Farmer Participation in Carbon Contracts

We now consider the farmer's decision to participate in carbon contracts in a heterogeneous region, following Antle and Dia-gana (2003). They show that, if expected net returns and the price of carbon are constant over time and the fixed cost of changing practices is equal to zero, the farmer formerly using practice i will adopt the carbon-sequestering practice s if

NR(p, w, z, s) + g(i,s) - m(i,s) - fc(i,s) > NR(p, w, z, i)

where NR(p, w, z, j) is the net return to practice j = i,s; p and w are crop and input prices, and z represents fixed factors of production; g(i,s) is a carbon payment for switching from practice i to practice s; m(i,s) is maintenance costs of changing practices per time period; and fc(i,s) is the cost of financing the change in practices.

This expression has several implications for analysis of adoption of soil carbon sequestration practices. First, suppose that there are no payments for carbon sequestration, so that g = 0. In this case, a farmer adopts the conservation practice only if it provides higher net returns than the conventional practice. If the productivity benefits of the conservation practice are realized with a time lag, Equation 28.1 shows that if a farmer is uncertain about future productivity benefits or highly discounts future benefits, she or he would bear the costs of adopting the practice, but would not be aware of or attach value to the benefits. Therefore, a lag between adoption and the realization of productivity benefits may create an adoption threshold. Furthermore, if farmers do not have access to well-functioning capital markets, they cannot finance the fixed component of the investment cost, and so the annualized investment cost term fc(i,s) would be replaced with the full investment cost in Equation 28.1, thus exacerbating the threshold effect.

Second, if there is a payment for adoption of practices that sequester carbon, Equation 28.1 can be rearranged to:

g(i,s) > NR(p, w, z, i) - NR(p, w, z, s) + m(i,s) + fc(i,s)

The expression on the righthand side is the farm opportunity cost for switching to system s from system i. Farmers will likely switch practices when the farm opportunity cost is less than the payment per period. If a per-ton contract, g(i,s) =

PAc(i,s), the condition for participation in the contract can be expressed as

P > (NR(p, w, z, i) - NR(p, w, z, s) + M(i,s) + fc(i,s))/Ac(i,s)

The term at the right is now the farm opportunity cost per metric ton of soil C, and thus the farmer will participate when the price per metric ton of soil C is greater than the farm opportunity cost per metric ton. This last expression shows that when farmers are being paid per metric ton of carbon sequestered, as would be the case when they participate in a market for carbon emissions reduction credits, the market price per metric ton of carbon plays a key role in determining which farmers would participate.

Equation 28.2 shows that when incentive payments are made, it is no longer necessary for the conservation practice to be more profitable than the conventional practice for adoption to take place. When farmers are informed about the benefits and costs of conservation investments, and they choose not to adopt them, we can infer that the conservation practices are less profitable. A positive financial incentive will be required to induce and maintain adoption.

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