Rental Contracts and Partial Credit for Temporary Carbon Storage

Arguably, the trickiest part of the burgeoning voluntary carbon market is not measuring the carbon sequestered, but ensuring the permanence of that sequestration. There are currently two novel workaround approaches to avoid this issue; Partial Credit for Temporary Carbon Storage, and Carbon Rental Contracts. It should be noted that neither approach is by any means fully developed or widely accepted at this juncture, but may be worth further consideration as the carbon offset market evolves.

One proposed workaround is to simply give carbon stored throughout time, dependent on how long it has been held, partial credit. For instance, under the most straightforward structure, one hundredth of a credit would be given for each ton of CO2 held for a year. Therefore, full crediting wouldn’t be possible until the ton of CO2 had been held for 100 years. The landowner would forfeit future credits but there would be no penalty if a reversal happened before 100 years had passed. Previously granted credits would remain unchanged. Therefore, a project that sequestered 1,000 tons for 50 years would be awarded a total of 500 credits, even if it were to end at that time.

Partial crediting offers a lot of benefits practically. Reversals are no longer considered a liability. There is no risk connected with reversals per se because credits are awarded on a “as-you-go” basis based on how long CO2 is held. A reversal would simply result in the loss of the chance to continue receiving (partial) credits for the carbon that was already released. Methodologically, however, partial crediting presents a number of challenges. In theory, the “correct” amount of partial credit to give for temporary storage of CO2 depends not only on the amount of time the CO2 is stored, but also damage associated with CO2 emissions over time. When predicting the potential harm caused by CO2 emissions and when assigning a monetary value to those harms in today’s dollars, there are significant uncertainties. Finally, as stated by Climate Action Reserve, “the logic of partial crediting from a climate change mitigation perspective may be tenuous. In terms of atmospheric concentrations of CO2, for example, it is hard to see how storing 10,000 tons of CO2 for 10 years (after which the CO2 is emitted) would have an effect equivalent to permanently reducing 1,000 tons of CO2 emissions”.

Another proposed workaround is carbon rental contracts. By issuing offsets with a predetermined expiration date, carbon rental contracts would be created (e.g., within 10 years). The liability for reversals of verified carbon removals would be effective until the rental contract’s expiration date (i.e. 10 years). An offset would be noted as expired in the PanXchange registry when it reached its expiration date. However, it would need to be replaced by retiring another offset if a buyer had already retired the offset against an emissions requirement. After that, project developers would no longer be required to store carbon, but they might decide to extend it for an additional ten years. The project developer would receive a fresh set of expiring offsets if the commitment was extended, which he or she might rent out on the market to the original buyer(s) or to other parties. Carbon rental contracts’ key benefit is that they would lay a far more bearable financial burden on project developers while upholding environmental integrity by ensuring the replacement of offsets when they run out or when a reversal takes place. To protect project developers from potential reversals during the period of a contract, rental agreements could potentially be combined with a buffer pool mechanism.

The major challenge with rental contracts is that they would essentially create a new and distinct kind of market instrument for carbon credits. The “price” for expiring sequestration offsets would be lower than the price for other kinds of offsets because it would be a rental price instead of a purchase price. As well, since carbon offsets (let alone carbon rental contracts) are not yet officially regulated by SEC (although the SEC is taking an increasingly leading role in improving climate-related disclosures), carbon rental contracts face a high level of regulatory risk. As such, it could take some time for market actors to fully appreciate and learn how to value this type of credit.