Should woodland and peatland credits enter the UK ETS?

Forest Carbon’s response to the Government (DESNZ) consultation on ‘Integrating Greenhouse Gas Removals in the UK Emissions Trading Scheme’. 

If you’re an avid reader of our blog, you’ll remember that we shared an article in July 2023 about the possible inclusion of nature-based solutions into the UK’s Emissions Trading Scheme (UK ETS). 

For those not familiar with the UK ETS, it underpins our compliance carbon market and exists to incentivise decarbonisation across high-emitting industries. Learn more about the UK ETS on our Knowledge Base – The UK and Climate Change.

Including Greenhouse Gas Removal (GGRs) – the name given to methodologies that directly remove/drawdown carbon from the atmosphere – in the scheme has been in hot debate, particularly nature-based approaches which raise concerns regarding permanence, fungibility, costs, and wider land management impacts.

Earlier this month, the consultation seeking views on integrating GGRs in the UK ETS closed. Below we share some of our key insights on the potential risks and opportunities of integration.

We have included a jargon library at the bottom of the article for anyone who needs it – we appreciate there is a lot of technical language in this article, and have tried where possible to minimise it.

Should new ex-post woodland units generated in line with UK Woodland Carbon Code standards be considered for inclusion in the UK ETS?

The Woodland Carbon Code (WCC) is a high-integrity carbon removal methodology yet the market for Woodland Carbon Units (WCUs) remains largely unproven. Inclusion in the UK ETS could: 

• Signal confidence to buyers, developers and institutional investors across the UK’s ETS and Voluntary Carbon Market (VCM).

• Provide further incentive for land managers to engage with the Code through confidence that there is a market for units throughout the lifetime of their project. 

• Further legitimise, strengthen, and scale the woodland carbon market.

However, potential roadblocks to consider include:

• While the buffer system enabled by the UK accreditation standards shows how we could mitigate the non-negligible risk of reversal, we’ve yet to see it in action and therefore have a limited understanding of how it will work.

• Inclusion would require further standardisation of contracts. On one hand, this could help scale the market by creating a level playing field. On the other hand, limiting flexibility could damage both supply and demand - where every actor has unique requirements and therefore a unique risk appetite. Our recommendation would be to develop a standardised market contract guidance handbook (a checklist of considerations) to help develop individual contracts.

• On the current trajectory of UK VCM growth, the delivery of ex-post units into the market to contribute to ETS allowances would be small-scale and far in the future. For woodland carbon to make an impact, and overcome the fungibility concerns raised, a declaration of confidence would be needed to catalyse significant scaling.

• Ex-post unit price would need to be high enough to cover the cost of the full project term, given the uncertainty of value, if any, for later Pending Issuance Unit (PIU) vintage strips.

If the Authority does include new ex-post woodland units generated under the UK WCC in the UK ETS, should any changes be made to the WCC?

The Code is well respected and has high standards of integrity. However, to scale, it would likely require improvements. We believe there are both opportunities and risks when it comes to changing the WCC.

Opportunities

• Changes to Measurement, Reporting and Verification (MRV) procedures would be welcomed if, whilst improving quantification and accuracy, they also help to reduce administration at validation and verification, improve site verification methodologies, and control cost inflation.

• This could be an opportunity to resolve the differential risk attached to Woodland Carbon Units (WCUs)/PIUs based solely on their serial number. Credits could become fractional, for example, if there is a 10% reversal in a vintage then instead of cancelling the highest 10% of serial numbers, all units in the vintage should be reduced by 10%, i.e. be worth 0.9tCO2 removed. 

• There could be more frequent MRV earlier in a project’s term to allow for earlier access to credits. But again, only if admin and costs don’t become too burdensome on developers and land managers.

Risks/Considerations

• Whilst more stringent requirements and improved MRV are needed to support the integrity of the market, this should be carefully implemented so that it does not come at the risk of being too onerous for land managers, as well as significantly increasing early capital costs, as this may deter their engagement in the market.

• To date, WCC authorities have been resistant to the development of a secondary market, but ETS inclusion would very much require that to provide liquidity.

• Thought is needed as to whether a project/scheme would have to commit to issuing credits as compliance or voluntary from the outset, or whether they’d have the flexibility to be both.

How should the Authority manage potential reversal events from GGRs? 

1. A pooled buffer, which already exists in both the Woodland and Peatland Code

2. Fractionalised units (see above)

3. Clarity in standard contracts on where liabilities sit. The difficulties in enforcing remedies on future owners would need to be overcome. Otherwise, delivery risk should be weighted more heavily on the end buyer. Current prices of UK PIUs in the VCM are reflective of trying to balance risk across the parties. The emergence of carbon insurance policies could also help.

Do you agree with the Authority’s assessment of peatland restoration? 

Whilst we recognise the reasons for the Authority’s decision to exclude Peatland Carbon Units (PCUs) from the UK ETS, we believe its exclusion to be detrimental to the UK's ambitions to reach future (legally binding) climate targets. 

It’s a perverse outcome to allow a peat bog to continue emitting whilst incentivising woodland creation next door. You could even argue that it has a greater detrimental impact on short-term climate goals than the positive impact created by a new woodland (which takes time). Both, of course, deliver much more in terms of positive impact than just Greenhouse Gas (GHG) removal/avoidance (water quality, biodiversity, flood prevention, etc.).

The Peatland Code is based on sound scientific data and methodology, but the market is yet largely unproven. Again, inclusion in the UK ETS (as well as further improvements to quantification and integrity) could be the vote of confidence buyers and sellers need to step up and enable market scaling.

This is particularly important in light of current public funding constraints in Scotland for peatland restoration. There is a clear requirement for other sources of funding to step up to enable this work to go ahead – without additional funding from the UK ETS/VCM the work won’t get done. With time running out to achieve science-based climate targets, we should be deploying all weapons in our armoury. Peatland restoration is a proven and powerful one.

In summary

We believe that incorporating nature-based solutions (NBS) into the UK ETS would be a positive step, as it sends a clear signal of confidence that is essential for fostering growth in our nature markets. Ultimately, this would mean more woodlands and healthy peatlands across the UK.

This move would help build trust on both the demand and supply sides by indicating that these projects are supported by an additional authoritative framework, lending credibility to what has so far been perceived as a relatively ‘unregulated’ market.

However, to be effective, issues must be addressed:

• The fungibility challenge – how will we match the immediate requirement of emissions at source when NBS projects take time to deliver?

• The scaling challenge – given current constraints and issues present in the market, how will we practically manage the scaling of the market?

• The permanence challenge – how can legislation and governance (particularly around land-use change), as well as improvements to current mechanisms and inclusion of new ones, help us overcome permanence concerns?

If you’d like to discuss or debate this topic with us or have questions, please don’t hesitate to reach out via our contact form or our social media channels.

Jargon Library:

• Pending Issuance Units (PIUs): Credits (woodland or peatland) which represent ownership of future carbon savings, like sequestration from trees in 50 years. 

• Woodland Carbon Units (WCUs): Woodland carbon credits which have already delivered carbon savings. 

• Peatland Carbon Units (PCUs): Peatland carbon credits which have already delivered carbon avoidance. 

• Ex-post credits: Credits which represent ownership of delivered carbon savings, like trees that have already sequestered carbon. WCUs and PCUs fall into this category,  but PIUs don’t. 

• Secondary market: The ability for onward trade of credits. At the moment, credits must be assigned/retired upon transfer. This restriction means investors/organisations cannot purchase credits now to trade onwards at a later date. A secondary market would free up liquidity, meaning investors could hedge against lower unit prices now, to commercialise at a later date - in turn bringing more capital into the market today.