Risks associated with carbon project development
Companies pursuing financing for their carbon project development and implementation need to ensure that the projects are sufficiently attractive for financiers to invest.
One of the key things that investors are always on the look out for, is ways in which a company plans to mitigate the risks it faces along the way. Currently, carbon project development is a high-risk businesses, especially due to the fact that the market is not fully developed.
The potential risks that carbon project developers are likely to face along the way are detailed below.
1) Project-specific risks
a) Operational risks
These are operational challenges that a company is likely to face that could delay the project implementation or reduce the volume of credits generated from the project.
For example, consider a partnership between two companies, Kaboom and Compass, implementing a biochar CDR project. Kaboom owns a pyrolysis machine that converts macadamia shells to biochar while Compass is a fertilizer producing company that integrates this biochar into its products. This improved fertilizer is then applied to farms in a bid to sequester carbon dioxide 1.
In their business plan, both companies must address potential risks arising from the partnership. For instance, what would happen if for some reason, Kaboom produced biochar but Compass is unable to incorporate it in their fertiliser? Addressing such concerns can help convince financiers of the project’s feasibility.
b) Community risks
People living in the area where the carbon project is being implemented are important stakeholders. They own the land and are likely to be employed in the projects. They can influence whether the project continues or not. Their concerns must be addressed throughout the project’s lifecycle, as their support is vital for successful and high-quality implementation. In their business plan, the company developing the carbon project should clearly state how they plan to address concerns from the community, when they arise.
c) Technical risks
This is an additional operational risk, especially for tech-based projects. What happens if Kaboom’s pyrolisis machine breaks down and there are no experts available locally to repair it? Kaboom may be forced to either send the machine to another country for repair, or have experts fly into the country to diagnose the problem. This could adversely affect the implementation timeline of the project. In their business plan, Kaboom needs to address how they plan on mitigating such risks.
d) Reputational risks
If a project’s impact is questionable, financiers may experience adverse reputational consequences.
Companies engaging in carbon project development need to demonstrate integrity and transparent monitoring processes to reassure financiers they are mitigating reputational risks.
e) Reversal risks
One of the key qualities that make a carbon offset project credible is permanence. Permanence ensures that the carbon dioxide sequestered from the atmosphere is not released back.
In ARR projects, carbon dioxide can be released back into the atmosphere through forest fires, pest infestations or deforestation. These reversals can undermine any carbon credits issued, so it’s important for project developers to address these risks and how they plan on mitigating them.
2) Macro-level risks
a) Political and regulatory risks
The laws and regulations in a given country can affect the future price of credits, the financial attractiveness of carbon projects in that country and cause uncertainties in the carbon market.
For example, on 28th October, 2022, the government of Tanzania gazetted the subsidiary legislation, under the Environmental Management Act. This legislation stipulates, among other things, how costs and benefits should be shared between the buyer of carbon credits, the national and village level authorities and the community.
This legislation states that the owner of the property involved in the carbon trading project should be entitled to 61% of gross revenue accrued from the sale of carbon credits. In the event that the owner is under the council, 10% of this revenue should be given to the council for conservation activities including carbon trading while the rest (51%) should be used by the village government or mtaa for community development and conservation activities at the village level. In case the owner of the property is not under the council, 10% should be used for community activities at the village level. 6% should be given to adjacent villages while 4% should be given to local government council for conservation activities. The owner of the property is entitled to the remaining 51%.
Out of the remaining 39% percent, the proponent2 should pay 9% to the Designated National Authority (DNA) or National Focal Point (NFP) 3. The DNA or NFP should pay 2% of this to the National Environmental Trust Fund, 1% to the agency responsible for energy, for the purpose of subsiding costs of cooking energy and the remaining 6% should be used by the DNA or NFP for management, control and development of carbon trading projects in the country.
This means that the buyer of these carbon credits takes home only 30%. This regulation may make projects unattractive for financiers, who require a return on their investments.
b) Price volatility risks
Changes in the global demand and supply of credits, a lack of price transparency, low market confidence and quality concerns can affect the price of future credits.
Footnotes
You can read more about the biochar CDR process in this article.↩︎
A legal or natural person proposing the execution of carbon trading project or programmes↩︎
Ministry designated under the regulation to co-ordinate matters relating to environment and carbon trading projects in the country↩︎