Ecosystem service markets: explained with a fruit metaphor
In the past, I’ve written about how Nori compares to other climate start-ups and blockchain plays, and how Nori compares to traditional carbon markets. This article is for anyone considering selling carbon removal services in the Nori market, and comparing it to other options.
What is an ecosystem service?
“Ecosystem service” is the term to describe the service that humans deliver when they protect natural and/or managed land and water systems to maximize the life-sustaining benefit we receive from those systems. In this context, “life” covers all living organisms — from microbes to plants, all animals including but not limited to humans. Life-sustaining benefits include clean air and water, fertile and resilient soils and grasslands, pollination, flood and forest fire control. In some cases, when a steward of a certain ecosystem — for example, a farmer — undertakes an action to create healthier, more resilient, and productive soils, those soil quality improvements may be deemed to be ecosystem services. In an ecosystem service market, the natural impacts of the service can be estimated and sold, separate from, but complementary to the outputs of the food production services the farmer traditionally provides. The purpose behind naming, documenting, quantifying, and commoditizing the impacts of the adoption of ecosystem services is to generate new revenues to encourage the accelerated substitution of sustainable and more natural systems.
At Nori, we often describe these ecosystem services with a fruit analogy. Forgive me for beating this metaphor to a pulp in the rest of this article. We encourage all stewards of the land to adopt natural system management practices that might deliver the largest and most diverse set of positive ecosystem impacts — different types of fruit — as possible. So a steward who adopts practices that build up soil organic carbon stocks, decrease fossil energy use per unit of food or fiber produced, increase the rate of moisture retained in the soil, and reduce nutrient runoff into the water supply, should be able to earn more new revenue than a steward who only delivers one of those ecosystem impacts. Delivering multiple services is like putting as many different types of fruit in the fruit basket as possible, increasing the odds that the basket will attract a high price at auction.
Nori is building a market that is dedicated to generating revenues for stewards who draw carbon dioxide out of the atmosphere and store the recovered carbon in natural systems and/or man-made storage. So service providers can sell only one ecosystem service outcome or resulting “benefit” in the Nori market: the fruit of carbon removal. Nori issues Nori Carbon Removal Tonnes (NRTs) to farmers who can show that they have removed one tonne of carbon dioxide removed from the atmosphere by managing their land and cropping practices differently and committing to retain the recovered carbon in their soil, root systems or plants for a minimum of 10 years. Our belief is that if we can make it simple for the world to understand how and where that fruit — the NRT — was made, how it was brought to market, and making it easy to buy, then the value and attractiveness of producing this fruit would be such that almost everyone would want to do it.
Got your fruit smoothie ready? Let’s dive into where we fit in the landscape and how we’re different.
What is the existing ecosystem service market landscape?
Today, there are 5 key players in existing ecosystem services (er, fruit) markets: (1) standard certification bodies, (2) market operators (or “Markets”), (3) brokers (or ecosystem service benefit “aggregators”), (4) suppliers, and (5) buyers.
So far, most of the organizations that we commonly refer to as “carbon markets” or carbon “market operators” are actually standard certification bodies. These organizations provide very important and valued services, in that they develop and publish guidelines — known as “protocols” or “standards” — with which stewards of the land must comply in order to earn the right to claim they have produced specific types of fruit, such as reduced greenhouse gas emissions, avoided greenhouse gas emissions, atmospheric carbon drawdown and retention in a natural or man-made terrestrial reserve. Stewards can get their proposed fruit making efforts — or “projects” — validated as consistent with the guidance of the standard certification body. Then, when independent auditors verify that the project owners have properly executed the projects and delivered the expected fruit, the standard certification body creates and deposits the fruit — greenhouse gas (“GHG”) “offset credits” —into a public registry account. Each different certification body applies a slightly different set of standards and issues a unique kind of fruit to stewards who comply with their method of quantifying the outcomes or benefits that result from compliance with those ecosystem service delivery standards. It is up to buyers to make their own decision about which certification standard they prefer, and which fruit they are comfortable buying.
Verra, American Carbon Registry, Climate Action Reserve, and Gold Standard are examples of competing standard certification bodies. Each operates a discrete project registry, which are the internet-based platforms in which the bodies publish approved ecosystem service delivery plans, confirmation that the plans are being executed well, and the amount of fruit issued to the ecosystem service “supplier”, and where the fruit represent the beneficial outcomes of adherence to the approved/certified plans.
But these registries are not technically “markets”. Any purchase or sale of real interest in the fruit is arranged off or outside the platform. Fruit buyers can, but are not obliged to, set up accounts on the registry and compel suppliers to transfer fruit into those accounts to represent a “sale”. (The buyers can contact the suppliers to simply retire or withdraw supply from the registry, on their behalf, avoiding the cost of setting up and maintaining their own accounts on the registry.) Buyers and sellers are not obliged to and do not report prices or terms and conditions of sale to the registry operator. There is no true price discovery function served by these registries. So these bodies do provide valuable services and information to the general public, through the maintenance of their registries. But these are not truly “markets”.
By comparison, Nori and the California Air Resources Board (“CARB”) are both standard certification bodies and market operators. Nori has laid out market operating rules in How Nori Works which describes different methodologies. The first set of rules with which a steward must comply to earn marketable Nori Carbon Removal Tonnes (“NRTs”) is outlined in the Nori US Croplands Methodology. In the future, Nori will introduce other methodologies enabling a wide range of carbon removal and retention service providers to earn and sell NRTs. NRTs can only be traded on the Nori platform, and any and all NRT transaction volumes and prices are disclosed on the Nori platform in real-time. Therefore, the Nori platform is truly a market.
CARB creates CO2 “allowances”, which are permits or government-sanctioned entitlements to discharge 1TCO2e of CO2 to the atmosphere. CARB currently freely allocates roughly 90% of the allowances they create directly to in-state greenhouse gas emitters. There are restrictions on the free allowance recipients’ rights to sell or trade those allowances. To the extent that the holders of free allowances are permitted to sell them privately, there is no requirement that the private, secondary market prices are reported to the market administrator, or verified, for each transaction.
The CARB-administered market takes the form of a quarterly allowance auction. Any approved and registered entity can buy allowances at the auction, and entities that have received free allowances can (in some cases, must) consign their allowances for sale in the government-run auction. A combination of allowances that can be immediately retired — used to cover state-dictated emission caps — and allowance that cannot be retired until 4 to 5 years from the auction date, are sold. The auction settlement prices are published shortly after bidding closes. In this way, the CARB auction-based market reveals a combination of current and future prices for the right to discharge 1TCO2e in the California cap and trade market. CARB does allow capped source owners very limited rights to retire select carbon fruit to achieve compliance with their emission caps. But the prices paid for the fruit is not reported by transaction. Estimates of fruit prices are supplied, voluntarily, by brokers, which estimates are not subjected to strict verification. So this market does not yet support true price discovery for the fruit that is applied toward compliance by capped source owners.
Another emerging standard certification body that is also working to create an ecosystem service fruit market is the Ecosystem Services Market Consortium, but there are no publicly accessible ESMC fruit production protocols or projects available at the time of this publication. Theoretically, ESMC could adopt the Nori standard to make it possible for stewards to sell carbon removal fruit.
Ecosystem service fruit standing purchase orders
In the ecosystem service space, Indigo Ag operates like a fruit broker. The Indigo Carbon contract is akin to a standing fruit purchase order. Indigo Carbon is neither a standard certification body nor a market, in the traditional sense. Indigo Ag is currently working with Verra and CAR, in the expectation that those bodies will establish new standards for carbon removal and emission reduction activities that ag land stewards can adopt. Farmers who elect to comply with those standards, once they are approved, will be issued fruit by Verra and CAR. The Indigo Carbon contract outlines the terms, conditions under which and prices how Indigo Ag will set the price they will pay for the fruit that contracted farmers might earn from those certification bodies. Indigo Ag currently proposes to be the sole fruit buyer for Indigo Carbon, and has the sole right to set the terms and conditions of the resale of those fruit to other parties. While the average or marginal price Indigo Ag pays for fruit, and payment terms, appear likely to be published in real-time (this is not yet certain), it appears unlikely that the prices Indigo Ag realizes for each fruit resale transaction will be publicly disclosed.
For these reasons, the Indigo Carbon contract is comparable to a standing fruit purchase order, when the Indigo Carbon contract is the means by which Indigo Ag pre-qualifies ecosystem fruit suppliers. In the fruit resale market, Indigo Ag operates much like a broker who has a “contract for differences” with their fruit suppliers. That means that to the extent there is a difference between the price Indigo Ag pays for the fruit and the prices they get on resale, Indigo Ag keeps/bears 100% of that difference.
Any ecosystem fruit supplier who signs up as an Indigo Carbon supplier is precluded from offering not just the carbon removal fruit, but any of the fruits they might accumulate in the Verra or CAR registries to any buyer other than Indigo Ag, for a minimum of 5 years.
The Nori NRT can only be transferred and eaten once
The Nori Carbon Removal Tonne (NRT) is retired — the fruit is consumed — upon its first sale. Since the Nori ecosystem fruit is used or retired upon sale, the NRT is deemed to be a commodity by US securities and commodity market regulators. Entities can build “over-the-counter” NRT options and futures markets, to complement the direct spot and forward contract price discovery that occurs in the Nori market. But those NRT options and forward markets will operate in a manner that is consistent with markets that trade fruit options and futures, where actual custody of the fruit does not physically change, with each option or futures contract that is executed.
Nori’s profits are aligned with the fruitseller’s
Nori is not the buyer of the carbon removal fruit. Nori’s long-term revenue model is to take a transaction fee on top of the fruit’s sale price. That means that it is in Nori’s interest to see the fruit producer get paid as high a price as the market will bear. This is different from other standard-setting and certification bodies that tend to generate most of the operating revenues by charging fees to list projects in their registries and annually recurring registry listing maintenance fees. The registry operators do also take small fees (in pennies per TCO2e) to execute fruit trades between accounts on the registry, as well as charging penalties when an ecosystem fruit provider elects to delist their fruit offering. To date, roughly 40% of the fruits ever listed in all of the certification body-administered registries, worldwide, have never been sold, once.
Nori’s NRT Agreement
The Nori NRT Agreement establishes the Nori terms for NRT — the Nori “fruit” — providers’ continuous compliance with the Nori certification standard, as well as their participation in Nori’s spot and forward contract markets. The NRT Agreement outlines a carbon removal service providers’ 10-year commitment to making best efforts to adopt maintain ecosystem management strategies that are reasonably expected to draw CO2 out of the atmosphere and store the recovered carbon in a natural or man-made terrestrial reservoir.
The NRT Agreement requires that the enrolled service provider will report a fixed set of operating data to Nori, each year, for 10 years. Nori uses the verified data to determine how many potentially marketable Nori fruit to issue to the contracted supplier, as well as to ascertain that the recovered carbon is being retained in the terrestrial reserve.
The NRT Agreement allows for selling other types of fruit such as CO2 and N2O reductions, water holding capacity, water quality improvement, increased biodiversity in other ecosystem service marketplaces. If the other ecosystem service marketplaces require incremental carbon removal to be part of their sale then a Supplier may leave the Nori market, but would still be required for continued data reporting.
Where can all fruit markets be the same?
Even though different fruits can sell in different markets, the world is looking for standardized forms of fruit. From Nori’s perspective, the harvesting of the fruit ultimately comes down to reporting data, annually, for ecosystem management practices known to result in beneficial outcomes (the “ fruit”), using transparent tools to estimate fruit supply changes, and adequate mechanisms to insure against carbon stock —fruit inventory losses. Over time, the continued monitoring allows for greater and greater accuracy and improved verification. Nori’s goal is to define the global premium ecosystem fruit quality standard, against which all other supply options might be indexed.
Now, who wants to eat fruitcake?