The effectiveness of carbon credit programs at reducing nutrient losses: An assessment of public and private conservation programs and their interactions.
Issue
The emergence and development of carbon credit programs and the targeting of specific sustainable milestones by many private companies have the potential for greater adoption of conservation practices by injecting additional funding and bringing innovations in incentive mechanisms. In particular, the emerging carbon credit programs will profoundly impact nutrient reduction strategies because conservation practices that reduce nutrient runoff can have implications for carbon, and vice versa.
From a policy standpoint, carbon and nutrient reduction are inseparable for two reasons: (i) most conservation practices that reduce nutrient loss also sequester carbon; and, (ii) both government and private incentives can support the same set of conservation practices. However, some important questions arise: to what extent farmers will participate in carbon markets, how carbon markets will interact with existing nutrient focused conservation programs, and whether and how existing conservation programs can be modified to improve cost-effectiveness in light of the carbon markets. To answer these questions, it is critical that we understand farmers’ views and willingness to adopt conservation practices through the emerging carbon credit markets and the corresponding private companies’ willingness to pay for such practices.
Objective
The overarching objective is to investigate the effectiveness of carbon credit programs at reducing nutrient losses. Researchers will investigate how emerging carbon credit programs interact with existing conservation programs that focus on nutrient reduction by examining farmers’ views and participation decisions, their minimum willingness to accept (WTA), and private companies’ maximum willingness to pay (WTP) for carbon credits and conservation practices.
Approach
Researchers will investigate these questions with a team of cross-disciplinary researchers at Iowa State University and non-governmental organization partners including The Nature Conservancy, Practical Farmers of Iowa and Sustainable Food Lab. The ultimate long-term outcome of the project is improved cost-effectives of conservation investment that reduces nutrient losses and improves the sustainability of farms.
Project Updates
Note: Project reports published on the INRC website are often revised from researchers' original reports to increase consistency.
July 2024
FINAL REPORT
They key research questions for this project were the extent to which farmers will participate in carbon markets, how those markets will interact with existing nutrient-focused conservation programs, and whether and how existing conservation programs can be modified to improvement cost-effectiveness in light of the carbon markets.
With data of program participation and existing literature, we illustrate the co-benefits of improved water quality and sequestered carbon by practices enrolled in USDA Environmental Quality Incentives Program (EQIP). We selected three widely adopted and extensively studied practices: cover crops (CC), no-tillage (NT) and reduced tillage (RT). We estimated the carbon impacts of CC, NT and RT from 2012 to 2021, which ranges from about 346,000 tons to about 1.371 million tons in total for Iowa.
Similarly, we estimate the ballpark water quality improvement of CC, NT and RT, as measured by NO3-N (nitrate-nitrogen) mass reduction. which are about 4.495 million pounds and 7.463 million pounds in total, respectively, for nitrate-nitrogen reduction in Iowa from 2012 to 2021.
By deriving back-of-the-envelope estimates, we found that the three conservation practices seem to have generated much more carbon benefits than water quality benefits, while the overall EQIP investment on the three practices seems to be comparable to the total carbon and water quality benefits ($14.6~$54.5 million).
We investigated the impact of different carbon payment systems on farmers' decision-making processes, considering environmental uncertainties, risk aversion, ambiguity aversion and transaction costs. We compared practice-based payments and performance-based payments and examined the environmental and economic impacts. Using cover crops as a case study, we incorporated parameters from the Dynamic Land Ecosystem Model (DLEM) and developed five climate scenarios to estimate soil organic carbon (SOC) change variation. Our findings reveal that different decision rules result in dissimilar adoption decisions and program outcomes due to uncertainties and risks inherent in carbon outcomes and payment schemes.
Although performance-based payments are generally considered superior to practice-based payments, our results suggest that, from the farmers' perspective and accounting for their risk attitudes, environmental uncertainty and transaction costs, performance-based payments may not be as advantageous as previously believed. Farmers are less willing to adopt conservation practices when they are risk and ambiguity averse. Our research highlights the importance of understanding farmers' responses to different carbon payment systems when assessing the cost-effectiveness of various payment schemes. We also investigated the impact of uncertainty and transaction costs on farmers' willingness to participate in conservation and carbon payment programs with both economics theory and experiments. We used a theoretical framework incorporating ambiguous carbon output and payment information, characterizing farmers' decisions under ambiguity that arises from ambiguous information and uncertain probability distribution. Using experiments, we examined risk aversion and ambiguity aversion in the context of carbon payment systems. We explored the impacts of two carbon output scenarios: one with a known distribution and another with an ambiguous, unknown distribution. The uncertainty premium in ambiguous settings is decomposed into risk and ambiguity premiums. We also used this information treatment to analyze the impact of transaction costs on farmers' decision-making.
Our results indicate a significant prevalence of risk aversion among farmers, with positive risk premiums observed in both control and treatment groups. The estimated transaction cost for the treatment group is $3.3/acre, constituting nearly 20% of the total expected payoff. Both groups demonstrate high levels of uncertainty aversion, while ambiguity aversion is less common. Notably, the control group exhibits a higher uncertainty premium and the treatment group exhibit a more negative ambiguity premium, with the difference in ambiguity premium being statistically significant. Robustness checks across small and large stake cases reveal no substantial differences in switching behavior between the control and treatment groups. The findings highlight the importance of considering uncertainty and transaction costs when designing and implementing incentive programs for carbon sequestration. By addressing these factors, policymakers can better support farmers in adopting conservation practices and participating in carbon markets, ultimately enhancing the effectiveness of carbon sequestration initiatives.
We also examined interaction between crop insurance policies, the largest farm support in the U.S., and a practice that is important part of nutrient reduction strategies, growers’ split nitrogen application (SNA) decisions. We considered both the traditional multi-peril Revenue Protection (RP) policy and the newly introduced single-peril Post Application Coverage Endorsement (PACE), which specifically targets SNA risk. We found that, bundling PACE as an add-on policy with RP, as currently implemented by the FCIP, may induce growers to apply more pre-planting N and less in-season N than either policy alone.
Other activities and accomplishments
Researchers give 8 presentations related to this project. One graduate student was supported by this project funding.
Publications (non-peer reviewed):
Du, Zhushan, Hongli Feng, and Wendong Zhang. 2022. “Carbon and Nutrient Co-benefits of Large Conservation Programs: An Illustration with EQIP in Iowa.” Agricultural Policy Review, Spring 2022. Available at: https://www.card.iastate.edu/ag_policy_review/article/?a=.
Du, Z. H. Feng, and L. Schulte Moore. 2022. “Conservation Investment and Carbon Payments in US Agriculture: Implications of the Inflation Reduction Act of 2022.” Agricultural Policy Review Fall 2022. Center for Agricultural and Rural Development, Iowa State University. Available at: https://www.card.iastate.edu/ag_policy_review/article/?a=146.
Toman, Michael, Justin Baker, Robert Beach, Hongli Feng, Eileen McLellan, and Emily Joiner. 2022. “Policies to Increase Mitigation of Agricultural Greenhouse Gas Emissions.” Issue Brief 22-10, December. Resource For the Future. https://www.rff.org/publications/issue-briefs/policies-to-increase-mitig...
March 2024
For this project period from July to December 2023, following up with our work as reported in the last two semiannual reports to further examine the drivers of farmers’ decision making and so their minimum willingness accept in order to enroll in carbon contracts. In conjunction with the objectives of another INRC project (project number 2022-08), we have finalized and implemented a protocol for economics experiments. We are still wrapping up our data collection from farmers. As of now, we have just over 190 observations from farmers and over 54 observations from students. We will be analyzing farmers views of carbon programs and their preferences regarding different features of the program.
Looking ahead, we plan to analyze the magnitude of premiums related to risk aversion, uncertainty aversion and transaction cost in relation to farmers’ willingness to accept a carbon contract and adopt conservation practices. We will examine the implications of these premiums on program participation. We have also formally investigated how risk factors influencing farmers’ decisions on nitrogen uses and how such decisions interact with existing government programs. We employ a two-stage expected utility maximization model to examine the optimal level of pre-planting N application and the roles of risk associated with in-season application. When in-season application risk is the sole factor affecting crop revenue, crop insurance policies incentivize a reduction in pre-planting N use and an increase in in-season N use.
In addition to traditional crop insurance policies, USDA has introduced a new crop insurance program called the Post Application Coverage Endorsement (PACE) specifically for split nitrogen adopters. PACE indemnifies split N application adopters when in-season N application is prevented due to unfavorable weather or field conditions. However, in years when in-season N can be applied as planned, growers pay PACE premiums for no returns. Furthermore, as an endorsement, PACE must be purchased with an underlying crop insurance policy, such as a Revenue Protection policy, and only covers the deductible portion of the underlying policy whenever the underlying policy also pays out. We examined the implications of PACE on promoting split N application decisions among farmers and its interaction with other insurance policies.
Related activities and accomplishments
Related presentations given or planned during this time period include:
- At annual meeting of two association, AAEA and AERE.
- How Carbon Payment Schemes Affect Farmers' Decisions—Implications for Nutrient Reduction”. Iowa Nutrient Research Center fall seminar series, 'Focus on the Future.' by Zhushan Du, PhD student, December 13, 2024.
- "Modelling Farmers’ Split Nitrogen Decisions and the Effects of Crop Insurance," has been accepted for presentation at the 2024 annual meeting of the SCC-76 Economics and Management of Risk in Agriculture and Natural Resources annual meeting.
June 2023
For the project period from January to June 2023, we continue our work as reported in the last semiannual report to further examine the drivers of farmers’ decision making and so their minimum willingness to accept an incentive in order to enroll in carbon contracts. In conjunction with the objectives of another INRC project (project number 2022-08), we have started designing a protocol for economics experiments, successfully applied for IRB approval, and pilot tested our experiments with students who came from agricultural background. Information treatment is embedded in the experiments as a tool to try to monetize the costs of transaction costs that will affect farmers’ willingness to accept payments for conservation practice adoption.
Looking ahead, we plan to explore the magnitude of transaction costs in relation to farmers’ willingness to accept a carbon contract and adopt conservation practices. We will continue to gather data regarding companies' attitudes toward various carbon initiatives targeting carbon sequestration in agriculture and related implications for nutrient reduction. We will also continue to reach out to farmers, our target audience, for collecting data from them and for distributing our research results. In addition, we will identify general guidelines for nutrient reductions strategies to proactively use emerging carbon credit programs. The project’s initial end date is in August 2023. We have requested and have been approved a no-cost extension to May 2024 as we try to finish the additional tasks.
Related activities and accomplishments
- 3 presentations, including:
Invited Seminar - March 2023, Department of Civil, Construction and Environmental Engineering, graduate seminar series, Iowa State University.
Submitted proposal: “Stimulating Climate-smart Conservation on Iowa’s Farmland: Incorporating Collaborative Storytelling into Integrated Modeling.” (Linda Shenk (PI), Richard Cruse, Hongli Feng, Kristie Franz, Brian Gelder, William J. Gutowski, Jr., Emily Zimmerman). Climate Smart seed grant, Iowa State University. 2023 - $50,000.
The PhD student (Zhushan Du) on the project successfully passed her prelim exam.
December 2022
Objective 1: The team has further studied the interactions between traditional conservation programs and the programs that target carbon. While existing Natural Resources Conservation Service programs like Environmental Quality Incentives Program (EQIP) and Conservation Stewardship Program (CSP) aim at providing multiple benefits, including mitigating soil and nutrient loss and improving water quality, the newly established Inflation Reduction Act investment (IRA) targets climate-smart agricultural practices. Of the NRCS’s climate-smart practices, many are also covered by EQIP and CSP. In particular, eight of the top-10 practices in terms of acreage enrollment in EQIP and CSP are also on the list of the climate-smart activities. So far, compared to private companies, the government continues to play the largest role in incentives for agricultural conservation and carbon sequestration. A simple comparison shows that the new IRA funding for EQIP climate-smart agriculture per year in 2021 ($2.11 billion) would be more than 500 times greater than the available Truterra payments ($4 million).
Objectives 2 and 3: The team has focused on the roles of uncertainty and farmers risk attitudes. Uncertainties are often modeled as having a probability distribution. This analysis recognizes that in the context of carbon sequestration in agriculture, the probability distribution is not known, i.e., there is ambiguity regarding the amount of carbon credits earned, and the total carbon payments farmers will receive. When ambiguity exists, an uncertainty premium (representing both a risk premium and ambiguity premium) will be required. An ambiguity-averse farmer is less willing to adopt a conservation practice that represents risky and ambiguous carbon payments compared to an unambiguous carbon payment (even if it is still risky). In this study, we extracted the risk aversion coefficient and ambiguity aversion coefficient from the existing literature. Results indicate that performance-based payment out-performs practice-based payment -- when there is no risk or ambiguity. However, carbon sequestration with practiced-based payment is more than twice the amount of carbon sequestration with performance-based payment when risk aversion and ambiguity aversion are considered. These results suggest that it is critical to thoroughly understand how farmers respond to different carbon payment systems when assessing the systems’ cost-effectiveness.
Objective 4: Feng has collaborated with a team, led by a researcher (Dr. Mike Tomen) at Resource For the Future (RFF), to produce a policy brief that lays out the challenges and opportunities of three policy approaches to voluntary carbon reduction. Looking forward, researchers will continue to quantify the impacts of risk and uncertainty on farmers’ willingness to participate in carbon payment programs. The research team will also gather data regarding the attitudes of agricultural companies toward various carbon initiatives targeting carbon sequestration in agriculture and related implications for nutrient reduction.
Other activities included two presentations and one workshop.
June 2022
Objective 1 - preliminary findings: With data of program participation and existing literature, the team explored the co-benefits of improved water quality and sequestered carbon by practices enrolled in EQIP. Three widely adopted and extensively studied practices were selected: cover crops (CC), no-tillage (NT), and reduced tillage (RT). The carbon impacts of CC, NT, and RT were estimated from 2012 to 2021 which ranged from about 346,000 tons to about 1.371 million tons in total for Iowa. Similarly, ballpark water quality improvement of CC, NT, and RT were estimated, as measured by NO3-N (nitrate-nitrogen) mass reduction. which were about 4.495 million pounds and 7.463 million pounds in total, respectively, for nitrate-nitrogen reduction in Iowa from 2012 to 2021. Based on back-of-the-envelope estimates, the three conservation practices seem to have generated much more carbon benefits than water quality benefits. The overall EQIP investment on the three practices seems to be comparable to the total carbon and water quality benefits ($14.6~$54.5 million).
Objectives 2 and 3 – progress: Identify and assess existing and emerging NGO and private company carbon initiatives and examine their impacts on nutrient reduction and Obj 3. Estimate farmers’ minimum WTA and private companies’ maximum WTP for conservation practices and assess the situational gaps between the two. Three basic types of common payment schemes were compared: practice-based payment (e.g., per-acre payment for conservation practices adoption), outcome-based payment (e.g., payment per tons of carbon sequestered), and commoditization of carbon benefits (e.g., a price premium for crops grown under certified climate-smart practices). Under expected profit maximization, the three payment mechanisms can lead to the same amount of carbon with appropriate payment rates. Situations become more complex under the expected utility and prospect theory. The curvature of the utility function leads to a smaller willingness to adopt and features of prospect theory make a risk-averse farmer even less willing to adopt a conservation practice. Thus, simple benefit-cost analyses will likely overestimate participation, resulting in overly optimistic predictions. In project’s
In the second year, researchers will continue to study the interactions of carbon-focused and nutrient-focused programs. Analysis of carbon payment systems will also continue by using simulation methods and economics experiments to shed light on willingness to pay and willingness to accept concerning conservation practices. Throughout the analysis of Objectives 1-3, researchers will simultaneous work on Obj 4 to identify general guidelines for nutrient reduction strategies to proactively use emerging carbon credit programs.
Other activities included one presentation.