By Matt Egerton-Warburton, Partner
Six Key Issues and Risks in Carbon Project Agreements:
1. Who is the Project Proponent?
The Project Proponent is the person (or company) that is responsible to the Regulator for carrying out the Carbon Project. The Project Proponent receives ACCUs in their name (in an Australian National Registry of Emissions Units (ANREU) account). The Project Proponent can be the landholder or the CSP.
Most Carbon Project Agreements drafted by CSPs seek to establish the CSP as the Project Proponent. It is argued this lessens the regulatory and legal risks for landholders. While this is technically true, these obligations and liabilities are then reciprocated in the Carbon Project Agreements, so risk remains with the landholder.
There are significant legal benefits for landholders if they are the Project Proponent and receive ACCUs in their name. Landholders can then appoint CSPs as their agents to act on their behalf to manage their Carbon Project with the Regulator.
2. Ownership of ACCUs
Having legal ownership of ACCUs is important as an owner of ACCUs can:
- use these assets as security for loans; and/or
- whether they sell their ACCUs (they may need them for their business in the future – buyers of farm products may seek to buy from ‘carbon neutral’ farms);
- to whom they sell their ACCUs (they may want to avoid selling their ACCUs to certain parties);
- when they sell their ACCUs (to time the market or climatic conditions); and
- at what price they sell their ACCUs.
Landholders should be cautious and conservative before they transfer any ACCUs to third parties (as this increases the complexity in managing and selling their land). If a landholder is the sole owner of ACCUs generated from their property they can:
- change how they manage their land without being answerable to a third party owner of ACCUs; and
- choose to cancel the Carbon Project – by handing back all their ACCUs to the Regulator.
3. Timing the Carbon Project commencement
Landholders should always seek to sequester carbon or emit less carbon but they can be strategic about when to conduct and submit their baseline survey.
Studies show a leading factor in carbon sequestration in soil is rainfall. It may be judicious for a landholder using the carbon soil method to wait until carbon levels naturally drop in their soil during dry periods before submitting a baseline survey.
4. Land management conflict and restrictions
If landholders provide a percentage of ACCUs to a CSP under a Carbon Project Agreement a conflict of interest develops between the landholder and the CSP.
The CSP is incentivised to encourage the landholder to manage their land to maximise the production of ACCUs whereas the landholder will want to manage their land for profit and long-term value (which may not prioritise ACCU generation).
In most Carbon Project Agreements drafted by CSPs, landholders are not allowed to change their land management techniques without express written approval from the CSP. This restriction may well lead to substantial litigation in the future.
Landholders should negotiate their Carbon Project Agreements to maintain maximum choice and control over how they manage their land. ACCUs should be a by-product of good land management, not the sole aim.
5. Selling Land and Novating the Carbon Project Agreement
The existence of a sub-optimal Carbon Project Agreement significantly detracts from the value of a property and may impact land saleability and value.
In most Carbon Project Agreements drafted by CSPs, landholders are barred from selling their land until the purchaser agrees to accept the novation of the Carbon Project Agreement – the new owner of the land must ‘step into the shoes’ of the selling landholder and accept all their obligations and liabilities under the contract.
In circumstances where a potential purchaser of land does not want to accept the novation of a Carbon Project Agreement either: (i) the buyer walks away; (ii) the seller attempts to renegotiate the Carbon Project Agreement with the CSP; or (iii) the seller has to buy ACCUs in the carbon market so they can cancel the Carbon Project. All of these scenarios create legal and financial difficulties at a difficult time.
We have provided advice to a land purchaser who bought land and accepted the novation of a particularly egregious Carbon Project Agreement without review or legal advice. The purchaser regretted that novation and sought our advice to rescind or amend the contract. Unfortunately the purchaser’s point of leverage was prior to accepting the novation of the contract and, as a result, they were unable to achieve a good outcome.
Landholders should negotiate their Carbon Project Agreements to incorporate options that allow future sales of the land without the need for a novation.
6. Who controls the sale of ACCUs?
When choosing CSPs, landholders often seek experienced soil scientists and ecologists. However, many Carbon Project Agreements include additional clauses that grant CSPs exclusive sale and marketing rights for ACCUs produced by the Carbon Project. These clauses provide CSPs with the exclusive right to sell ACCUs owned by the landholder at a price and time controlled by the CSPs over the life of the contract (which can be 25 or 100 years).
So while landholders believe they are contracting for scientific and ecological services they are often also contracting for commodity trading and brokerage services.
Since it is unlikely that persons who are good at establishing a carbon project (ecologists and engineers) are also expert in trading commodities (buying and selling ACCUs), landholders should consider deleting these additional sales and marketing clauses.
As it is unclear how the market for ACCUs will develop or who will be skilled at trading these assets, landholders should reserve the right to choose who is best placed to sell their ACCUs in the future (if they want to sell them).
Another risk with these clauses is that if a CSP has control over when it can sell ACCUs and to whom and at what price, they may conduct a sale that does not maximise value (potentially to a related party or as part of another transaction).
Seven Key Recommendations:
1. Assess project viability and introduce forecast accountability
Before committing to a Carbon Project, landholders should conduct a feasibility study (potentially by an independent fee-for-service entity not interested in being a CSP) to determine whether their land is suitable and likely ACCU generation. Not all carbon projects are viable and some projects have been undertaken on the basis of inflated carbon sequestration projections.
Landholders can make CSPs accountable for their forecasts by making a portion of their payment dependent on these forecasts being reasonably accurate.
2. Flip the script – take control of the process
As there are over 25 CSPs in Australia, landholders have considerable leverage to choose the right CSP, at the right price and on reasonable terms.
There is no reason landholders need to be passive ‘price takers’ – they can flip the script and take control of the selection process by tendering out this service like any other normal service on land.
Landholders can conduct a processes in which their lawyers send out an “RFP” (request for proposal) and term sheet to eligible CSPs. Under this process the parties contract using landholder friendly Carbon Project Agreements drafted by the landholder’s lawyers. This process should result in better choice and terms and it will save landholders time and money in negotiating and amending CSP friendly contracts.
3. Pay in cash
If landholders want to establish a Carbon Project, and they have the finance available (or cheap “Green Loans”), they could choose to pay cash to CSPs so they retain all the ACCUs (like most service agreements), at least until they see how the project and the ACCU market develops.
If landholders want to pay using a mixture of cash and ACCUs, CSPs should only receive ACCUs if they perform their service to certain standards and hit certain benchmarks.
4. Own the ACCUs
When landholders own their ACCUs they have better flexibility to manage issues in the future. Owning ACCUs allows landholders to:
- maintain a certain amount of ACCUs to offset their carbon production – so the producer can be “Carbon Neutral” or “Net Zero”;
- use these assets as security for loans;
- pick and choose when to sell these units and how many to sell (at present, no one knows how many ACCUs a landholder will need to retain to be carbon neutral);
- cancel a Carbon Project in future without having to buy ACCUs in the market (if landholders want to manage their land differently or a future potential buyer does not want to receive the novation of a Carbon Project Agreement);
- receive the financial upside for improving their land – not grant that upside to some third party.
5. Minimise or eliminate land management and sale restrictions
While CSPs have a role in encouraging and assisting landholders to sequester carbon, these agreements should provide landholders with flexibility to:
- change how they manage their land; and
- selling their land in the future without having to novate the Carbon Project Agreement.
6. Consider separate contracts for separate tasks
There are a number of services landholders require for a Carbon Project:
- feasibility study (agricultural economists);
- baseline testing (scientist);
- assistance with the Land Management Strategy (to remediate the property) (consultant/engineer/ecologist);
- regulatory compliance (compliance officer); and
- trading ACCUs (commodities trader).
It is unlikely a CSP has all these skills – under most Carbon Project Agreements, CSPs typically reserve the right to sub-contract these skills to third parties.
Landholders may choose ‘horses for courses’ – and contract with different service providers for different tasks. There is no legal requirement for one “umbrella” arrangement.
7. Anticipate that some CSPs will not perform and may go out of business
As with any service provider you need to be able to replace non-performing persons.
Carbon Project Agreements with CSPs need to allow landholders to terminate non-performing CSPs with minimal consequences.
Carbon Project Agreements should also be amended so a landholder is protected if CSPs go out of business.
Matt Egerton-Warburton was interviewed by Jackson Hewett and James Wagstaff on The Australian Ag Podcast about these issues and risks, listen here.
Matt also conducted a webinar with the Carbon Farming Foundation on this issue, read more here.
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