The Scottish Government recently published a report looking at options to encourage responsible private investment into peatland restoration; including overcoming barriers to scale the voluntary carbon market which plays a key role in the restoration of peatland in Scotland.
The report builds on a 2021 report by NatureScot and Finance Earth which evaluated a range of mechanisms which might unlock further investment in Scotland's natural capital. The 2021 report identified two mechanisms to be developed, namely a Scotland Carbon Fund (SCF) and a Price Floor Guarantee (PFG).
The latest report involved extensive stakeholder consultation, alongside research and data analysis to consider how each of these systems might be designed, with a particular view on how each system might finance peatland restoration.
Scotland Carbon Fund
The report considered two ways to develop an SCF as a tool to unlock large scale peatland restoration. In particular, the paper weighed up the advantages of the SCF being structured as a project finance vehicle, where the SCF would provide finance to cover upfront project costs, with returns paid as the project sells verified carbon units, versus a liquidity vehicle, where the SCF would purchase pending issuance units ("PIUs") from the peatland project and generate investor returns by selling these on the open market once the PIUs vest into verified carbon units. The stakeholder consultation showed a preference for a project finance vehicle, which would address issues around initial project financing and more alignment between the objectives of the project and the investors.
The report identified that a fund size of at least £50m would be required to be impactful in restoring larger areas of degraded peatland whilst also maintaining efficient project management. Funding for the SCF, the report suggests, should come from both investors and from the Scottish Government. The conclusion of the report was that by contributing to the Fund the Scottish Government would in turn increase investor confidence.
The report also addresses how the SCF would be compatible with the Scottish Government's land reform agenda, noting that there was a risk by putting more capital into the market that it may inadvertently support further concentration of land ownership. The report proposes to address this by promoting a model where finance is offered to projects that lease land from existing landowners, with the landowner compensated by being entitled to a share of a portion of the carbon benefits.
Lastly, the report also addressed the possibility of community wealth building, which forms part of the Scottish Government's land reform agenda. The report proposed that a "conservation dividend" would be the most attractive option to investors, where a portion of the profits are diverted from investors to communities as a donation upon the project achieving pre-defined objectives.
Price Floor Guarantee
The 2021 report proposed a PFG as an alternative mechanism to the SCF, however the current report proposes that a PFG would be more suited as an aligned mechanism together with the SCF to increase investor confidence.
The PFG would enhance confidence for project developers by guaranteeing a floor price for a fixed duration, thereby reducing the downside risk of low carbon prices affecting the viability of the project. As carbon markets are currently very volatile and prices are prone to fluctuation, the stakeholders expressed support for the PFG as an additional mechanism to enhance the viability of projects.
In particular, by guaranteeing a floor price the report believes that developers would be more likely to hold PIUs to verification, which tend to achieve a higher price. Combined with the SCF proposals, above, this could also lead to greater investor returns.
The report did however note a number of downsides to the PFG mechanism. In particular, there was greater risk for the Scottish Government compared to the SCF proposal, as a price floor would have to be guaranteed for a greater length of time compared to a one off capital injection and in the case of peatland there was a minimum projection duration of 30 years. There was also a risk to the wider carbon market, as a price floor risks the creation of a "race to the bottom" where projects with low costs generating low quality returns are favoured by developers seeking the guaranteed "floor" return compared to projects which might have greater upside in the form of biodiversity and community benefits, but require more in the way of upfront costs.
The report does not address the concerns in significant detail, other than to propose minimum eligibility criteria to avoid a "race to the bottom" but it was accepted that criteria are already set out in the Peatland Code and further research may be required on this point.
Conclusion
The report concludes by inviting the Scottish Government to continue exploring policy mechanisms, alongside the two initiatives above, that can be implemented to address remaining barriers to effective peatland restoration.
With peatland forming one third of Scotland's land area, it seems clear that this is an area which will continue to be the focus of both the public and private sector and Brodies will continue to monitor new developments and initiatives in this area.
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