Permanence Discounting for LandBased Carbon Sequestration

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Permanence Discounting for Land-Based Carbon
Sequestration

• Man-Keun Kim
• Joint Global Change Research Institute
• University of Maryland
• Bruce A. McCarl
• Regents Professor of Agricultural Economics
• Texas AM University
• Brian C. Murray
• Director
• Center for Regulatory Economics and Policy
  Research
• RTI International
• Presented at USDA Symposium on
• Greenhouse Gases Carbon Sequestration
• in Agriculture and Forestry

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Conclusion First,

• Are offsets fungible?
• No, offsets are not fungible due to permanence
  issues such as saturation and volatility
• So, permanence considerations could affect the
  terms of trade for (potentially) land-based
  carbon sequestration and permanent emission
  reductions (fuel change, direct reduction etc.)

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Presentation Outline/Study Objectives

• Examine market consequences of permanence
  characteristics of biological carbon
  sequestration
• Develop a grading standards approach
• Derive a permanence related grading standard
  discount
• Investigate the empirical magnitude of the
  grading standard permanence discount

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Biological Sequestration and Permanence

• Approach to Equilibrium/Saturation - differential
  rate of accumulation over time and a long run
  decline to a near zero rate of net sequestration
  when carbon inputs and carbon decomposition
  reaches equilibrium
• Volatility - sequestered carbon can be rapidly
  released back to the atmosphere if practices are
  reversed
• Contract terms - influence offset value and
  involve
• project duration
• payment terms including possible maintenance

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Saturation of Sequestration in Ag Soils and
Forests

• Absolute Change in the Annual Rate of Carbon
  Sequestered Following a Change from Conventional
  Tillage (CT) to No-Till (NT) - (West and Post
  2002)

West and Post, Oakridge NL Birdsey et al, USFS,
FORCARB Note saturation by year 20 Note
saturation by year 80
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Permanence and Grading Standards

• The question is whether the permanence concerns
  associated with sequestration may alter the value
  of the resultant carbon offset to purchasers in
  the market place
• Offsets are not fungible from an offset
  purchasers point of a view, an impermanent
  sequestration asset may be worth a different
  amount than permanent offset
• In turn prices may differentiate based on
  permanence characteristics like a grading standard

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Grading Standards

• Market grading standards
• Gasoline prices by octane level
• 2 Yellow corn, CD plywood, Long staple cotton
  etc
• Items receive a price premium/discount depending
  upon their characteristics and the consumer value
  of those characteristics
• Biological carbon sequestration may have consumer
  characteristics in terms of claimable quantity of
  offsets over time or cost due to permanence /
  dynamic flow of offsets

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Deriving a Permanence Discount

• Suppose we consider two alternatives
• Perfect alternative without any permanence issues
• Imperfect alternative with permanence issues and
  a potentially discounted price
• Equate the effective cost per ton and solve for
  discount

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Cost per ton

• Take cost paid divided by tons obtained
• But tons and cost arise over time
• Effective cost per ton (PE) today for perfect
  (permanent) offset
• Pt current and future carbon price,
• Qt quantity of offset
• T is duration of the contract

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Permanence Related Terms in Cost

• Buyback - At the end of the sequestration
  contract or when things like forest harvest
  occur, the purchaser has to buy new offsets to
  cover those previously held through the
  sequestration contract
• Maintenance cost terms in the contract to
  compensate for efforts to maintain sequestered
  carbon that are not a pure function of quantity
  by year

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Components of Cost

• Several relevant terms
• Price paid for carbon in year t
• Permanence discount
• Buyback after contract expires or when release
  occurs
• Maintenance cost independent of carbon quantity
• PE today
• Bt buyback,
• Mt maintenance cost,
• PDisc permanence discount

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Deriving a Permanence Discount

• A perfect offset has PDisc0, without maintenance
  cost or buyback
• Assume a constant carbon price, P0
• PE equals the price for the perfect prospect

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Deriving a Permanence Discount

• Now suppose we equates the cost per ton from an
  imperfect with a perfect prospect and solve for
  the permanence discount (PDisc)
• We assume a constant carbon price, P0
• This may be solved for solving for PDisc

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Resultant Permanence Discount

• Permanence discount (PDisc)
• When is discount zero
• - No Buyback
• - No Maintenance cost

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How Big is the Discount?

• Agricultural soil carbon sequestration
• 25 year lease with 100 buyback approximately
  49 price discount
• Maintenance cost at 5/acre approximately 36
  price discount
• Afforestation
• Harvest year 20 without reforestation 52
• Harvest year 20 with reforestation 23
• Harvest year 50 without reforestation 20
• Harvest year 50 with reforestation 7

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Implications and Conclusions

• Permanence discount indicates the amount that the
  offset price would be reduced to reflect the
  alternative characteristics of the non-permanent
  offset
• Permanence considerations could substantially
  affect the terms of trade for (potentially)
  temporary carbon sequestration and permanent
  emission reductions
• Temporary storage may be an interim strategy
  (bridge to the future) but will face discounted
  prices if projects expire or maintenance costs
  involved