Contract and market design for land-based carbon offsets

Agricultural activities often create environmental externalities that are felt by individuals other than the landholder. A theoretically efficient approach to addressing these externalities involves changing prices to align private and public interests. Governments and international organizations have spent billions of dollars in recent years on incentives for land use changes that improve environmental outcomes. The share of these projects focused on land use based carbon offsets is likely to grow along with the emphasis on REDD (Reduced Emissions from Deforestation and Degradation) in global climate negotiations. In spite of these trends, relatively little evidence is available on the relative performance of alternative land-based carbon offset program design.

The proposed research focuses on one aspect of land use payment programs: the option value that such programs offer to landholders. Farmers face numerous sources of uncertainty in their land use choices: weather, crop prices, illness and other shocks. According to the options model, landuse payment contracts provide farmers with an option value if (a) there exists a random shock that affects the opportunity cost of complying with the contract, (b) this shock is not observed before the landholder decides whether to participate and (c) the program provides little penalty for non-compliance. While a contract with high option value unambiguously increases farmer's welfare, it also results in high take-up accompanied by low compliance rates, which can substantially increase the operational and monitoring cost of these programs.

Our study examines the importance of option value in take-up and compliance with voluntary land-based carbon offset programs, through combination of a structural model and a field experiment in Zambia. While options models have spawned a large theoretical literature, empirical evidence on their predictive power remains scarce. We vary the input prices that farmers face and the rewards offered for tree survival to measure the importance of option value for program outcomes with an eye to designing an optimal contracts and markets.

The project is being implemented in Eastern Zambia, in collaboration with the implementing partner, Mitengo Zambia, and a large contract farming company, Dunavant Cotton. The project focuses on the adoption of fertilizer trees (faidherbia albida) by Dunavant’s smallholder contract farmers. In addition to sequestering carbon, faidherbia albida fixes nitrogen in its leaves and drops its leaves at the time of the first rains, providing farmers with a source of organic fertilizer. However, these private benefits are slow to accumulate and are insufficient to overcome the up-front investment costs in the absence of short-run incentives.

Of the approximately 1400 farmers trained, around 80 percent choose to join the program. The probability of take up is decreasing in the cost of inputs and increasing in the reward offered at the end of one year, conditional on tree survival. Results on tree survival will determine whether higher take up at lower input costs is associated with the option value of the contract, and the relative importance of screening on input costs versus incentive payments for improving contract performance.