Considering Carbon: Overview of Carbon Market Composition

Source: National Agricultural Law Center 

An interest in reducing environmental impacts and achieving climate sustainability within the U.S. is growing significantly among both the public and private sectors. As a result, several different entities are considering voluntary carbon credit markets to encourage the reduction of greenhouse gases (“GHG”). Generally, these markets offer credits to market participants based on the amount of carbon dioxide they have sequestered in the soil. In turn, these credits are sold to companies in the carbon marketplace. Because of the escalating interest in reducing GHGs, voluntary carbon markets are quickly developing a carbon industry.

Meanwhile, agriculture has become a centerpiece of the climate discussion because the agricultural sector is capable of delivering natural climate solutions. Specifically, many agricultural producers across the nation are capable of reducing carbon emissions by undertaking certain “carbon-smart” farming practices that sequester carbon. Agriculture’s ability to capture and sequester carbon has prompted the carbon industry to encourage agricultural producers to participate in carbon markets.

Currently, several voluntary carbon market operators offer market programs to agricultural producers who implement sustainable farming practices to boost market participation. While these market programs are currently operating, there is still some uncertainty surrounding these markets. Much of this uncertainty arises from the lack of information about carbon credit markets. Voluntary market programs within the U.S. are almost entirely operated by several different private companies, and because these market-operating companies rarely publicize details on business arrangements and how their voluntary carbon markets are operated, the industry continues to be complex and unclear.

Even though there is some uncertainty surrounding the existing voluntary carbon markets, these markets do have a potential to benefit the agricultural industry. Specifically, producers engaging in these markets are advancing the goal of climate sustainability, while also receiving a new source of revenue by selling credits on the voluntary carbon market. Thus, it is important for individuals and entities participating in the agricultural sector to understand the basic characteristics of carbon markets. This article discusses a general overview of the existing carbon market structure, the parties involved in these markets, participation requirements, and how these markets generate a new source of revenue for the agricultural industry.

Types of Carbon Markets

Currently, there are two types of carbon markets within the carbon industry: compliance markets and voluntary markets. Compliance carbon markets (also known as “mandatory markets”) are usually organized by governments to target certain industries or sources that emits GHGs. Typically, the government places caps on GHG emissions, and the industry or source emitters is legally mandated to offset their emissions. In a compliance market, emitters obtain pollution permits or allowances in order to meet the emission cap limits. These emitters are allowed to trade unused allowances to other emitters or financial intermediaries to make a profit. An example of a compliance market is California’s Cap-and-Trade Program.

While compliance markets exist, most carbon markets within the U.S. are voluntary markets. Unlike compliance markets, voluntary markets are instituted by private companies who develop and operate their own marketplace to facilitate transactions of carbon offsets, the act of reducing emissions of carbon dioxide into the atmosphere. Voluntary markets are incentive-based markets that allow individuals and private entities to purchase carbon offsets or credits on a voluntary basis. In other words, the market-operators use their voluntary market to link buyers and sellers of carbon credits.

Overall, voluntary carbon markets are relatively flexible and far less regulated than compliance markets because voluntary markets operate in the private sector. Because voluntary markets are developed by several different private companies, each market can differ from one another. Specifically, each market operator sets their own verification standards, credit registries, participation requirements, and project criteria for their carbon market. While voluntary markets differ, most markets are structured the same and each implement similar operational practices.

Voluntary Market Structure

In general, once private companies establish a voluntary carbon market, they seek participants who have the ability to capture and store carbon dioxide into soils, a process known as sequestration. Many agricultural producers have the ability to sequester carbon by implementing certain farming practices. Thus, various markets provide specific market programs for producers to encourage their participation in the carbon market. However, these programs have specific eligibility requirements that producers must satisfy in order to participate in an operator’s market.

Producers choosing to participate in a carbon market must implement certain carbon-smart farming practices into their operation. Exercising carbon-smart practices is required to participate in a market because these practices sequester carbon, which is how carbon credits are quantified. The most common practices include crop rotation, cover crops, buffer strips, no-till/reduced-till, livestock grazing, and applying soil amendments to fields.

Producers who implement at least some of these practices will reduce carbon emissions, and depending on the market program, will be eligible to participate in a voluntary market to sell the carbon credits they produce. However, before a producer is enrolled into a market program, they are usually required to provide records and documents to certify they have incorporated carbon-smart practices in their farming operation. The market operator—or a third-party verifying company—reviews the producer’s records and verifies the producer’s farming practices to ensure the producer is capable of sequestering enough carbon to participate in that market program. If the verification deems the producer eligible to participate, the producer can accept the verification and enroll in the carbon market.

Typically, producers enrolling as a market participant must execute a contract provided by the market operator. The contract will likely contain provisions that allows the market operator to collect certain data from the producer’s croplands. Basically, this data is necessary to measure and verify the amount of carbon the producer sequesters. Additionally, the contract will likely require the producer to hire an independent third-party company to verify the amount of carbon they sequestered. Once verified, the market operator issues carbon credits to the producer based on the amount of carbon they sequestered.

Because various different private companies operate their own voluntary carbon market, the data measurement procedures to calculate the amount of sequestered carbon may differ from one market to the next. However, many of these voluntary markets are using similar methods to determine the number of carbon credits a producer earns. Some markets issue carbon credits to producers who simply implement carbon-smart farming practices, but other market operators issue credits based on measured outcomes. These market operators choose to issue carbon credits either on a per-acre or per-metric-ton basis.

Many producers currently enrolled in a voluntary carbon market are likely participating in a market that measurers sequestration on a per-acre or per-metric-ton basis. In these outcome-based markets, carbon credits quantify the amount of carbon the producer sequesters. If a producer participates in a market that uses a per-acre method, the producer receives the value of the market operator’s carbon credit for each acre carbon was sequestered.

Producers participating in a market that measures carbon sequestration on a per-metric-ton basis, the producer receives carbon credits based on the tonnage amount. In some markets, one metric ton of sequestered carbon equals one carbon credit. Depending on the market’s measurement procedures, the third-party verifier determines how many metric tons of carbon dioxide the producer sequesters. Once tonnage is verified, the market operator issues carbon credits to the producer based on the number of metric tons they sequestered.

Voluntary Carbon Marketplace

In general, the voluntary carbon market is driven by numerous individuals and private companies who are taking steps to eliminate GHG emissions. Specifically, several businesses are setting net-zero or climate-neutral targets, but many entities face financial or technological difficulties to reach their goals. In some instances, it is less expensive for companies to pay others to reduce emissions instead of implementing emission-reducing practices within their own business operations. Thus, in order to meet their climate-neutral targets, many companies purchase carbon credits available in the voluntary market to reduce their GHG emissions.

Many voluntary carbon markets facilitate their own carbon marketplace. Private market operators use the marketplace to link buyers and sellers of carbon credits. In other words, a carbon marketplace provides individuals and business entities the opportunity to purchase carbon credits a producer has generated. In most markets, either the market operator or a third-party broker will sell a producer’s credits to a buyer. Once sold, the producer receives the proceeds from the sale.

Early Adopters

One issue surrounding voluntary carbon markets is the idea of additionality. Currently, only some carbon markets provide programs for early-adopting producers, but only for a limited number of years. Many voluntary markets only offer market programs to producers who are implementing new carbon-smart farming practices in their operation. Thus, producers who previously adopted carbon-smart practices have difficulties enrolling in a voluntary carbon market. As voluntary carbon markets continue to develop, more market operators may offer programs for producers that previously incorporated carbon-smart practices in their farming operation.

Conclusion

The development of voluntary carbon markets has the potential to benefit agricultural producers greatly. Producers enrolling to participate in a voluntary market implement carbon-smart farming practices, and these practices have the ability to enhance soil health, crop yields, and sustainability. Additionally, these carbon markets also provide producers a new source of revenue by selling credits in a carbon marketplace.

Although voluntary markets offer potential benefits for participating producers, these markets operate almost entirely in the private sector and are not currently regulated by the federal government. However, Congress recently proposed the Growing Climate Solutions Act, a bill that provides the federal government the ability to assist in the development of voluntary carbon markets. Also, the United States Department of Agriculture recently began judging the feasibility of creating a carbon bank, which would reward producers who implement carbon-smart practices in their farming operation.

Overall, voluntary carbon market operators are currently enrolling producers across the nation to participate in their market programs. However, each voluntary market operates differently from one another, such as enrollment criteria, acreage requirements, credit value, and payment structure. Therefore, before signing a contract to participate in a market program, producers should seek legal advice to determine if enrolling in a carbon market will benefit their farming operation.

Source: National Agricultural Law Center