The Emergence of Agricultural Carbon Credits

An economic tool to penalize greenhouse gas (GHG) emissions and incentivize the adoption of low-emission technologies is carbon pricing. The goal of carbon pricing is to force the GHG emitter to internalize the costs of abating the negative effects of emissions on society—such as additional health care costs or property damage from extreme weather events—through a price on the emission, usually in monetary units per metric ton of CO₂ equivalent (MtCO₂e). Carbon pricing allows emitters to choose the most cost-effective way to inter­nalize societal costs: changing practices to reduce emissions or paying the carbon price so damage abatement activities can be financed through the resulting revenue. The World Bank reports seventy government-sanctioned direct carbon pricing instruments operating around the world, thirty-six carbon taxes, and thirty-four emissions trading systems (ETSs), covering 23 percent of global GHG emissions.¹ ETSs emerge after a relevant government agency determines the maximum level of GHG emissions for a group of entities, and excess emission allowances are traded between entities with emissions below their regulated thresh­old and entities with emissions above their regulated threshold. ETSs also allow, to different extents, the use of carbon offsets generated in other sectors in lieu of excess emission allowances.

In the United States, the agricultural sector accounts for 11 percent of all GHG emissions (mostly nitrous oxide from crop fertilization and methane from livestock production). It is, however, one of the few sectors of the economy that can also remove GHGs from the atmosphere and store carbon in the soil with existing technologies, through regenerative practices. The National Academies of Sciences, Engineering, and Medicine report that, even without new technology, agricultural practices to enhance soil carbon storage can sequester 250 million MtCO₂e annually in the United States, equivalent to around 4 percent of the country’s emissions.²

Agriculture can sequester CO₂e and generate tradable “carbon credits” that can be used by other sectors to compensate for their direct GHG emissions (also called “scope 1” emissions), and their indirect GHG emissions throughout their value chain (also called “scope 3” emissions). When carbon credits are used against scope 1 emissions, they are referred to as carbon offsets, and when they are used against scope 3 emissions, they are referred to as carbon insets.

This article discusses the role of agricultural carbon credits in the context of the most historically relevant ETSs as well as current volun­tary initiatives in the United States. I will also highlight the challenges faced by the U.S. agricultural sector to become a major supplier of carbon offsets.

The Kyoto Protocol

The current era of carbon credit trading essentially began with the Kyoto Protocol. The Protocol, adopted in 1997 and in legal effect since 2005, operationalizes the United Nations Framework Convention on Climate Change by committing industrialized countries and economies in transition to limit and reduce GHG emissions in accordance with agreed individual targets.³ The Kyoto Protocol set binding emission reduction targets for thirty-seven countries that added up to an average 5 percent emission reduction compared to 1990 levels over the first commitment period (2008–12). The Protocol regulates the emissions of six GHGs—namely, CO₂, nitrous oxide (N₂O), methane (CH₄), hydro­fluorocarbons (HFCs), perfluorocarbons (PFCs), and sulfur hex­afluo­ride (SF₆)—converted into CO₂e units for compliance purposes.⁴ The United States accounted for 36 percent of the GHG emissions among the committed Kyoto parties in 1990, and agreed to a 7 percent reduction target over the first commitment period. Although the Clin­ton administration signed the Protocol in 1998, the U.S. Senate never ratified it, making it nonbinding for the United States. In December 2012, the Doha Amendment to the Kyoto Protocol was adopted for a second commitment period (2013–20), with the goal to reduce GHG emissions by at least 18 percent from 1990 levels, though the Doha Amendment has never been implemented because of lack of support among the current parties to the Protocol.

Parties with commitments under the Kyoto Protocol in 2008–12, usually called Annex I Parties, had to meet their targets primarily through national measures, but they could make progress toward their goals by trading emission permits.⁵ Each Annex I Party was assigned a number of emission units called “assigned amount units” (AAUs). Countries with unused AAUs could sell them to other countries with emissions above their targets. The Protocol also allowed three other mechanisms to achieve commitments: removal units, emission reduction units, and emission reductions.

Investments in activities related to forestry, afforestation, reforestation, deforestation, revegetation, forest management, cropland management, and grazing land management⁶ that resulted in additional net removals of GHG from the atmosphere could be used to generate removal units (RMUs) to offset emissions under the Protocol. In addition, under the joint implementation mechanism, an Annex I Party could invest in an emission reduction or emission removal project in another Annex I Party to earn emission reduction units (ERUs) that would count towards its Kyoto target. This mechanism would benefit the host party through foreign investment and technology transfer. The Clean Development Mechanism (CDM) allowed Annex I Parties to invest in emission reduction projects in developing countries and earn saleable certified emission reductions (CERs) that could be used to off­set emissions and meet the Kyoto target. The CDM was the first global, environmental investment and credit scheme of its kind, providing a standardized emission offset instrument, the CER.

The Kyoto Protocol creates a monitoring, review, and verification system for AAUs, RMUs, ERUs, and CERs, jointly referred to as “Kyoto compliance units,” as well as a compliance system to ensure transparency and hold Parties accountable. Countries have to monitor actual emissions and keep precise records of the executed trades to com­ply with the Protocol. Reporting requirements include annual emission inventories and national reports at regular intervals. A network of registry systems tracks and records transactions by parties under the mechanisms, and the United Nations Climate Change Secretariat keeps an international transaction log to verify that transactions are consistent with the rules of the Protocol. A compliance system ensures that parties meet their commitments and works with them to address emerging challenges. Furthermore, each Annex I Party is required to maintain a reserve of Kyoto compliance units in its national registry equivalent to at least 90 percent of its AAUs or five times its most recently reviewed history, whichever is lowest.⁷

During the first commitment period (2008–12), trading of AAUs was usually bilateral with confidential prices. At the end of the first compli­ance period, Annex B Parties held 48,745.6 million AAUs, 287.5 million ERUs, 537.2 million RMUs, and 325.5 million CERs.⁸

Carbon Markets

The European Union ETS. The largest carbon market is the EU ETS, which is a mandatory cap-and-trade system covering almost 5 percent of the world’s annual GHG emissions; it includes all EU member states.⁹ The EU ETS currently covers three GHGs—namely CO₂, N₂O, and PFCs—from power generation, energy-intensive industry, and commer­cial aviation sectors.

EU member states also have binding annual GHG emission targets for sectors of the economy that fall outside the scope of the EU ETS, namely road transport, heating of buildings, agriculture, small industrial installations, and waste management. These non-ETS sectors generate about 60 percent of the EU GHG emissions and have a 29 percent target emission reduction by 2030, compared to 2005 levels. Annual targets are distributed among EU member states according to the Effort Sharing Regulation (ESR) adopted in 2018, based on relative gross domestic product per capita and cost-effectiveness.

A recent proposal by the European Commission intends to expand the EU ETS to include national targets for emission reductions from non-ETS sectors, starting in 2025.¹⁰ The proposal would increase the target emission reduction by 11 percentage points by 2030 and provide a more flexible mechanism to achieve the target through the EU ETS. It would also integrate the policy framework covering activities related to agriculture, forestry, and land use (afolu) under one climate policy tool beyond 2030; increase the net carbon removals target from forestry and land use by 15 percent to 310 million MtCO₂e for the EU by 2030; include non-CO₂ agricultural emissions such as those from fertilizer use and livestock in the calculation of GHG emissions from afolu; and aim for reaching climate neutrality in afolu by 2035.

The Chicago Climate Exchange. In 2003, the Chicago Climate Exchange (CCX) was established as the world’s first and North Ameri­ca’s only active voluntary GHG emissions cap-and-trade program. It was voluntary in the sense that participants freely chose whether to participate in the CCX, but participants were legally obliged to achieve their annual emission reduction target. The program targeted six GHG emissions—namely, CO₂, CH₄, N₂O, HFCs, PFCs, and SF₆—and included participants from the United States, eight Canadian provinces, and sixteen other countries, while incorporating offset projects worldwide. Participants established their own GHG emission baselines and were allocated annual emission allowances that ranged from 99 percent of their emission baseline in 2003 to 94 percent of their baseline in 2010. Members who reduced emissions below their targets had surplus allow­ances, known as exchange allowances, to sell or bank. Members who emitted GHGs above their targets complied by purchasing CCX Car­bon Financial Instrument Contracts (CFICs), each representing one hundred MtCO₂e.

CFICs included exchange allowances and exchange offsets. Exchange offsets were generated by qualifying offset projects on the basis of sequestration, destruction, or reduction of GHG emissions. All CCX offsets were issued on a retrospective basis with the CFIC vintage applying to the program year when the GHG reduction took place. Projects underwent third-party verifications and verification reports were inspected for completeness by the Financial Industry Regulatory Authority (finra). The only agricultural offset projects that qualified for the CCX were based on methane collection and soil carbon seques­tration. The minimum scale to trade carbon offsets in the CCX market was ten thousand MtCO₂e (equivalent to one hundred CFICs), which roughly translated into twenty-five thousand acres in conservation practices.¹¹ Consequently, most agricultural projects were managed by aggregators that charged 8–10 percent of the value of carbon offsets at market price on a yearly basis.¹² Forestation, forest enrichment and conservation, and urban tree planting also qualified for generating CCX offsets. The scale required to supply carbon offsets to the CCX severely limited interest from the agricultural sector and small forest landowners.

Although the price of carbon offsets traded on the CCX peaked at $7.40 per MtCO₂e in May 2008, it plummeted to 10 cents per MtCO₂e in August 2010.¹³ Comfortable baselines, unambitious emission reduc­tion targets, lack of a minimum price on CFICs, and investments in new and cleaner technologies by CCX members contributed to the cessation of the trading platform in 2010. The problem of the CCX was that the verified emission reductions exceeded the compliance requirement, re­sulting in an oversupply of carbon offsets.¹⁴

The Regional Greenhouse Gas Initiative (RGGI). In 2005, the RGGI was established as a cooperative effort among the states of Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jer­sey, New York, Rhode Island, Vermont, and Virginia to cap and reduce CO₂ emissions from fossil fuel power plants with an output exceeding twenty-five megawatts. The compliance obligation started in 2009 with a cap of 170 million MtCO₂ that should have declined to 82.6 million MtCO₂ by 2014, reaching 72.8 million MtCO₂ in 2019. But the cap was adjusted lower in 2014 to account for the surplus of allowances previ­ously accumulated. The adjusted cap amounted to 52 million MtCO₂ in 2019.¹⁵ New Jersey left the program in 2012 and rejoined it in 2020 and Virginia did not fully participate until 2021. The adjusted cap increased to 67 million and 91 million MtCO₂ in 2020 and 2021, respectively. The regional cap will gradually decrease to total a 30 percent emission reduction by 2030 relative to the 2020 emission level.

Allowances are distributed quarterly via regional auctions. The first auction of RGGI allowances took place in September 2008. To prevent extreme price fluctuations, a Cost Containment Reserve (CCR) and an Emissions Containment Reserve (ECR) were implemented in 2014 and 2021, respectively. The CCR is the mechanism to hold allowances in reserve and sell them if allowance prices exceed the trigger price. The CCR trigger price started at $4 in 2014 and climbed to $13 in 2021. The trigger price will increase by 7 percent annually thereafter. The size of the CCR is 10 percent of the regional cap each year. The CCR allowances were sold twice in March 2014 and September 2015 at prices of $4 and $6.02, respectively. The ECR allows states to withhold up to 10 percent of their annual budget if prices fall below the trigger price ($6 in 2021). The ECR trigger price will also increase by 7 percent annually. Al­though the trigger price of the CCR and ECR are increasing at the same rate, the 2021 prices of the CCR is higher. As a result, the gap between these two trigger prices will widen. In sum, the CCR acts as a ceiling to allowance prices, and the ECR acts as a floor.

While agriculture and forest emissions are not directly regulated in the RGGI, carbon offsets from methane capture and destruction as well as from carbon sequestration through afforestation can be purchased by power plants to be used against their excess CO₂ emissions. The use of offsets is limited to 3.3 percent of a power plant’s total compliance obligation. The offsets are also issued on a retrospective basis and require third-party verification. The RGGI CO₂ Allowance Tracking System only lists one project as an authorized source of offsets that has produced 53,506 MtCO₂e through landfill methane capture and destruc­tion in Maryland since 2017.¹⁶ In comparison, 156,464,910 MtCO₂ were auctioned off over the control period, from 2018 to 2020, at an average price of $6.05 per MtCO₂. Throughout the life of the initiative, CO₂ offsets were not widely used, representing less than 0.1 million allowances, compared to more than one billion allowances sold in auctions.

The California Cap-and-Trade Program. The California Cap-and-Trade Program (CCTP), launched in 2013, places a cap on GHG emissions from the state’s power, industrial, and transportation sectors. Facilities that emit more than 25,000 MtCO₂e per year are required to comply with the CCTP. The program covers three GHGs—namely, CO₂, CH₄, and N₂O—accounting for about 80 percent of the state’s GHG emissions.¹⁷

California’s allowances are distributed via free allocation and auction. Facilities receive free allocation at about 90 percent of average emissions, updated yearly based on production data. In addition, participants are allowed to bank their unused allowances, subject to holding limits, for future compliance. Borrowing from future allowances, however, is not permitted. California’s program linked with Quebec’s cap-and-trade program in 2014 and Ontario’s program in 2018, though the latter linkage was short-lived. The linkage permits the use of allowances issued in Quebec’s program to meet compliance obligations in California and vice versa. Allowances are auctioned off under two programs. In the Current Auction, allowances for the current year are traded. In the Advance Auction, allowances for the third year into the future are traded, up to a volume equal to 10 percent of the combined allowance budgets for that year.

A regulated facility can use offsets from unregulated sectors within the United States to meet up to 8 percent of a facility’s compliance obligation until 2020, up to 4 percent in 2021–25, and up to 6 percent in 2026–30. CO₂e offsets are issued on a retrospective basis, and the gen­erating project must be verified by an independent third-party accredited by California Air Resources Board (CARB). The program only allows agricultural offsets from the capturing of methane from livestock manure and rice.¹⁸ As of October 12, 2021, total offsets issued throughout the life of the program amounted to 228 million MtCO₂e. According to CARB, only 3.5 percent of those offsets came from livestock projects, and none from rice cultivation projects, whereas forestry pro­jects generated 82 percent of total offsets (via reforestation, improved forest management, and avoided conversion).

Voluntary Agricultural Carbon Programs

A growing number of private companies are trying to capitalize on the growing demand for carbon credits from entities pursuing carbon neutrality. In the agricultural sector, multiple “carbon programs”—start‑ups, nonprofits, and existing ag businesses—are entering into con­tracts with farmers to have them implement regenerative practices and certify the provision of environmental services in exchange for compensation. A survey of thirteen private voluntary programs indicates that tillage management (reduced till, no-till, strip-till), improved cropping practices (cover cropping, extended crop rotations, and diversification of cropping systems, including perennial crops), grazing management, and improved nitrogen efficiency (nitrogen inhibitors, split applications, and in-season applications) are the most commonly accepted farming prac­tices to generate agricultural carbon credits.¹⁹ The specific methodologies to measure CO₂e removal vary across carbon programs: Cibo Impact uses the System Approach to Land Use Sustainability (salus) model to calculate carbon credits; Nori and the Soil and Water Outcomes Fund use the comet-farm model; and Ecosystem Services Market Consortium (ESMC) uses the DeNitrification-DeComposition (DNDC) model to calculate carbon credits.²⁰ All methods, however, rely on a comparison of GHG emissions in the current production system (baseline) against emissions in a modified production system with additional regenerative practices.

Carbon programs require that changes in agricultural practices implemented to generate carbon credits be “additional” (i.e., they would not have been adopted without payment) and “permanent” (i.e., re­sulting in long-term carbon removal or avoidance). Yet, while some programs define additionality in terms of a change of practices with respect to past practices on the same field, others require that practices in the field be different from common practices in the area (even if the same practices were implemented for many years in the field under consideration). Similarly, while some carbon programs offer ten-year contracts to farmers, others offer five- or even one-year contracts. All programs require information on the history of farming practices over the past five to twenty years, and such information is corroborated via satellite imagery and publicly available records. Changes in farming practices that remove more units of CO₂e result in higher payments to farmers under “per outcome” contracts. Most carbon contracts calculate payments “per outcome,” but Bayer Carbon and Agoro Carbon Alli­ance pay farmers annually on a “per practice” basis: up to $12 per acre to implement cover crops and no-till, and five cents per pound of nitrogen fertilizer reduced per acre, respectively.

According to the decision tool Net Returns to Carbon Farming,²¹ which is based on the Comet-Planner carbon model, a corn and soybean farmer in central Iowa (Boone County) enrolling a quarter section (160 acres) into a five-year carbon program could generate about $3,500 in net returns (present value). The calculation assumes a price of $30 per MtCO₂e; an average annual removal of 0.63 MtCO₂e from switching to no-till and adding cereal rye as a cover crop in the fall with a 25 percent reduction in nitrogen fertilizer application; initial net extra costs of $26 per acre declining yearly at a 5 percent rate; and $15 per acre in cost-share payments from federal programs in years one to three.

Despite incipient efforts to standardize the definition and attributes of an agricultural carbon credit, such as those by the Integrity Council (“Core Carbon Principles”) and the Keystone Policy Center (“Ag Cli­mate Markets Principles”), carbon programs operate in silos using heterogeneous carbon accounting methods, as well as different measurement, reporting, and verification (MRV) systems for agricultural prac­tices. Furthermore, no clearinghouse of information on the number of agricultural carbon credits issued, sold, retired, and cancelled (along with specifications of the agricultural projects that generated them) across carbon programs is currently available. This lack of information increases the search costs to potential buyers of agricultural carbon credits.

Outlook for Agricultural Carbon Offsets

The agricultural sector has played a minor role in generating carbon offsets for mandatory ETSs, but there are multiple reasons to believe that it can become a major producer of carbon offsets for voluntary markets in the United States. Given that only 3.88 percent of continental U.S. cropland is planted with cover crops and only 26.35 percent is in no‑till systems,²² and that nitrogen application rates are above recommended rates in 36 percent of corn acres, 19 percent of cotton acres, 22 percent of spring wheat acres, and 25 percent of winter wheat acres, there seems to be a large potential for developing the supply of agricultural carbon credits.²³ Nevertheless, since carbon credits and offsets are credence goods (goods with qualities that cannot be ascertained by consumers), scaling up voluntary agricultural carbon markets faces multiple challenges, both from the demand and the supply side.²⁴

On the demand side, and related to the MRV process supporting a carbon credit, markets can fail in the presence of difficult-to-verify claims; a misunderstood or poorly worded label; lack of clear, consistent, and uniform guidelines across certifying parties; lack of trust in certifiers (especially when these are not independent third parties); and label proliferation (the existence of too many labels in a market or on a good leading to confusion about competing claims). Consumers would likely not trust the producer to correctly self-report carbon seques­tration because it is arduous for consumers to detect whether a firm’s suppliers follow carbon sequestration processes. Certification agents (public or private) who specialize in such detection are necessary in cases where the labels signal the production methods, regional sourcing, environmental impacts, safety, or quality of a good. The absence of the label for a desirable attribute creates a “lemons problem,” in which consumers who have a higher willingness to pay for a carbon credit cannot detect the attribute in the absence of a label and will not believe it in the absence of certifier credibility.²⁵ The market will fail not because of a lack of demand but because of a lack of information. Without government-backed standards, we should expect questionable carbon claims and an increase in competing claims, so-called label proliferation. The concern here is that consumers become so overwhelmed by com­peting messages that they lower their willingness to pay for an attribute because of the noise. Label proliferation leads to a “crowding out” of desirable attributes similar to Akerlof’s lemons problem. In short, in the absence of standards and verification, buyers of carbon credits and the downstream consumers of credit buyers’ products or services may be reluctant to assign much value to a GHG sequestration or emission reduction claim.

On the supply side, farmers may be reluctant to change production practices in order to generate carbon credits of unknown value. Like­wise, in the face of an uncertain market, lending institutions may be reluctant to fund producers who possibly need specific assets for the production methods applied in the generation of carbon credits. The complexity involved in comparing potential carbon credits generated by one specific practice in a particular farm across programs could discour­age objective technical comparisons of programs and result in farmers choosing programs with the best customer service rather than the high­est potential net returns.

Accurate measurement and verification of carbon credits from agricultural and forestry activities are typically difficult and costly.²⁶ Collecting soil samples and measuring soil organic carbon is currently the most accurate way to measure the amount of carbon stored in the soil, but it is too expensive and time-consuming to be widely used.²⁷ Data collection from satellite mapping may provide an accurate calculation of soil carbon at a lower cost, yet this method is still lacking in terms of roughness, soil moisture, and vegetation cover, which would lead to less robust estimation.²⁸ Carbon programs are evaluating the effectiveness of using data from multiple sources to measure CO₂e at field level.

Even with a credible verification and certification system mitigating uncertainty in the conversion of agricultural practices into carbon credits, suppliers of agricultural carbon credits will face competition from other suppliers of carbon credits generated in forestry, geological carbon sequestration, ethanol production with carbon capture and sequestration, landfill methane capture and destruction, and multiple other sources. The quality of credible agricultural carbon credits, de­pendent mostly on the degree of additionality and permanence of the carbon sequestration, will play a critical role in the determination of payments received by farmers.

The Role of Public Policy

ETSs develop and operate under government-sanctioned rules and over­sight. Agricultural carbon offsets, however, play only a minor role in ETSs. The main challenge for the U.S. agricultural sector to become a major supplier of carbon offsets—mostly for voluntary markets—is the standardization of the definition of an agricultural carbon credit and the MRV system to verify that changes in agricultural practices remove or avoid GHG emissions, ensuring credibility for buyers and attainability for agricultural producers.

A textbook example of overcoming a market failure for credence goods is the case of U.S. organic markets before and after certification. Prior to specific standards for the production, the market for organics was very small, with lenders reluctant to finance operations. Once standards were set and claims were verified, many farmers overcame their reluctance to join the industry, consumers overcame their distrust of product claims, and lenders had a greater understanding of the needs of producers in this new market.²⁹

A major piece of legislation in support of increasing transparency and standardization in voluntary agricultural carbon programs is the Con­solidated Appropriations Act, 2023, signed into law on December 29, 2022. The Act authorizes the USDA to establish a voluntary GHG technical assistance provider (TAP) and third-party verifier (TPV) pro­gram, after completing an exhaustive analysis of the pros and cons, by October 2023. If the program is established, the USDA should maintain a list of approved TAPs and TPVs, and create an advisory council to review and recommend changes to the list of protocols and qualifications; make recommendations to the secretary regarding best practices included in the protocols and description of qualifications; and advise the secretary regarding current methods used by voluntary credit mar­kets, means to reduce barriers to entry, means to reduce compliance and verification costs for farmers, and issues relating to land and asset ownership. In practice, the USDA would become a clearinghouse of information on voluntary carbon programs. The Act expressly denies the secretary the authority to establish or operate a federal market through which credits may be bought or sold, however.

It must be noted that while the USDA administers several voluntary conservation programs, none of them are currently tailored toward sequestering carbon. They nonetheless indirectly incentivize the seques­tration of carbon by supporting conservation activities to improve water and air quality, increase soil health, and reduce soil erosion. Recent federal programs, spurred by the Inflation Reduction Act of 2022 and the USDA Partnership for Climate-Smart Commodities, created new venues to support the development of voluntary markets for carbon credits to help reduce U.S. carbon emissions by 40 percent by 2030. Agriculture, in particular, will receive $19.5 billion through existing USDA programs over the next five years to expand the adoption of conservation practices, plus $1 billion in technical assistance, $2.8 billion in grants to spur the development of climate-smart commodities, and $1 billion for climate-smart commodities market expansion.

In sum, although agricultural carbon credits remain in a nascent stage, efforts are underway to expand their adoption and marketability. The challenges surrounding verification and standardization remain con­siderable, but improvements in these areas could bring rapid growth. Widespread adoption of agricultural carbon credits could create a mean­ingful source of income for agricultural producers, while also incentivizing significant reductions in emissions.

This article originally appeared in American Affairs Volume VII, Number 1 (Spring 2023): 50–63.

Notes