3rd USDA Symposium on Greenhouse Gases & Carbon Sequestration in Agriculture & Forestry CARBON BANKS: AN EFFICIENT MEANS OF ALLOCATING RISK IN CONTRACTS TO SEQUESTER CARBON IN AGRICULTURE AND FORESTRY Adeyemi Gbolahan Esuola and Alfons Weersink Department of Agricultural Economics and Business University of Guelph N1G 2W1

3rd USDA Symposium on Greenhouse Gases & Carbon Sequestration in Agriculture & Forestry Introduction Agriculture and forestry sectors have the potential to remove or reduce atmospheric carbon The sequestered carbon is reversible Contracts to sequester carbon are complicated by the issues of permanence and risk (carbon release, price and policy)

3rd USDA Symposium on Greenhouse Gases & Carbon Sequestration in Agriculture & Forestry Introduction (contd) Several contract designs have been suggested to handle the permanence of sequestered carbon Most of these contract designs do not explicitly consider the allocation of risk This study intends to fill that gap.

3rd USDA Symposium on Greenhouse Gases & Carbon Sequestration in Agriculture & Forestry Sequestration and contract risks Risks in carbon sequestration contracts –Carbon release Intentional Unintentional –Price risk US involvement in Kyoto Russian ‘hot air” –Policy risk Uncertainty about climate change and policy response by government

3rd USDA Symposium on Greenhouse Gases & Carbon Sequestration in Agriculture & Forestry Alternative Designs for Carbon Contracts Pay-as-you-Go -Perpetual sequestration -seller bears all the risks Carbon Annuity Account -perpetual sequestration -seller bears all the risks Ton-Year Accounting -Ton-year sequestration -seller bears all the risks

3rd USDA Symposium on Greenhouse Gases & Carbon Sequestration in Agriculture & Forestry Alternative Designs for Carbon Contracts (contd) Variable-Length -Temporary sequestration -seller bears the risks but flexible Ex Ante Discounting -Perpetual sequestration -seller bears the risks Renting/leasing Temporary sequestration -Similar to the variable length -seller bears all the risks but flexible

3rd USDA Symposium on Greenhouse Gases & Carbon Sequestration in Agriculture & Forestry The Carbon Bank A single aggregator pools carbon credits together and functions as a financial bank. Contract is based on the amount of carbon sequestered or that can be sequestered Sequestered carbon belongs to the sink generator and is deposited with the bank

3rd USDA Symposium on Greenhouse Gases & Carbon Sequestration in Agriculture & Forestry The Carbon Bank (contd) Large industrial emitters can buy or rent carbon from the bank The number of credits bought by the bank is greater than the amount sold or rented out to emitters Serves as a carbon reserve against any contingencies Carbon deposit can be withdrawn at any time Payment based on the amount of sequestration done

3rd USDA Symposium on Greenhouse Gases & Carbon Sequestration in Agriculture & Forestry The carbon bank (contd) Sequestered carbon can be deposited with the bank for as long as possible Payments made at the end of each 5 year period Since sink generators don’t get paid until the end of the 5 year period, the bank invests the money at the advise of the sink generators

3rd USDA Symposium on Greenhouse Gases & Carbon Sequestration in Agriculture & Forestry If farmers/foresters withdraws or change management practice, then they lose their credits and get no payments. Where N 1 + N 2 >M N 1 = No. of Farmers (Risk averse) Sells/rent Carbon Credit deposit Carbon Credit Pay $/Ton of C02 Carbon Bank (Risk neutral) M= No. of Large Emitters (Risk averse) N 2 = No. of Foresters (Risk averse) Pay $/Ton of C02 FRAMEWORK FOR THE CARBON BANK Deposit Carbon Credit Pay $/Ton of C02

3rd USDA Symposium on Greenhouse Gases & Carbon Sequestration in Agriculture & Forestry The Carbon Bank (contd) Ability to Deal with Permanence Issues and Risks Intentional carbon release (credit withdrawal) -The sink generator gets paid till the time credit is withdrawn but not asked to replace the lost carbon Unintentional release (fire, pest or hurricane) -Two options 1. carbon release risk adjusted price-insurance 2. carbon release unadjusted price (market price) The insurance is for the stream of income and not the lost carbon credit

3rd USDA Symposium on Greenhouse Gases & Carbon Sequestration in Agriculture & Forestry The carbon bank (contd) Price risk –Price review to reflect current market condition –Sink generators have the choice of locking in their credits at the contractual price or having a portion in the going price and some fixed –Large industrial emitters too can either buy credits annually or for a period of time depending on their expectation of carbon price

3rd USDA Symposium on Greenhouse Gases & Carbon Sequestration in Agriculture & Forestry The carbon bank (contd) Policy risk –The bank can adjust to new information –Contracts to sequester carbon are not in perpetuity –If the science behind global warming is refuted or enforced both the sink generator and emitters can adjust to the new information

3rd USDA Symposium on Greenhouse Gases & Carbon Sequestration in Agriculture & Forestry Risk Allocation The bank ensures that when carbon is withdrawn from the bank, buyers of carbon are not thrown out of compliance Sink generators can deposit and withdraw their credits without having to pay back Prices are reviewed or locked in depending on the attitude to risk of the sink generators

3rd USDA Symposium on Greenhouse Gases & Carbon Sequestration in Agriculture & Forestry Risk Allocation (contd) Emitters can buy carbon yearly or for a period Sink generators’ stream of income in any one 5 year period can be insured against any unintentional carbon release Sink generators are at liberty to use their credit as they will

3rd USDA Symposium on Greenhouse Gases & Carbon Sequestration in Agriculture & Forestry Conclusions Contracts to sequester carbon are complicated by issues of permanence and risk Several contracts designs have not examined the aspect of risk in carbon sequestration contracts The use of a carbon bank can help ensure permanent carbon sequestration without committing any sink generator to a perpetual sequestration contract The risk of carbon release, price and policy are well allocated within a carbon bank system.

3rd USDA Symposium on Greenhouse Gases & Carbon Sequestration in Agriculture & Forestry THANK YOU!!! QUESTIONS?