Carbon Project Agreements – Landholder Risks and Recommendations

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

Gadens has recently been busy acting for landholders (mainly farmers) who are drafting and negotiating Carbon Project Agreements (CPAs) with CSPs (who test carbon levels and establish Carbon Projects with the Clean Energy Regulator (Regulator)) to generate Australian Carbon Credit Units (ACCUs).

ACCUs are a significant new asset class that reward good environmental stewardship but also involve significant 25-30 year land management and land sale obligations.

This article discusses the issues and risks for farmers entering into Carbon Project Agreements.

Carbon Project Agreements

CPAs are 25-30 year contracts that establish the legal ownership of ACCUs, land management obligations, land sale restrictions and the rights to market and sell generated ACCUs.

CPAs document the relationship between landholders and CSPs. Under these agreements:

• CSPs test and measure carbon emitted and sequestered by the property and in soils. They also assist landholders to develop their Land Management Strategies (LMS) (to document to the Regulator how they plan to change their management of a property) and submit documents to the Clean Energy Regulator to establish Carbon Projects on the land.
• Landholders draft and manage their land according to the LMS. Depending on their LMS landholders may plant trees, manage effluent, use new fire management techniques, manage their livestock differently and rehydrate their landscapes to reduce carbon usage and sequester carbon in the soil.

CPAs are also known as ‘Carbon Project Licence and Sales Agreement’, ‘Carbon Project Agreements’, ‘Carbon Project Services Agreements’ and ‘Services Deed (Carbon Project)’.

Every five years, Carbon Projects are audited and when carbon is sequestered, the Regulator issues ACCUs. Each ACCU represents one tonne of carbon dioxide equivalent (tCO2-e) of emissions stored or avoided by a Carbon Project. ACCUs can be sold to generate income, either to the Australian Government through a carbon abatement contract or to companies and other private buyers in the secondary market to offset their carbon emissions.

At present (and the industry is in it’s infancy) CPAs are typically drafted by CSPs and (unsurprisingly) they represent preferred CSP positions. We have seen CPAs in which:

• CSPs receive all the ACCUs (not the landholder) and commit only to providing landholders with a conditional income stream sometime in the future (which may not reflect the market price of the ACCUs);
• CSPs take little to no financial risk but receive a large percentage of the upside – some CSPs seek large upfront payments from landholders to cover the costs of establishing the Projects while also seeking a large percentage of ACCUs (15-30%);
• Landholders are unable to change the management of their land without CSP approval; and
• landholders are unable to sell their land without novating the CPAs to new owners.

While entering into arrangements to measure and sequester carbon in soils is a net positive for landholders and the environment, landholders need to be careful, informed and deliberate when entering into these tricky, 25-30 year relationships. CPAs can and should be negotiated to ensure landholders are protected and receive the reward for their efforts to sequester carbon in their land. Below are some key issues, risks and recommendations for landholders to consider.

Five key issues and risks in CPAs:

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 CPAs drafted by CSPs seek to establish the CSP as the Project Proponent.

When acting for landholders we typically recommend the landholder should be the Project Proponent and receive ACCUs in their name as it is their actions to remediate their land that generates ACCUs. Landholders can appoint CSPs as their agents to act on their behalf to manage their projects with the Regulator.

2. Ownership of ACCUs

Having legal ownership of ACCUs (by being the Project Proponent) is important, as an owner of ACCUs can:

• use these assets as security for loans;
• choose:
  • 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.

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. They also have the choice to cancel the Carbon Project – in which case they will need to hand all their ACCUs back to the Regulator.

If a Project Proponent wishes to cancel a Carbon Project and they have sold a percentage of their ACCUs, they will need to go into the market and purchase an equivalent number of ACCUs. If the price of ACCUs has risen since they sold these ACCUs, the Project Proponent may suffer significant financial loss.

Once a landholder sells its ACCUs to third parties they remain responsible for 25 years to that third party to ensure a certain level of carbon remains sequestered in the land. When things go wrong (droughts or bushfires) or circumstances change, a landholder’s ability to react will be constrained by their obligations to this third party. The destruction of ACCU producing land could cause a bad situation (bushfire) to become a worse situation (needing to purchase ACCUs from the market in a drought).

Landholders face an uncertain climatic future and studies show a leading factor in carbon sequestration is rainfall. By selling your ACCUs to third parties at the start of a 25 year project (and at the end of a wet few years on the east coast), landholders are ‘locking in’ a potentially abnormal climate pattern. Landholders will not want to have to buy-back ACCUs during a drought if future audits show decreased carbon in soil.

We recommend landholders are cautious and conservative before they transfer any ACCUs to third parties (as this increases the complexity in managing and selling their land).

If landholders want to establish a Carbon Project and they have the finance available, they should consider simply paying cash to CSPs (like their other service agreements) so they retain all the ACCUs, at least until they see how the project and the ACCU market develops. We also expect ‘Green Loan’ products will become attractive and more available as time goes on to assist this strategy.

3. Ability to manage land

When you agree to provide a percentage of ACCUs to a CSP under a CPA, a conflict of interest develops between the landholder and the CSP. The CSP will want the landholder to manage their land to maximise the production of ACCUs whereas the landholder will want the flexibility to manage their land for profit and long-term value (which may not include the maximisation of ACCU generation).

In CPAs drafted by CSPs, landholders are not allowed to change their land management techniques without approval from the CSP. We expect this will lead to litigation in the future.

Also, changes in land management may contribute to unintended carbon ‘leakage’ – increased soil carbon may increase pasture production which in turn allows a landholder to run more livestock – which may have the unintended consequence of increasing emissions.

We recommend landholders either amend CPAs proposed by CSPs or draft their own CPAs so they maintain maximum choice and control over how they farm their land. ACCUs should be a by-product of good land management, not the driving incentive.

4. Ability to sell land

If a landholder wants to sell their land a conflict of interest develops between the landholder and a CSP who holds ACCUs or who may be the future recipient of ACCUs.

In CPAs drafted by CSPs, landholders are barred from selling their land until the purchaser agrees to accept the novation of the CPA – the new owner of the land will have to ‘step into the shoes’ of the selling landholder. Also, CSP’s often seek to place a caveat over the land to ensure potential buyers are aware of their interest and a sale cannot progress until that caveat is removed.

If the purchaser of land does not want to enter into a particular CPA (they may want to set up their own Carbon Project or manage the land differently), this may stop them from buying the land and the selling landholder may lose a potential purchaser.

We recommend landholders either amend CPAs or draft their own CPAs to ensure they have the option to sell their land free of these restrictions to maximise the opportunity to attract potential purchasers.

5. Who controls the sale of ACCUs?

Many CPAs seek to provide CSPs with the exclusive right to sell ACCUs at a price and time controlled by the CSPs.

The risk with this arrangement is that persons who are good at establishing a carbon project (often ecologists and engineers) are not skilled in trading commodities (buying and selling ACCUs). These are two different skill sets.

ACCUs are regulated financial products that are often classified as ‘derivatives’ (a specific type of financial product). Unless an exemption applies, CSPs will need to hold an Australian Financial Services Licence (AFSL) before they provide advice or trade ACCUs on a secondary market.

If a CSP has control over when it can sell ACCUs and to whom and at what price, this opens the door for sub-optimal behaviour, such as a sale to a related party at a low price to allow that related party to sell the ACCUs at a later time at a higher price.

At present, it is unclear how the market for ACCUs will develop or who will be skilled at trading these assets in future, so we recommend landholders do not give this right away. In five or ten years, landholders should choose who is best placed to sell their ACCUs.

In summary, signing a sub-optimal CPA 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 establish they run a ‘carbon neutral’ farm;
• result in landholders having to buy ACCUs at a later date for a much higher price; and
• lead to ACCU price upside going to a third party (and not the landowner who generated the ACCUs).

Our Recommendations:

1. Take control of the process

There is no reason landholders need to be passive ‘price takers’ – landholders should take control of this process and tender this service out like any other normal service on their land.

We recommend landholders consider:

• conducting a ‘RFP’ (request for proposal) process to seek expressions of interest from CSPs;
• drafting their own CPAs and producing their own set of terms (Gadens has model contracts available);
• providing a set of terms in which landholders:
  • remain Project Proponents (and appoint CSPs as agents);
  • receive ACCUs in their name;
  • have the option to either pay all cash or a mixture of cash and ACCUs for the service;
  • decide if, and when, and at what price, they sell their ACCUs;
  • decide who is best placed to market and sell their ACCUs in the future;
  • are protected if CSPs go out of business (many will);
  • maintain maximum control over how they manage their land;
  • can terminate the CPAs and the Carbon Project with minimal cost or impact; and/or
  • can sell their land at any time in the future without the need for consent or interference from CSPs.

Gadens has landholder friendly template CPAs that can be provided to landholders.

2. Own your ACCUs

When you own your own ACCUs you maintain choice and control to manage issues in the future.

Owning your own ACCUs will:

• be useful in the future if you need to have a certain amount of ACCUs to offset your carbon production;
• allow you to use these assets as security for loans;
• allow you to pick and choose when you sell these units and how many you sell;
• allow you to maintain a buffer of ACCUs in case there is a drought or fire and your soil loses carbon;
• mean you can avoid having to go into the market and buy ACCUs if your land loses carbon in the future; and
• mean you receive the reward for improving your land – not some third party.

Landholders face an uncertain climatic future and studies show that the accumulation of soil carbon is being driven by rainfall. By selling your ACCUs to third parties at the start of a 25 year project you are ‘locking in the current climate pattern’ (and we have just had a wet few years on the east coast).

3. Minimise or eliminate land management and sale restrictions

While CSPs have a role in encouraging and assisting landholders to sequester carbon, they should not force landholders to manage their land in a certain manner.

Also, CPAs should be amended to restrict the ability for CPAs to negatively affect any future sales.

No one knows what the future holds or how markets will develop – we recommend landholders maintain flexibility and control in how they manage and sell their land.

4. Pay in cash not ACCUs

Everyone is trying to control ownership and rights to trade ACCUs for a reason – they could be a very valuable asset in the future.

If you can pay for the services of CSPs in cash (like any normal service provider), you will receive all ACCUs. This enables you to control these assets and how you farm, sell and finance your business on your land.

If you want to pay using a mixture of cash and ACCUs, CSPs should only receive ACCUs if they perform their service to a certain standard and hit certain benchmarks.

Banks and financiers are offering, and will offer, ‘green loans’ on good terms to encourage these projects – we recommend you explore these options. See our recent article for more information – https://www.gadens.com/legal-insights/australian-carbon-credit-units-financiers-tap-into-carbon-farming-and-development-projects/

5. Consider separate contracts for separate tasks 

There are a number of services landholders require to set up a Carbon Project:

• baseline testing (soil scientist);
• establishing a project with the Regulator (contract administration);
• assistance with the Land Management Strategy (to remediate the property) (consultant/engineer/ecologist); and
• trading ACCUs (commodities trader).

It is unlikely that a CSP has all these skills – you will note in CPAs that 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.

A good soil scientist may be a bad commodities trader…

6. 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 service providers.

CPAs with CSPs need to be reviewed and amended to allow landholders to terminate non-performing CSPs with minimal consequences (including that CSPs have no rights to ACCUs not yet issued).

CPAs should also be amended so a landholder is protected if CSPs go out of business.

Gadens is here to help you negotiate a sensible CPA for you and your business. Please contact Matt Egerton-Warburton on (+61 2 9163 3031) to discuss further.

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Matt Egerton-Warburton was interviewed by Jackson Hewett and James Wagstaff on The Australian Ag Podcast about these issues and risks, listen here: The Australian Ag Podcast – Should farmers sign up for carbon sequestration?

Authored by:
Matt Egerton-Warburton, Partner