CAREFULLY Consider Carbon Credit Contracts | Ruder Ware
Written by Tim Hartwell on May 14, 2022
Carbon credits have been a hot topic around the country as a potential opportunity for extra farm revenue. However, like any contract, farmers should carefully consider the terms of a carbon credit sale before signing an agreement.
There are several terms that could trip up the unwary signer.
What is a “carbon credit?” A carbon credit is a fictional currency representing the farm’s credit for undertaking certain practices to sequester carbon in the soil. Typically, each credit represents about one metric ton of carbon sequestered.
There are many terms to review carefully when presented with a carbon credit contract:
Parties. The farmer will be party to the contract as a producer, but who else will be included? Be sure to ask the broker about their role, who will serve as a verifier, and who will purchase the final credit.
A farmer may wish to perform due diligence on the other parties to learn about their abilities to fulfill financial obligations, leadership qualifications, and their company overall.
In addition, if the farm is renting the land, the broker may require permission from the landowner, as well as the renter.
Term. Carbon credit contracts last on average about 10 to 15 years, although they can run anywhere from two to 100 years. The term identifies how long a farm is committed to performing these practices and continuing the relationship.
If a farmer intends to retire, needs to sell, or simply wishes to implement other practices, the term of the contract becomes even more important, as exiting the agreed upon contract may be difficult.
Obligations. What is expected of the farm? Consider whether the contract is clear about the practices you will be asked to implement and how modifications may be made.
Carbon sequestration practices may include a variety of options, whether that’s cover crops, no-till or reduced till, buffer strips, regenerative grazing, or something else entirely.
Your contract should explain whether the farm is required to implement specific practices or if payment is solely outcome-based. It should also detail how practices are selected and whether you may change methods throughout the term of the contract.
Additionality. Many carbon credit contracts depend on the concept of additionality. Additionality means that a producer is only rewarded for new practices that are implemented, not those they have used for years.
Permanence. Not only do many carbon credit contracts require new practices, but several also require permanence, or an agreement to commit to continue the new way of doing things for a set future timeframe.
The goal of the purchaser is to sequester carbon for a long period of time, so if the farm no-tills for three years and then starts plowing again, there may be a penalty for releasing that carbon again.
Data Privacy. When the verifier comes to the farm to verify your practices and measure sequestered carbon, they may be requesting access to your farm, soil, practices, yields, inputs, and more.
Your contract will likely control who owns that data and how the verifier and other parties can use it. Be sure any confidentiality obligations are clear.
Payment. Carbon credit contracts typically appear to use one of two primary forms of payment: either a per acre calculation or a per metric ton (of carbon sequestered) calculation.
Farm economist David Aiken from the University of Nebraska noted that early signers reported payments of 10-15 dollars per acre per year, but after review, he believes those numbers might be due to early signing bonuses and that the yearly payments may not be as high.
Instead, Aiken indicates that payments are more likely to be based on the per metric ton calculation, with approximately 5-10 dollars per metric ton of carbon sequestered. Aiken suggests that it may take 5-10 acres to sequester one metric ton of carbon, leaving the payments closer to 1-2 dollars per acre.
After running the calculations, farmers should be sure to read the fine print about payments. Some contracts may also require the farmer to pay the verification fee (about one third of the profit).
Contracts could include a vesting schedule and holdback, meaning remaining profit might not be paid up front, but rather have a several-year wait to ensure the permanence condition is met.
Whether the remaining payment is sufficient is a business decision for the farmer to make, but a lawyer can help to understand how the fine print could impact the annual payment.
Farmers should also keep in mind that any disagreements about practices implemented, or their verified impacts, might result in penalties that further reduce related payments. It is important to know all possible impacts before entering the contract.
Verification. A verifier is part of the process to ensure practices are implemented and taking effect.
Farmers are encouraged to consider whether the contract should specify what type of verification will be occurring, what information the verifier will request from the farmer, how frequently the verifier will be at the farm, what the audit process will be for the farmer, and what the dispute resolution process will entail in case the farmer and the verifier disagree.
Stacking. Many carbon credit contracts also disallow stacking, or enrolling the land in multiple programs, to avoid double dipping.
However, some contracts also disallow stacking with government programs on the land. Be sure to know what programs the farm currently employs and whether any will be affected by a carbon credit contract.
Termination. Finally, every good contract begins with the exit in mind. Especially with a lengthy term, it is important to consider how parties may exit the contract.
This includes whether the contract can be assigned (or transferred) to another party, penalties for early termination, whether notice is required to terminate, and whether termination is allowed at all.
Gaining a new, unselected partner or being unable to pivot in the future might have unintended consequences.
Farmers and brokers playing the carbon credit market are engaging in a game of chance.
Carbon credits are in fashion again as part of the conversation about reducing greenhouse gases and climate change. However, they are not a new concept.
The Chicago Climate Exchange offered the opportunity to trade carbon credits from 2003-2010. However, the Chicago Climate Exchange closed in 2010 after nine months of zero trading.
The market had expanded in anticipation of a greenhouse gas emissions regulation program under President Barack Obama. However, when Congress did not enact that legislation, the level of interest in buying carbon credits decreased significantly and the market dissolved.
Carbon credit prospectors today anticipate future regulations on environmental emissions, as well as the social push for environmentally friendly practices.
If they can buy low, locking producers in at a low rate over a long time, the hope is to sell high if market takes off.
Policy changes to achieve net zero emissions would drive the price upward. This tracks with recent regulatory changes, such as the Securities and Exchange Commission’s (SEC’s) new proposed rule requiring publicly traded companies to report additional information about their environmental and social governance interests.
Entering the carbon credit market now might allow for easier means of meeting the additionality requirement, but farmers should carefully consider the risks of a long-term contract before signing.
Risks can be minimized, and rewards maximized, through careful consideration and negotiation before committing.
© 2022 The Badger Common Tater, Antigo, WI. Reprinted with permission.
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