Carbon Markets, Voluntary Versus Mandatory

There has been a great deal of discussion in recent months about the possibility that agricultural producers could receive financial payments as a result of changing or modifying traditional farming practices and methods. The key to unlocking this new value is to switch to a practice or method that releases less carbon dioxide into the atmosphere over time. There may be other benefits that accrue from the switch like reduced fuel use or less requirement for fertilizer that also benefit the bottom line, but the goal is the reduction of naturally occurring atmospheric compounds that comprise the category called greenhouse gases (GHG), like carbon dioxide, nitrous oxide, and methane. Generally adopting practices that achieve beneficial results can earn the practitioner an “environmental credit”, which is essentially a certificate which certifies that the farm did indeed change its practices and reduce its GHG emissions.  The farmer can then sell that “credit” to a person or company. One of the confusing aspects of all of this is that there are a variety of credits in existence today that depend on the market in which they originate and the markets in which that are fungible.

A leader in the development of markets that recognize the benefits of transitioning to practices that produce reduced GHG emission is the government of the state of California. To incentivize the transition to carbon-beneficial agricultural methods, formal programs have been established that certify the program participants who will be applying for “State of California Environmental Credits” as originators – the term “originator” refers to the farm that is changing practices as the program prescribes. The second part of the market is the buyers – the GHG producers who are currently exceeding their program prescribed allowance. These may be electricity generators, or commodity manufacturers like aluminum smelters, or steel plants that emit large amounts of emissions as a by-product of their production processes.

Market participants exceeding prescribed allowances are required to purchase the credits in the marketplace at a price, in most cases, established by supply and demand. In the case of California the market was established by law or in a legal rulemaking that established requirements to comply in achieving a goal to reduce GHG emissions or, in the alternative, purchase equivalent credits (sometimes referred to as allowances) in the marketplace. This incentivizes the market to take actions that result in the origination of additional credits. Instead of buying credits, market participants also have the option to invest in new technology to reduce their GHG emissions below acceptable levels.

California’s credit market is an example of a mandatory market. Voluntary carbon markets also exist for the purpose of allowing companies to demonstrate their commitment to reducing GHG emissions. Large buyers in the marketplace like chain store retailers may set conditions on the award of long term contracts for consumer products like dish soap or bath towels that require a reduction in GHG emissions below targets set by the buyer (Wal-Mart or Target come to mind). Reductions in GHG emissions, even though voluntary, can be a condition for legal sales agreements. This allows the ultimate seller of the consumer products to make claims in advertising about the sustainable features or qualities of their product in comparison to competitors who have not made the GHG emissions reduction effort.

As the challenge to reduce carbon dioxide emissions grows, both mandatory and voluntary compliance markets will evolve. What is necessary is a reliable platform that all market participants, whether mandatory or voluntary, must use to manage credit origination and trading activity. In this way the size and value of the market can be determined and monitored. The trading platform must be designed to assure accuracy and authenticity. It must be able to track every credit certificate from the day it is created to the day it was retired and provide a record of ownership during its life. In the wholesale electricity industry, the Generation Attribute Tracking System is such platform serving a mandatory compliance market. For those voluntarily originating and selling credits and the buyers of the same they can use platforms like Green-E for certification, tracking, and authentication.

While the world of agricultural related carbon dioxide emissions reductions may seem disconnected from the realities of day to day farming or the marketing needs of mass market retailers there is a growing linkage driven by market forces. Understanding how retail and other commercial markets are beginning to monetize practices to reduce or eliminate GHG emission can help add a new cash flow to the positive side of the ledger for many agricultural producers.