Jeremy's Blog 6th August 2021: Managing Risks in Environmental Agreements

This article by Jeremy Moody first appeared in the CAAV e-Briefing of 5th August 2021

Understanding risks is a key part of making a market work. A buyer wants to know exactly what is being bought; the seller wants to contain the risks in that. Market pressures, contract law, consumer protection and other interventions seek to help with means, like the Land Registry, to authenticate major assets. Environmental agreements, including biodiversity gain, have risks as much as any other transaction. America’s forest fires in areas used for carbon offsetting bring this into focus. Their stored carbon is now in the atmosphere, their prospective storage capacity destroyed, their offsets nullified but the companies’ emissions could continue.

Whether compensatory habitat or environmental land management, the ideal would be to pay for outcomes achieved. However, the variability and uncertainty of natural systems often make this an impossible risk for a farmer or landowner to take on, perhaps especially with climate change. The risks increase where the change costs more and takes longer to deliver – more for woodland than short-term feeding habitat for turtle doves. The risk of underperformance, even failure, is there for all such projects.

Thus, biodiversity is now tackled by habitats, not directly species. New schemes increasingly look to pay for actions that, over time and over area, are consistent with the desired outcomes. The state as buyer assumes the risk of them not happening but can look across its portfolio of agreements.

With apparently rising threats to trees from fire, drought, disease and pests, how might such risks be handled?

• simply by discounting the price of offsets, even when carbon is trading at relatively low values, leaving the risk with the buyer
• like the Woodland Carbon Guarantee scheme, paying only on carbon achieved, leaving the risk with the seller
• the seller can, as in parts of the USA, keep a buffer of unsold credits which can replace credits covering trees now burnt, preserving the bargain but fewer credits sold
• forest design with firebreaks and wetlands, lowering the planted area.

CO₂ in the atmosphere for at least a century requires a judgment and possible contracts covering a century’s risks and lower returns today. Woodland, postponing emissions more than cancelling them, is still one of the range of means needed to manage climate change. Foresters assume the risk of future regulation, as perhaps now in the EU, limiting their ability to harvest.

As in any other market, good advice in environmental markets manages risk and reward with an eye to resilience in changing times.