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Carbon contracts are becoming a topic again for many agricultural producers around the country. As we will discuss, there are several legal considerations when deciding if such an agreement fits your needs. At the same time, please keep in mind that this is a developing area with several unknowns regarding how these agreements work. Producers should seek qualified legal advice before signing any contract.
Basic Terminology
Before discussing contracts, let’s look at some basic terms. Carbon credits are produced when a business or person reduces carbon dioxide or other greenhouse gas (GHGs). Carbon offsets occur when a person purchases carbon credits to offset their carbon emissions. An airline may buy carbon credits, for example, to offset carbon emissions from the airline’s planes.
Other terms to keep in mind related to carbon credits would be the difference between an aggregator and data manager. An aggregator is an individual or company pooling together agricultural operations utilizing carbon-sequestering practices. A producer sells carbon credits to the aggregator based on the terms in the contract. A data manager is an individual a producer may work with to enter the marketplace to sell carbon credits. Working with a data manager allows the producer to control when to sell carbon credits.
The other definition to keep in mind is verification. Verification is the process of evaluating the amount of greenhouse gas emissions sequestered or reduced based on implementing the new practices. In many contracts, a third-party verifier will conduct this process.
Contract Considerations
Keep in mind that currently, there are very few rules and regulations in place to protect either party in this developing market. It is, in many cases, the wild west; producers should pay attention to contract terms, ask questions when a term does not make sense, and seek legal advice from an attorney. Before entering into a contract, make sure you understand the key terms and get it reviewed, if possible, by your own attorney.
You must also understand what such a contract will be paying for; it only pays for adopting new conservation practices that would sequester carbon, and it will not pay for continuing existing practices on the agricultural land. If you are already utilizing no-till on your farm, for example, other practices would need to be added in order to qualify for the carbon credits. If you are looking to be paid for existing practices, then you would need to work with the company to get paid for those practices.
Carbon contracts also typically prevent you from double-enrolling acres in other programs. This usually means that the practices you are adopting are not already required under the terms of another program or contract. For example, if you have enrolled cropland in the Conservation Reserve Program, you potentially would be ineligible for a carbon contract. Again, this is something to make the company aware of early in the negotiations.
Payments will be based on a dollar amount per the CO2 equivalent (CO2e) per metric ton sequestered. Companies may withhold a portion of the payment representing a natural buffer for carbon that could potentially be lost from the soil based on a natural loss rate. For example, if the contract includes a withholding amount of 20 percent, then any payment would be reduced by 20 percent for that withholding factor. If the company is offering $15/metric ton of CO2e, then the payment per metric ton would be $12/metric ton after considering the withholding factor.
Keep in mind that the contract may specify additional fees to reduce the payment rate further. For example, producers may have to pay a fee for third-party verification costs or soil sampling, although in some cases, these might be covered by the company. Producers should pay attention to additional costs which could further reduce the payment rate. For more information on how payments flow through these carbon programs, please see, Plastina, Alejandro, How do Data and Payments Flow through Ag Carbon Programs (A1-77, 2021).
Some contracts may provide an annual payment, while others only provide payments at the end of each verification period. If the contract is for ten years with a verification period every five years, for example, the producer would be paid after each of the two verification periods.
Keep in mind the contract will contain provisions laying out penalties when practices cannot be implemented. For example, if the weather prevents planting cover crops on the farmland, the contract’s penalties may apply. The contract may also contain penalties if carbon is released during the contract. This release may be the fault of the producer or by accident, but it is essential to understand what the penalties are and how they would be applied depending on the situation.
Another issue to be clear on is what currency you will be paid in. From looking at sources, these contracts may specify that you get paid in U.S. dollars, cryptocurrency, or credits towards future purchases. Make sure the form of payment will work for you.
Also, keep in mind data ownership issues. Carbon contracts require the producer to provide data at various intervals. This data could include soil samples and production records to help verify that the producer is adopting the practices needed. The producer needs to understand who will access the data provided and how the data will be maintained securely. Verifiers will utilize the data in the verification process to determine if the amount of carbon sequestered is based on the agreed practices being employed.
Understand how the contract will impact your land title and any ability to sell the property. In some cases, these contracts place restrictive covenants or liens on the property to make a future buyer aware of the carbon contract on the property. It’s worth paying attention to what restrictions might be placed on the property which could impact its sale.
Wrap Up
As we see more and more interest in these carbon contracts, it’s worth paying attention to the terms, asking questions of the companies presenting contracts, and seeking independent legal advice. Understanding the terms of the contract can help limit future disputes and allow you to negotiate a better agreement.