently as part of an emission reduction trading system would face.

Conclusion

GHG removals with sinks need different policies and markets than GHG emission reductions. If soil sinks are an important strategy to helping Canada manage its GHG problem, then policies need to be developed that encourages land managers to adopt best management practices. Any policy that increases a land manager's risk would, at best, not stimulate adoption and may be a disincentive. A market system for GHG removals that transfers risk from emitters to land managers would likely be a failure. Farmers and foresters already assume tremendous risks due to the uncertainty of managing biological systems as well as volatile commodity markets. A market system for GHG removals with sinks would not provide any incentive for land managers to adopt best management practices if it adds yet another risk to an already risky operation.

If GHG levels in the atmosphere pose a serious environmental threat, we need to remember that GHG removals with sinks are the only current mitigation tool that actually removes GHGs from the atmosphere. This is a limited opportunity for society and should not be squandered in the early stages of addressing dangerous GHG concentrations in the atmosphere. GHG removals can be very useful as a "bridge" to meet short-term GHG targets to allow emitting industries the time they need to implement permanent emission reductions. GHG emission reductions and GHG removals are very different, and therefore require different markets to stimulate the desired activities.

Bibliography

McConkey, Brian, B. Chang Liang, Glenn Padbury, and Wayne Lindwall. 2000. Carbon Sequestration and Direct Seeding. In proceeding of 2000 Saskatchewan Soil Conservation Association Direct Seeding Workshop, SSCA, Indian Head, Saskatchewan, Canada. (See web site http://ssca.usask.ca/conference/2000proceedings/McConkey.html)

Kyoto Protcol to the United Nations Framework Convention on Climate Change (UNFCCC). 1997. http://www.unfccc.de/resource/docs/convkp/kpeng.html

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