By Matt Egerton-Warburton, Partner

Mills Oakley is active in the Australian Carbon Market advising landholders, Carbon Service Providers (CSPs), financiers, traders and other participants.

Introduction – the Carbon Market

When you reduce carbon emissions on farm and sequester carbon in soils and vegetation this has significant benefits for both the landholder and the environment.

The Australian Government, through the Clean Energy Regulator (Regulator), has established a market to support these efforts and reward landholders for positive carbon stewardship by providing Australian Carbon Credit Units (ACCUs) to landholders who emit less carbon or sequester carbon in their land.  Each ACCU represents one tonne of carbon dioxide equivalent (tCO2-e) of emissions stored or avoided by a Carbon Project.

These ACCUs can either by used as farm “inset” credits (to offset a farm’s emissions) or they can be sold to governments and third parties as “offset” credits (to offset the third parties’ emissions) as Australia pushes towards Net Zero by 2050.

While there are potential environmental, productivity and financial benefits for landholders who establish carbon projects, these benefits can be squandered by landholders who agree sub-optimal contracts with Carbon Service Providers (CSPs).

In worse case scenarios, bad contracts can lead to disputes and litigation as landholders struggle to sell land burdened by bad carbon project agreements or change how they manage their properties.

Carbon Service Providers and Carbon Project Agreements

To establish a Carbon Project, landholders typically enter into legal agreements with CSPs (Carbon Project Agreements).  Under these agreements the CSP will typically:

• provide advice on which method to use (the Regulator accepts a broad range of methods to reduce or sequester carbon including soil carbon, cool burning, tree planting, etc);
• conduct a feasibility study to determine whether it is worthwhile conducting the project;
• conduct a baseline survey (a reference point against which net-emission levels will be assessed);
• provide a template or guidance on the Land Management Strategy the landholder must submit to the regulator (to establish how the landholder will manage their land differently – the “newness requirement”);
• submit the Land Management Strategy, baseline survey and other paperwork to the Regulator to establish a Carbon Project;
• monitor the Carbon Project for compliance with laws; and
• assist third party auditors to certify how much carbon has been sequestered or reduced once the project is established.

CSPs are typically paid for these services either in cash or ACCUs or a combination of both.

Some CSPs also seek additional exclusive marketing and trading rights over all ACCUs generated by the Carbon Project over the life of the project.

Carbon Projects and Permanence Obligations

Within the first five years (depending on the method chosen), Carbon Projects are audited.  When carbon is sequestered or less carbon is emitted over and above the baseline survey, the Regulator issues ACCUs.

When ACCUs are first issued, the Regulator places a “permanence obligation” on the land, which runs with the land. This obligation requires the landholder to store this amount of carbon on their land for either 25 or 100 years (depending on the length chosen for the project).

Prior to the placement of a permanence obligation on the land the landholder can cancel their Project with little regulatory consequences (although there may be contractual consequences under the Carbon Project Agreement).

After the permanence obligation has been placed on the land, a Carbon Project can only be cancelled if the same number of ACCUs issued by the Regulator for the Carbon Project are returned to the Regulator.

If a landholder has sold or given away their ACCUs and they want to cancel a Carbon Project at some stage in the future, they will need to go into the market and buy that same number of ACCUs (at whatever market price).

Different Business Models – Buyer Beware!

There are a wide range of CSPs (over 25 and counting), with significantly different business models and legal agreements (there is no standard contract).

To avoid signing a sub-optimal contract for 25 or 100 years, landholders need to carefully choose the right CSP with the right contractual terms.

There are three basic business models:

1. Fee for service – landholders pay CSPs cash to conduct the service and landholders receive all ACCUs generated by the Carbon Project (with no obligation to provide any ACCUs to CSPs);
2. ACCU income stream – where CSPs receive all the ACCUs and agree to provide the landholder with a conditional income stream when the CSPs sell the ACCUs (the income may be an agreed fixed price per ACCU or an amount linked to the market value of ACCUs); and
3. ACCU sharing – where CSPs and the landholder share the ACCUs generated. Typically CSPs seek between 5% to 30% of ACCUs.

Landholders should seek legal advice before entering these arrangements. Some CSPs operate complicated legal and financial models which seem designed to provide maximum financial benefit and legal protection to the CSPs and their financial sponsors.

Signing a sub-optimal Carbon Project Agreement may:

• lower the value of a property;
• provide restrictions on how landholders manage their land;
• prevent landholders from being able to use ACCUs as security for loans;
• make it difficult for landholders to prove they run a ‘carbon neutral’ operation;
• result in landholders having to buy ACCUs later for a much higher price; and
• lead to ACCU price upside going to a third party (and not the landowner who generated the ACCUs).

Carbon Project Agreements can and should be negotiated to ensure landholders are protected and receive the reward for their efforts to sequester or emit less carbon on their land.

Please see part 2 of this article here.