Agricultural Carbon Markets Have a Long Way to Go

Recently we conducted research for a client attempting to address a farmland business management question that is getting a lot of hype in the press right now. Namely: should they be entering the market for carbon credits derived from farmland management practices? If so, with whom of the many potential vendors/partners? What crops and practices are considered eligible and in what regions? How large is the potential income stream and what are the payment terms? And finally, what exactly am I selling and what and how long are my legal and other obligations? Is this a permanent legal easement against the farm ground? And what happens if I need to change crops and practices or sell the property?

Although our report is 65 pages and highly detailed, the bottom line is this: The markets for farmland derived carbon credits is in its infancy with wildly varying contract terms, is a long way from consistency, and may not survive over the long term.

Let’s start with big picture eligibility and narrow it down from there. Geographically, this currently is a Midwest corn belt, delta, and southeastern states play. Why? The straightforward answer from a person with a company developing a platform is “Because that’s where the data is”. What they meant by that is most of the research attempting to nail down the difficult to “measure”, or more accurately stated, estimate, the carbon being sequestered and therefore marketable, has been on row crops such as corn and soybeans in the eastern U.S. and not so much for permanent plantings and/or other crops west of the Rockies. Want to do irrigated crops, multiple yearly plantings or perennials (i.e. farmland west of the Rockies)? While there are a few companies experimenting with pilot farms, you’re going to have to wait.

Speaking of math, there is little agreement between vendors, farmers, corporate credit buyers and interest groups as to what and when specific practices should be eligible, never mind how much sequestered carbon is actually generated. Many farmers and farm advocacy groups believe and often assume that they’ll be marketing actual carbon sequestered as measured in the soil. But the market seems to be headed in a very different direction.

To see where, a key term to become familiar with and understand is the concept of “additionality”. Simply stated, additionality in the context of crop production carbon credits is a term used to differentiate newly adopted farming practices assumed to capture carbon vs those already being practiced or that would have happened without the financial incentive of marketable carbon credits. Has your farmland been in no-till production since the 1980’s? Sorry, no-till production on that land next year would have happened anyway and so it is not additional. Want to convert flat fields of highly productive black prairie soils in northern Illinois that would actually produce higher crop yields in an alternative reduced tillage system? There is a contract for you. How much marketable carbon will that practice on that soil type actually sequester vs how it was previously being farmed? Please wait while the models are consulted. No physical measuring tools required.

Now that we’re clear (ahem,) as to what and how much we are buying and selling, let’s talk about when and how those unhatched chickens are paid for. The terms are as varied as the number of market service providers, ranging from mostly simple per-practice per-acre payments, to carbon credits market value being accounted for as NFT’s or Non-Fungible Tokens. Never heard of an NFT or don’t know what it is? We’ll come back to that, but in the meantime go ask your teenage children or grandchildren. They’re probably day trading them as Pokémon or other digital fantasy characters.

Let’s start with the simple model. A number of the agricultural input providers are now offering to pay for carbon credits generated by their customers. The terms are generally simple: there is a schedule for the number of credits which can be generated by a given practice at a fixed value per acre established up front. Perform them and get paid (or credited toward your seed, etc.?) But even here the farmer or landowner will not get the full value in year one. “Why”, you may ask? It’s due mainly to how the end purchaser is using that credit. Most purchasers are using the credits to offset their company’s emission sins. They need to be sure that the carbon they purchased (that same carbon that was sequestered by the grower) is going to remain in the ground. At least for a while anyway. Therefore, they need to be sure a grower doesn’t generate a credit in one year and then do something unenlightened, like run an old-fashioned plow through the ground a year or two later, which the models say will release all the carbon which was captured.

To deal with that risk, even the simple business models in this market do not pay the full value of the credits up front. A typical example with input providers is 50% of the value is paid in year one, 20% in year two, and 10% in years three through five. This has the added benefit for the input providers of locking a grower in for the term of the contract. Oh, and they are probably capturing all the data generated on the farm as well.

On the opposite end of the complexity spectrum, we have NFT’s and Blockchain. In this model, the credit generated exists in a blockchain environment as an NFT. To be clear, an NFT is not the same as crypto currency such as Bitcoin. According to Forbes:

“Physical money and cryptocurrencies are “fungible,” meaning they can be traded or exchanged for one another. They’re also equal in value—one dollar is always worth another dollar; one Bitcoin is always equal to another Bitcoin. Crypto’s fungibility makes it a trusted means of conducting transactions on the blockchain. NFTs are different. Each has a digital signature that makes it impossible for NFTs to be exchanged for or equal to one another (hence, non-fungible).”

In other words, the NFT generated with a particular carbon market vendor on their proprietary exchange likely cannot be sold to, through, or otherwise transacted via any other exchange. Think this is an outrage of these tricky new carbon markets? Try trading the wheat futures market position you hold via the Minneapolis Grain Exchange formed in 1881 via the Chicago Board Trade formed in 1848. Or, if you are a crop producer, try taking that fall delivery contract you hold with grain merchandiser A and reselling it to or through merchandiser B. Attorneys will soon be reading you the fine print.

Here, as in the prior example, the NFT’s generated are not all saleable for cash in year one and in some cases are not fully convertible for ten years. You can “sell” them on the proprietary exchange much like that wheat futures contract, you just can’t cash out all at once.

These terms might sound a little one sided, but we can’t hold this against the investors and entrepreneurs trying to create these products and markets from whole cloth. They are facing a situation in which they are taking on financial and legal obligations in a market for which the product definitions and qualifications are not standardized and as such the necessary “Terms and Conditions” are not fully understood. Indeed, some contracts contain language reserving the right to change how much carbon is assumed to be sequestered by practice, crop, or soil type as future standards may change.

The good news for the grower or landowner is that in all of the contracts and terms we have read or discussed with our clients and the various vendors, they are not required to maintain the carbon stores after the 5 – 10 year agreement expires and so may plow it under, burn off excess biomass, change crops, plant houses, or whatever else they deem fit. This benefits the landowner in the long term because it avoids a permanent easement against the farm ground which would restrict future use and potentially decrease its value. The implications that come with a permanent easement, after landowners realize this, would likely reduce the number of participants.

Because of the requirements of additionality, however, they could in theory benefit from a reset and be able to capture value from the next carbon sequestering practice they might choose to adopt. There is likely a fight brewing here; environmentalists will want permanence and will likely label contracts without it as “greenwashing”.

Starting to get the picture here? The concept of paying farmers and farmland owners to do things like grow cover crops or switch to no-till planting that in theory sequester carbon from the air and store it in the soil sounds simple. But coming to a common agreement on quantification, terms, and values that will satisfy the needs and wants of all sides is devilishly complicated in the real world.

Don’t get us wrong, we’re not saying it can’t or shouldn’t be done, only that there is a great deal or work to do before the market for farm and farmland derived carbon credits achieves standardization and critical mass. And if the (at least) five stakeholders involved, namely farmers and landowners, marketplace vendors and entrepreneurs, purchasers of the credits needing the offsets, the environmental lobby, and possibly, state and federal governments can’t agree to a financially viable system, it is not inevitable that these markets will reach a sustainable scale.