Lachlan Soil Carbon Market Based Instrument Pilot Dr Jason Crean Industry and Investment NSW

Lachlan Soil Carbon MBI Project - overview  Background Widespread interest in recognising changes in soil carbon as part of Australia’s greenhouse response Uncertainty about future policy environment, scientific and economic potential of soil carbon trading  Objectives Better understand the real potential of soil carbon markets to: provide effective incentives to producers for storing carbon; and deliver cost effective abatement to the broader economy  Methods implement an MBI pilot that is: 1.Scientifically credible 2.Economically robust

Soil carbon measurement  Development of Soil Carbon Zone Matrix Organises existing soil carbon data sets Prioritises the further collection of soils data through field program Components o Soil types based on existing soil landscape maps o Collates results of previous soils research o Rainfall zones from Bureau of Met data o Landuse/land management practices

Soil carbon measurement  Soil Carbon Field Program Sites selected randomly from within a group of collaborating landholders Each site selected fulfilled sampling criteria - soil type, landuse and history Data recorded at each site: o Sampling depths – 0-5cm, 5-10cm, 10-20cm, 20-30cm, 30-40cm o Bulk density, total organic carbon, soil carbon fractions etc o Landuse data collected for 10 yrs prior to sampling Cropping – crop type, yield, stubble mangt, tillage Pasture – stocking rate & type, pasture type, grazing practices All paddocks – rainfall, fertiliser, soil conditioners

Economic theory and MBIs  Market failure –Markets are the prime means by which resources are allocated –But market failure is common in environmental areas public goods and externalities  Approaches to environmental problems –Regulatory –Suasive –MBIs Source: National MBI Pilot Program

Economic theory and MBIs  MBI’s - cost-effective achievement of environmental policy goals  Where MBI’s are likely to offer advantages Heterogeneity in market participants Differences in opportunity costs - gains from trade Flexibility in responses to market signals Scope for innovation  Where MBI’s fit in the policy mix Source: Pannell’s investment framework – adapted by BDA and CSIRO (2007)

Economic research into MBI design and evaluation 1.Stage 1: Literature review of the application of MBI’s to soil carbon sequestration 2.Stage 2: Test basic MBI design issues 3.Stage 3: On-ground MBI pilot 7

Stage 1: Literature review  Many impediments to soil carbon markets –costs of measuring and verifying soil carbon sequestration –linking changes in practices with changes in soil carbon –managing issues of permanence, additionally and leakage –restrictions on landholders flexibility  Key factors influencing the design and operation of markets for soil carbon sequestration were identified: –Whether contracts should be designed to target actions (management practices) or outcomes (measured levels of sequestration). –Questions concerning the permanence of sequestration, contract length, and alternative payment schemes. 8

Literature review  Actions vs. Outcomes –What are the market consequences of targeting actions or outcomes? Action or practice-based approaches prescribe management practices that landholders will undertake in order to receive payment. Outcome or quantity-based approaches pay landholders for measured outcomes that are directly related to policy objectives. –Action-based or outcome-based approach will depend on : design of monitoring and enforcement schemes scientific and biophysical uncertainties associated with the links between actions and outcomes (e.g. practical questions of measurement) spatial and temporal heterogeneity in the biophysical system risk attitudes and other behavioural characteristics of landholders as decision- makers and market participants 9

Literature review –The high cost of measuring soil carbon content increases the likelihood that emissions policies will be associated with on-farm management practices instead of the direct measurement of emissions (Australian Farm Institute, 2009). –Such action or practice-based approaches might also be preferred by risk- averse landholders (Whitten et al., 2007; Gorddard et al., 2008). –In theory outcome or quantity-based approaches might better take into account the uncertainty surrounding the links between alternative management practices and outcomes for soil carbon as well as spatial heterogeneity in soil carbon. 10

Stage 2: MBI design  Stage 2 - Test basic MBI design issues University of Sydney/CSIRO Test contract options to handle impediments to soil carbon trading Test payments based on management practices (actions) or outcomes Test responses to uncertainty proposed by ACIL ‘portfolio’ approach to handling uncertainty use of ‘options' to tap into possible upside of undertaking actions now  Components in Stage 2 Part 1 – experimental economics - laboratory testing (workshops with students) – Oct 2010 Part 2 - field testing (workshops with farmers) Part 3 – incorporate findings from 1 and 2 into MBI pilot

Experimental economics  Laboratory research, glass house trials, field trials and commercial crop trials all play an important part in the development of new crops and new agricultural technologies.  Laboratory and field experiments can play a similar role in economics as new agricultural and environmental policies are being developed. 12

Experimental Economics  Method of evaluating alternative policies under controlled conditions  Participants in the experiment face choices with real monetary rewards – they face market incentives with payments based on trading outcomes  Allows policies to be tested prior to implementation - provides an empirical basis to policy section, minimises MBI design faults  Useful for designing and evaluating new MBIs for natural resource management – extensively used in National MBI Pilot Program

 Laboratory experiments can serve as a testing ground for institutional design.  Human behaviour is variable – experiments use multiple replicates to enable statistical comparisons.  Market outcomes can be compared with known benchmarks that would be unknown in field settings.  The performance of different market institutions can be compared under the same controlled conditions and the same market institution can be studied under different environmental conditions. 14 Experimental Economics

 Soil carbon experiments –Currently being undertaken by CSIRO/University of Sydney –Various contract designs considered related to actions versus outcomes, trading impediments (eg. permanence) and uncertainty –Key aspects: Alternative land uses – various land uses and practices that have an economic return and soil carbon effects Each market participant is given certain endowments and choices to make Alternative market institutions – alternative ways of recognising soil carbon outcomes

 Example of Experiment - Actions vs outcomes –compare the performance of markets where payments depend on the choice of management actions with markets where payments depend on increasingly uncertain outcomes. 16 Experimental Economics

 Example of Experiment - Actions vs outcomes –General payments to participants depend on the decisions they make and market outcomes. Parameters for production decisions and associated levels of soil carbon sequestration are based on data from sub-catchments in the Lachlan catchment Participants decide their production activity and decide how much to invest in this production activity. Different production activities have different production values and also different levels of sequestration. –This experiment As increasing weight is placed on outcomes, payments increasingly depend on measured levels of sequestration rather than purely on the choice of management practice. With increasing uncertainty, the level of sequestration from different practices is risky and a range of outcomes is possible. 17 Experimental Economics

Stage 3: MBI pilot Stage 3 – March to June 2011 Launch the actual MBI pilot Use an auction based approach to select economically efficient projects Evaluate bids and allocate funding I&I NSW complementary research into non-soil options Existing and new technologies to reduce methane emissions Existing and new technologies to reduce nitrous oxide emissions Development of GHG abatement portfolios to manage uncertainty Options to minimise transaction costs associated with measurement, reporting and verification