Risks Associated with Environmental Markets and Contracts

1. Ray Massey Commercial Ag Program Crops Economist Risks Associated with Environmental Markets and Contracts

2. Overview of Presentation • 2009-2010 NCRMEC grant funded program • Held five 3-hour meetings in Missouri; presented partial material in many more meetings. • Results from post workshop surveys: • Decided not to enter into a contract • Pursued further information before contracting • Decided to enter into a contract

3. Sources of Educational Materials • Agebb.missouri.edu/massey.htm • Environmental Markets contains guides and powerpoint presentations • http://www.agrisk.umn.edu/

4. Timing of the Project Grant Received Educational Program Conducted

5. Typical Workshop • General environmental market information • General contract information • Topic 1: GHG markets • Topic 2: Energy markets • Discussion/Activity regarding cooperative activities in new markets

6. Environmental Concerns(March 2009) Ag Involved Ag Involved Ag Involved Ag Involved Ag Involved http://www.gallup.com/poll/117079/Water-Pollution-Americans-Top-Green-Concern.aspx

7. Emerging Agricultural Markets • Market Niches: • Local foods • Organic foods • Natural foods • Energy markets: • Ethanol • Biodiesel • Biomass • Wind energy • Methane derived electricity

8. Emerging Agricultural Markets • Greenhouse Gas Markets: • Soil carbon sequestration • Forest carbon sequestration • Methane destruction (from manure storages) • Easements: • Conservation • Farmland Preservation • Power line • Pipeline

9. Market Participation • Contracts are the most common way of participating in emerging markets. • Participation in new markets uses contracts because the new responsibilities, rewards and risks are evolving. Contracts are a way of fostering the necessary dialogue. • Policy involvement is also a method of opening or creating and participating in new markets.

10. Evaluation of Market Opportunities • Contracts • Opportunity for Return(Profit) • Possibility of Risk(Loss) • Assumption of Responsibilities • Guide: Contracts in Agriculture • Didn’t have a significant PowerPoint presentation

11. Input or Output Based Contracts • Input based: • Organic contract requires only that you follow certain steps. • Soil carbon sequestration contract only requires that you use no-till production system. • Output based: • Wind energy contracts are based on kilowatt hours of electricity produced. • Methane destruction contracts based on tons of methane destroyed.

12. Asset Specificity • Assets that can do only one thing are more risky, and potentially rewarding, than an asset that can do multiple things • Grain bin has high asset specificity • Tractor has low asset specificity • New contracts with high asset specificity • Lagoon covers for methane destruction - risky • Ridge tops with high wind speeds - rewarding

13. Contractual Incompleteness • Contracts cannot contain every possible outcome so they try to talk about the most likely outcomes or the most important outcomes. • Where a contract does not specify an outcome, there is opportunity for reward or risk. • Contractual incompleteness is often called loopholes.

14. Greenhouse Gas Markets • Guides • Agriculture and Greenhouse Gas Emissions • Introduction to Greenhouse Gas Markets and Cap-and-Trade • Presentations • Emerging Environmental Markets

15. Question for Agriculture • Greenhouse gas limitations have the • Potential to profit agriculture • Potential to regulate agriculture • Which is the greatest potential and how will it impact agriculture? • Is agriculture a source of offsets or a source of emissions?

16. EPA Key Categories of GHG Emissions, 2007 Source: EPA. Inventory of U.S. Greenhouse Gas Emissions and Sinks: 1990-2007

17. Agriculture’s Perspective Agriculture Can Provide Environmental Benefits via: • Carbon Sequestration in soils and forests • Methane Capture and Destruction • Renewable Fuels • Increased Efficiency

18. Offset Characteristics • Permanent • Additional • Verifiable • Enforceable

19. Voluntary Market for CO2 in US http://www.chicagoclimatex.com/market/data/summary.jsf 1/12/10

20. Risks to Offsets Providers (farmers/landowners) • Failure to comply with responsibilities results in fines and penalties. • 5 year contract reduces flexibility in land management. • Don’t know the price that you will receive. • CCX Market is set to expire in 2010. • Aggregators are not bonded. • Land tenure changes do not nullify the contract.

21. Rewards to Offset Providers(farmers/landowners) • Receive money for offsets provided. • May receive this for no additional work if already using conservation practices. • 20% of offsets are held until the end to insure compliance

22. Emerging Energy Markets • Presentations • Wind Energy Leasing – Shannon Ferrell • Environmental Contracts – Shannon Ferrell

23. The Top 5 Questions to Askabout Wind Leases • How will your current uses of the property be affected by the project? • How long will agreement last? • What are your obligations under the agreement? • How will you be compensated? • What happens when the project ends?

24. Energy Markets: Ethanol & Corn Profits Source: ISU AgDecisionMaker

25. BioEnergy Markets • Energy (gas, electricity, etc.) is a commodity. • Agricultural inputs (corn, biomass) into energy are a commodity. • Eventually all commodity prices tend to zero profit. • New energy markets pose • new profit opportunities • new risk opportunities

26. Political Risk and Return • New markets are frequently fostered by legislation or regulation. • Opportunity for profit in affected markets. • Subsidies are political decisions: • $1/gallon biodiesel subsidy ended Jan 1, 2010.

27. Easements • Guide • What Landowners Should Know When Considering Conservation Easements by Hoag, Marshall, Seidl and Mucklow.

28. Easement • An easement is a legal agreement between a landowner and another party that permanently limits the use of the specified property. • Examples • business – power and pipe lines easements • non-profit organization – conservation easements • government agency – Grassland Reserve Program or public access to land

29. Economic Value (cost) of Giving an Easement • Easements always limit land use and, therefore, almost always reduce the market value of the land. • Easements can increase the value of surrounding land because it bestows some benefit • Preserves the scene • Creates a buffer from encroachment

30. Conservation Easement Economic Risks • Missing Tax Benefits • Requires a permanent easement • Requires that the easement grants public interest values to the grantee (party receiving the grant) • Costs associated with selling an easement can be significant and the easement might never materialize.

31. Conservation Easement Risk • You and the easement holder disagree on the interpretation of the property rights each of you possess. • Does agricultural use only allow a horse boarding stable? A confined hog operation? • Easement holders possess a property right – one that they can sell if they desire. • If the value of the land becomes great enough the easement holder may allow it to be “developed” for a price.

32. Cooperative Agreements • Presentation • When Personal and Group Interests Conflict

33. Ray Massey Commercial Ag Program Crops Economist Developing Markets for Agriculture