Natural capital projects in Scotland: carbon credits

Following on from our insight on biodiversity projects, this second article in our two-part series on natural capital in Scotland explores carbon credit projects.

Carbon credits are increasingly viewed as a tradeable asset for offsetting emissions and creating value from land-based environmental projects.

Here, we consider the operation of UK carbon credit schemes, how carbon units are verified, and the practical approaches to structuring land and project rights to deliver carbon projects successfully while managing long-term risks.

UK carbon credit schemes

There are two carbon credit schemes operating in the UK: the Woodland Carbon Code, which administers the validation and verification of Woodland Carbon Units (“WCUs”); and the International Union for Conservation of Nature (IUCN) UK, which administers the validation and verification of Peatland Carbon Units (“PCUs”). Each WCU or PCU (together referred to as “CUs”) is a verified credit representing one tonne of carbon dioxide equivalent removed from the atmosphere by a UK woodland creation project or peatland restoration project, respectively.

The intention behind CUs is to create a tradeable asset which can be purchased by parties looking to offset their own carbon emissions. However, the level of tradability is largely determined by the account type which the project developer holds with the UK Land Carbon Registry, and true trader status cannot be achieved by non-FCA regulated bodies. The system is designed to permit landowners to develop carbon projects on their own land, or to allow them to enter into agreements with third-party developers to deliver carbon projects on their land.

Issuance and buffer accounts

In order to have CUs verified, project developers must first register their project, which involves meeting the additionality test of proving that the proposed project will truly result in the removal or sequestration of “additional” carbon from the atmosphere, which would not otherwise have been removed. For example, commercial forestry fails this test because the tree crop is planted for commercial purposes, and not simply for the purpose of sequestering carbon. Following registration, the project developer must complete the work required to deliver it e.g. tree planting or peatland restoration. Once the work is completed, it must be independently inspected to become validated, following which Pending Issuance Units (PIUs) will be issued for each CU which is expected to be delivered. The works must be independently inspected five years after validation, and assuming all goes well the CUs will be issued. The project is then subject to regular inspections every five or ten years to ensure that the project is continuing to develop and sequester carbon from the atmosphere at the expected rate, and adjustments to the number of issued CUs can be made if performance falls low.

Of the PIUs and CUs issued, 20% will be automatically transferred to a “buffer” account, which acts as an insurance policy for purchasers of the CUs in the event of damage, destruction or other failure of the relevant carbon credit project. The buffer can be called upon by project developers to top up any shortfall between the number of issued CUs and the number of CUs sold so that purchasers’ emissions are still being offset, but this may be subject to the project developer replenishing the buffer with the number of CUs drawn in excess of their 20% contribution.

Structuring land and carbon rights

In circumstances where a third-party is being appointed by a landowner to create and manage a carbon credit project on their behalf, the parties need to consider whether the third party will be granted (1) proof of rights, or (2) a communications agreement.

Proof of rights: this effectively splits the carbon ownership from the land ownership in a way which results in legal separation of those rights. It’s worth noting that a proof of rights agreement can cause difficultly for the carbon owner transferring that carbon ownership onto any party other than an end user, unless they have a trader account. 

Communications agreement:  this sets out the rights and responsibilities of the landowner and the project developer, including how the developer will manage the PIUs and/or CUs on behalf of the landowner. However, this does not have the effect of separating the land ownership from the carbon ownership, and so the landowner remains the owner of the carbon even if the project developer has taken on the full responsibility for and costs associated with the creation and management of the project.

Unlike minerals, carbon rights are not a separate tenement in Scotland, which means it’s not possible for one party to hold a title to the land and another party to hold a title to the carbon. As a consequence, the grant of a proof of rights can cause some risk and uncertainty since it results in a personal right to the carbon ownership, but without constituting a real right of ownership or otherwise being publicly registered against the landowner’s title.

If you would like to discuss anything raised in this article, please get in touch with Alan Gibson or your usual Burness Paull contact.

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