Authors: Matt Trudeau, Nori CEO, and Rick Berg, Director of Methodology at Nori
Key Insights:
- Financial additionality impedes the voluntary carbon market, especially soil organic carbon.
- It does not appropriately consider the costs and risks for farmers to adopt regenerative practices.
- It penalizes the early adopters, who are stewarding the land and can set an example for other farmers.
- It creates a catch-22: a liquid soil organic carbon (SOC) credit market can't exist without famers, and farmers can't be confident in the opportunity without a liquid SOC market.
Additionality has become one of the measurements that underpin the accepted wisdom of carbon credit quality in the voluntary carbon market. While we would challenge the application of financial additionality to carbon removal broadly, we will focus here on its application to soil organic carbon specifically.
As generally applied to soil organic carbon, financial additionality seeks to assess whether a project (i.e. adoption of regenerative agriculture practices that sequester carbon in the soil) would or would not have been implemented in the absence of revenue generated through the sale of carbon credits.
An additionality standard, in this context, applies demerits to credits where policy, regulatory, commercial or other incentives are present and/or where the activities of a farmer are deemed “common practice” for a given locale. More specifically, if the project can financially survive on its own without selling carbon credits in the VCM, the project falls short of the stated financial additionality criteria.
The baseline assumptions for project-level additionality screening are:
- Each project can, and should, be evaluated on its own, discretely
- Farmers are in a financial position to make the up-front, multi-year investments required to implement practice changes
- A mature and readily accessible voluntary carbon market exists and farmers can forecast the revenues they will earn from the carbon credits they produce
When assessing the implications of applying financial additionality as a measure of the quality of a soil organic carbon credit, it is important to consider the collective goals of promoting regenerative agriculture and soil organic carbon sequestration:
- Conservation of our land and soil
- Reduce chemical fertilizer and pesticide use
- Reduce negative impact on water quality from runoff
- Increase biodiversity
- Increase soil drought and erosion resistance
- Restore and regenerate soils
- Remove CO2 from the atmosphere and sequester it at a scale sufficient to slow, and potentially reverse, the negative impacts from climate change by reducing atmospheric carbon parts per million (PPM)
- At the upper end of the range of estimated impact, soil has the potential to sequester carbon at a rate of 2.5 Gt/yr (the annual global target for all carbon dioxide removal is 10 Gt/yr)
Systems-level conversion from conventional to regenerative agriculture is required to realize these objectives.. Of the roughly 900 million acres of arable land in the United States, only 13.5 million acres (approximately 1.5%) are currently being farmed regeneratively. Why?
Farmer economics and the VCM
We need to consider farmer economics. The reality is that many farmers are locked in a sisyphean cycle of simply trying to make enough money to break even, or profit enough, to make it to the next season.
According to the USDA, of the roughly 2 million U.S. farm households, slightly more than half report negative income from their farming operations each year.
They face many risks and uncertainties — pests, drought, weather, crop price fluctuations — that can vary substantially from year-to-year, with very little margin for error. Their operations are often debt-financed. If crop revenues fall short it can mean financial ruin, and livelihood destruction.
The only way money-losing farms, approximately half of U.S. farm households, are viable is through various incentive programs that would potentially make them fail the financial additionality test. This is not a set of circumstances ideally suited to multi-year risk-taking, experimentation and early adoption, even assuming that the funds can be raised to invest in new ventures.
As a result, farmers tend to be conservative in making changes to the historically tried and true. When they do, it is typically slow and incremental, e.g. testing new practices on a small number of acres and gradually rolling them out more broadly as confidence grows. This may require multiple growing seasons, which can be a challenge when 100% of productivity is required in each growing season just to make it to the next. The challenge becomes even greater when a change requires a substantial up front investment.
Framed a little differently, if a typical farming career is about 40 years, farmers have 40 harvests to earn their livelihood. If generating revenue from carbon credits takes 3-4 years, the implication is that farmers are potentially risking as much as 10% of their lifetime earnings to make a transition to regenerative practices. The case for early adopters who are willing and able to take the risk may be undermined by financial additionality requirements if it prevents them from being rewarded. Without them, there aren’t examples of success for others to emulate. Such impediments are noted in the USDA Assessment on Agriculture and Forestry in Carbon Markets as one of the obstacles to greater participation by farmers in the VCM.
As an example, the average price of conventional tillage is between $25-$35/acre. Converting to no till, a regenerative practice that helps sequester carbon, can reduce the cost of tillage to $16-$28/acre by reducing the cost in fuel and in a farmer's time. However, this requires an upfront investment in a new planter ranging from ~$20k-100k. Only about 38% of acres for which tillage practices were reported in 2022 were no-till.
Another conservation practice — incorporating cover crops into agricultural rotations — provides farmers with the benefits of reduced erosion, natural weed suppressant, improved soil health and increased carbon drawdown. For example, a farmer in Clark County, Nebraska used rye (seed price of ~$17/acre) that suppressed weeds to the extent that he did not need his second typical herbicide pass (~$30 savings/acre) and was able to manage the herbicide-resistant weeds in his area (potentially saving a third pass as well). Planting cover crops requires an up-front investment in cover crop seeds and the labor of planting them.
Despite the potential benefits, farmers are hesitant to take on the risk when they haven’t seen many examples of success — mostly because relatively few farmers are even trying. For example, in a 2019-2020 SARE Cover Crop Survey, only 6% of respondents had used cover crops on their farm. Much of the hesitation is due to the risk versus return on investment in light of the added risk and added labor of changing practices. Observing positive results experienced by other farmers from changes in practices in a given locale may help farmers be more willing to take the risks to make changes, but then their carbon credits may fail the ‘common practices’ test of additionality.
The financial gains from selling soil organic carbon credits in the voluntary carbon market seem to be a logical and elegant solution to some of these challenges. In theory, it is! If the revenue earned from selling VCM credits makes the conversion of a farm from conventional to regenerative practices financially viable, then those credits meet the financial additionality test. In reality, things aren’t so simple.
For farmers to have confidence in projecting the revenues from participation in the VCM to calculate their expected return on investment there are a few requirements:
- Reliable carbon quantification projections for sequestered soil organic carbon
- A liquid market with readily available buyers of credits at the scale the farmer wishes to sell
- Reliable price discovery for the fair value of soil organic carbon credits
In other words, farmers need to be certain how many credits they will generate and that they can sell 100% of their credits to willing buyers at a reasonably predictable price that will generate a positive return. The reality is that none of these requirements can be currently met with sufficient certainty and predictability for a farmer to rely solely upon revenues from the VCM to justify a practice switch. This is even before taking into account how such a conversion will be financed. The farmer will need to come up with the money for new equipment, seed, and labor potentially years before there is a sufficient carbon stock in their fields to begin generating and selling credits.
Achieving systems-level change in agriculture
The current VCM is immature, illiquid, and a poor price discovery mechanism. Supply of soil organic carbon credits is relatively short and demand is tepid (largely because of uncertainty about credit quality or concerns about additionality and durability). Transactions are mainly bi-lateral and undisclosed (or at best a few details are disclosed) so trade volumes and prices are unreliable even if they can be found.
The notion that a farmer will seek (and secure) the financing necessary and undertake the risk of conversion to regenerative practices solely on the basis of the financial additionality of the VCM is unlikely in light of the reality of modern agriculture and the current state of the VCM. In a purely academic model with a theoretically mature VCM with liquidity and price discovery, one could assume that farmers can secure financing to invest in practice changes that have a high probability of being profitable. That just isn’t the case today, but it could be in the future.
To achieve a systems-level change in agriculture, we need to help farmers manage the risks and economics of making practice changes. Revenue from a mature, liquid VCM is just one piece of the puzzle. Policy and regulatory incentives alongside learnings from common practices are others. Buyers need to become less hesitant based on concern about meeting exacting standards of financial additionality that are impractical. All of these are needed, in the aggregate, for the risk/reward equation to work.
When the VCM offers sufficient scale and maturity for liquidity and efficient price discovery, the revenue from selling soil organic carbon credits may be sufficient and predictable enough to become the only driver necessary for broad-based adoption of regenerative practices and the achievement of the stated objectives thereof. To accomplish that outcome, we need to increase demand for soil organic carbon credits, thereby increasing the price and incentive for greater participation and supply growth.
The way to do this is to increase buyer confidence by making it much simpler and easier to understand and purchase soil organic carbon credits. We encourage ratings firms and standards developers to take a pragmatic approach to the definition of credit ‘quality’ in relation to additionality that recognizes the current realities vs. future potential. Additionality at the project-level, as described above, creates an impediment to achieving the foundational components necessary for systems-level change.
Durability Ratings
Ratings evaluating the durability of regenerative agriculture credits seem to currently focus solely on physical durability characteristics of stored carbon. We encourage ratings firms and standards developers to take a holistic view of the factors contributing to the durability of not just the physical carbon, but also to the durability of a credit and of a claim, which credits underpin. The durability assurance mechanisms in a methodology greatly affect the durability of credits and claims, particularly for storage of organic carbon, which requires continued monitoring and management practices throughout its duration of storage.
Nori’s recent article discussing durability gives an in-depth exploration of the durability assurance mechanisms that may be implemented, highlighting how mechanisms within methodologies can help ensure that every tonne of CO2 sequestered today remains out of the atmosphere for the intended duration, robustly contributing to climate mitigation efforts. Effective measurement, monitoring, reporting, and verification requirements have a material effect on durability, and should be considered in ratings firms’ and standards developers’ analysis. In addition, other mechanisms can mitigate reversal risk and increase expected durability of a credited carbon removal. As described by Arcusi & Hagood, these include governance mechanisms such as transfer of liability, and reversal management mechanisms such as buffer pools.
Beyond improving durability of a credit using methodological mechanisms, additional tools are available to ensure the durability of a carbon removal claim, which credits underpin. Carbon insurance, for example, is a mechanism that can be implemented to improve the durability of a carbon removal claim — rather than of a specific credit — as some insurance mechanisms may replace a defunct credit with a new credit, or pay out cash to buy replacement credits. Another mechanism to improve the durability of claims exists through combining credits from various CDR activities via “vertical stacking” or “horizontal stacking”, such as is achieved with the Nori Net Zero Tonne.
We encourage ratings firms and standards developers to take into account methodological durability assurance mechanisms when rating various crediting methodologies for regenerative agriculture soil organic carbon sequestration.