Will Emerging Carbon Markets Add Value for Farmers?
When it comes to finding ways to reduce carbon, farming is often mentioned as a sector that has promise in reversing climate change. This is because farming practices – like cover crops and reduced tillage – can limit the release of carbon into the atmosphere by “sequestering” it in the soils.
Unfortunately, policies and markets are still trying to evolve that will give needed price signals to farmers for adopting these practices. The idea of a market for “carbon sequestration services” is admittedly abstract, and the varying degree of state, national, and even international policies on carbon has created a difficult landscape for the development of a unified carbon market.
Note: This article is based in part on the FBN® Roundtable discussion from January 20, 2021 moderated by FBN Chief Economist Kevin McNew and included panelists Dean Watson, President of POET Grain, US Representative (SD) Dusty Johnson, Steele Lorenz, Head FBN Sustainable and Brendan Jordan, VP Transportation, Great Plains Institute.
Here, we distill the key factors that we believe will shape the future of Carbon Markets and Farming.
Necessary pillars of a carbon market
For a market to function properly it generally requires three key actors. These include:
Consumers (or buyers) which have a need or desire for a product/service.
Producers (or sellers) who can effectively deliver, make or create the product/service.
Institutions that provide rules for fair trade, legal enforcement, or verification.
In the case of carbon, the evolution of carbon markets has largely been focused on the service of “carbon sequestration”. In this context, the consumers of carbon sequestration services are companies that emit carbon as part of their operations.
As society begins to impose costs on carbon emission through direct policies that limit carbon, companies must decide whether they will take steps to change their practices (which is costly), or “buy carbon offsets” from a supplier to meet their carbon reduction needs. Here, farmers are one such supply source for carbon sequestration.
A company could potentially work with farmers, offering to pay for a set of practices that the farmer will undertake that yields a defined quantity of carbon removal. Hence, a market is born.
Today, the market for carbon services is still at its infancy. The world’s first international emissions trading system started in Europe in 2005, which mandated compliance of certain sectors to reduce carbon emissions.
This is what is often referred to as a “mandatory” carbon market as government policies require carbon reduction, and this regulatory obligation on companies creates a demand to pay for carbon reduction services.
In the United States, regional examples of mandatory programs exist. California created a mandatory system and the Regional Greenhouse Gas Initiative (RGGI) was formed by 11 Northeast states, but today no overarching US system exists as in Europe.
At the other end of the spectrum, you have “voluntary” carbon markets. Here, companies pledge to reduce their carbon footprint and these promises generally involve a mix of own-company emission reductions with additional reductions achieved through open market purchases of carbon offsets.
Unlike a mandatory market, companies have no legal obligation to reduce carbon and as such their demand for carbon services could be viewed as less robust than those companies that fall under mandatory authorities.
However, investor and societal pressure are signaling more companies to engage openly in carbon reduction making voluntary participation by companies necessary for future financial success.
In this space, food and ag companies like Tyson, Unilever and Danone are just a few examples of companies actively engaging at the farm level around carbon in an effort to meet corporate sustainability goals.
Drivers of carbon services: Grain buyers
Today, grain buyers and end-users are still trying to find value in the carbon space. One avenue where there are direct linkages is in ethanol.
Here, US ethanol manufacturers have a direct line into a carbon-tied market through California’s Low Carbon Fuel Standard.
This policy scores motor fuels differently based on the carbon intensity of the product. Fuels that are produced with a low carbon score are rewarded versus high carbon fuels which are not.
Under this yardstick of carbon intensity scoring, ethanol gets a fixed premium regardless of how the underlying feedstock was produced.
POET, which buys around 1 billion bushels of US corn every year to make ethanol, in conjunction with FBN, has been advocating the California policies be adjusted to allow for a variable score that would be derived from practices used at the farm level.
Corn produced from practices that reduce carbon (or what is deemed a low carbon intensity score) would fetch a premium, thereby giving the farmer a price signal to adopt more carbon friendly practices.
To date, most of the effort by POET and other grain buyers has been around building an understanding between carbon intensity scores and farming practices. Indeed POET and FBN have been researching this issue with real-world farm trials. The results of these studies are impressive on two fronts:
If you simply look at existing practices that corn farmers use today (or at least as represented by their sample of farms) then the carbon intensity score of the average is better off than what California currently pays today as a fixed rate for ethanol. In other words, by not taking into account existing agricultural practices of corn production, farmers are losing out on possible value.
Even more important, if the California laws were optimized to reflect the carbon intensity of each unique farm’s practices, the potential rewards to a farmer would be impressive. POET and FBN found some premiums for low-carbon corn could be as high as $0.75 a bushel.
Opportunities for farmers in evolving carbon markets
So far, our discussion has mostly centered around the linkages up the chain to the fuel market. But in grain, are there opportunities from a carbon-based grain buying program for food and feed end-users?
The answer is yes according to Steele Lorenz, FBN’s Head of Sustainability. Companies are setting clear goals at reducing emissions and offering transparency about their progress.
This is especially true for publicly traded companies. NASDAQ’ Environmental Standards Group reported that over 40% of Corporate Annual Reports they sampled had clear targets for greenhouse gas emissions.
Today, FBN works in tandem with Tyson Foods around their goal to have 2 million crop acres used for feed grown with sustainable practices.
While the food and feed space today may not have clear linkages to regulations which provide market-based incentives for carbon reduction, there are still important indirect consequences for companies that are not taking these steps.
First, financial institutions like banks, investment firms and insurers are increasingly requiring or at least monitoring company metrics on these goals thereby signaling the importance that companies have demonstrated programs for carbon reduction.
Second, while policies that drive carbon reduction may not exist today, they likely evolve in the future, giving early adopting companies a competitive edge if carbon regulations are enacted.
Our view on the future of carbon markets and linkages back to farms for value creation is bullish. There is still much to be done around policies, institutions, and systems that will support the transmission of carbon value back to the farm but those necessary building blocks will likely be stood up in coming years.
What will a farmer need to do? More than crop practices
Carbon based markets for agriculture are still yet to be fully formed. Will carbon intensity of a farm product like corn be the attribute that is valued?
Or will companies act to “buy” carbon sequestration services, and as such the amount of carbon sequestered by a farm will become the traded metric. These two paths of how carbon could be traded – as an “Attribute” using carbon intensity, or as a “Volume” based on the amount of carbon sequestered – are not necessarily restrictive in terms of companies or farmers choosing one or the other but they could involve subtle differences worth considering.
In an Attribute system, carbon intensity becomes a verifiable and priceable metric assigned to every bushel of grain. This is not too dissimilar from how grain is treated today based on grades for moisture, protein, etc..
But here, the carbon intensity score must be verified based on the inputs and practices used. Farm records on farm fuel use, types of fertilizer and amounts are data points that will be necessary to verify and compute carbon intensity. Farming practices like tillage and cover cropping also play into scores.
For a Volume system, which trades carbon as a financial asset directly, the farmer will need data and verification on tillage practices and cover crops.
These will likely involve longer term commitments by the farmer to maintain those practices across a multi-year program, thereby assuring the buyer a fixed supply for a lengthy period of time. In contrast, an Attribute system will likely be tied to specific bushels sold and as such farmers could maintain flexibility around their willingness to participate.
Regardless of which way a farmer goes, the cornerstone of either program will be data. This will start with machine readable data like what is generated from modern planter, applicator and harvester equipment.
Those data sources will likely become industry requirements for participation and streamline verification and value creation back to the farm, so making those investments today may help reap benefits quickly once carbon markets develop.
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