Financial Solutions for Peatland Restoration: Additional Modelling Method and Results Overview

5. Sensitivity Analysis

5.1 Introduction

In order to fully test the robustness of the core message of this analysis, a set of sensitivities has also been tested to confirm the findings.

These sensitivities are as follows:

• A change in net emissions per ha from 2.82 tonnes (reflecting shallow peats) to 15.05 tonnes (reflecting deep peat beds);
• A change in the social discount rate from 3.5% to 6%;
• A change in hectarage restored from 100% easily accessible peat to 60%, with an additional 40% added as costly access (3.5 times higher restoration cost for peat that is harder to access);
• A change in the market price of Peatland Carbon Units (PCUs) from £25.97 (using the WCC as a baseline) to £15;
• A change in the market price of PCUs from £25.97 (using the WCC as a baseline) to £45;
• A decline in the traders’ premium markup from 30% to 0%;
• A 30% reduction of the price of PCUs at the farm gate;
• The inclusion of biodiversity credits to be traded in association with carbon credits; and
• A change in the increase in the PCU real price from 2% to 0.01%.

The following section details the headline impacts of each of these changes, with greater detail provided in the model output titled “Results and sensitivity analysis v1” found at Appendix 4.

5.2 Headline Findings

a) Emissions reduction per ha CO2e pa change from 2.82 tonnes (shallow peats) to 15.05 tonnes (peat beds)

Government indicators

Production costs per credits dramatically decline with deeper peat restoration.

Government revenue and societal benefits are highly responsive to the depth of peat restored, when government trades credits.

Individual carbon contracts' Benefit Cost ratio and private sector expenditure leveraged are highly responsive to peat depth restored.

Carbon credit trader indicators

Trader costs are high due to the large magnitude/ volume of credits purchased.

Trader revenues, IRRs and Benefit Cost ratios are extremely sensitive to the depth of peat depth restoration, especially for funds.

Landowner indicators

Production costs per credits dramatically decline with deeper peat restoration.

Landowner revenues, IRRs and Benefit Cost ratios are extremely sensitive to the depth of the peat being restored, especially for funds. The deeper the peat beds being restored the greater the volume of emissions reduction, and hence the greater the numbers of credits produced per hectare. Deeper peats, however, tend to experience greater restoration costs.

Synopsis

In sum, in this scenario all instruments perform exceptionally well, but note restoration costs have been held constant which may not be true.

b) Social discount rate – changed from 3.5% to 6.0%

Government indicators

Government revenue and public benefits are highly responsive to social discount rates, especially where government trades credits.

Carbon credit trader indicators

Both costs and benefits are highly responsive to discount rates for traders.

Landowner indicators

Both costs and benefits are highly responsive to discount rates for landowners.

Synopsis

In sum, in this scenario all instruments are similarly highly sensitive to discount rates. The implication is that any uncertainty or risk to investments which lead to higher discounting rates, will significantly reduce incentives for private sector participation.

c) Inclusion of 40% hard-to-access peat

Government indicators

Government costs are sensitive to restoration costs per hectare. A 200% increase in restoration costs results in a 53% to 88% increase in costs, and a 32% to 47% reduction in Benefit Cost ratio.

Government revenue when a loan is made to the private sector responds positively due to the loan values increasing as restoration costs increase.

Carbon credit trader indicators

The IRR for traders involved in funds and restoration, is highly sensitive to the restoration costs.

Landowner indicators

The IRR for landowners is highly sensitive to restoration costs and accessibility.

Project / society indicators

Benefit Cost ratios are reduced by 21% to 28% for a 200% increase in restoration costs.

Synopsis

In sum, without a corresponding increase in credit prices, an increase in restoration costs may make a fund not viable.

d) Market price for Peatland Carbon Units declines to £15.00

Government indicators

A 42% decrease in the market price of credits results in a 42% decline in revenue when government trades credits, but no change when offering loans.

Government Benefit Cost ratios are negatively impacted by low prices in instruments where-in government trades credits. Low prices represent risk to government trading.

Carbon credit trader indicators

Low prices impact negatively on traders' IRRs, and are therefore a serious risk.

Landowner indicators

Landowners may be buffered from low prices in government contracts, where government bears the restoration cost burden, but where landowners take on some restoration burden, the IRRs are at risk.

Synopsis

In sum, land owners may be buffered by government contracts, but not when involved with funds. However, government would be hard-pressed to service contracts with reduced revenue. Government and traders are at serious risk with price reductions.

e) Market price for Peatland Carbon Units increases to £45.00

Government indicators

A 73% increase in PCU market prices results in a 73% increase in revenue.

Carbon credit trader indicators

A high PCU price results in attractive IRRs for traders, implying that both funds work well for traders in a high PCU price scenario.

Landowner indicators

Landowners IRRs respond positively to PCU price increases, but returns may not be attractive.

Synopsis

In sum, in higher PCU price scenarios, funds outperform government contracts in respect to societal benefits.

f) Traders' premium mark-up declines from 30% to 0%

Government indicators

Government revenue responds negatively with no mark-ups when trading credits, especially in the First Loss option, with little or no revenue for re-investment.

Carbon credit trader indicators

Without a mark-up between PCU bought at the farm gate and traded as offsets, traders face poor IRRs and Benefit Cost ratios, as the only income may be the difference between PIU prices and PCU prices. However, capital costs have not been accounted for in the model, and consequently, little or no revenue may be generated.

Landowner indicators

Landowner returns are not responsive to mark-ups.

Synopsis

In sum, in this scenario government and private sector PCU trading is not viable.

g) The price of PCUs at farm gate is discounted by 30%

Government indicators

Government trading is not impacted by discounted PCU prices at the farm gate, as government does not buy PCUs from farmers it takes a share on the credits.

Carbon credit trader indicators

The costs of PCUs decline for traders buying from landowners. PCU selling prices for traders do not change.

A 30% discount rate for PCUs at the farm gate generates a modest increase in IRRs but may still not be sufficiently large enough to make the fund instruments viable for traders.

Landowner indicators

The IRRs for landowners decline in this scenario. However, whilst the funds offer landowners unacceptable returns, the contracts with government are sufficiently lucrative to buffer the impact of a discount.

Synopsis

In sum, in this scenario returns to landowners are not sufficient to warrant trading PCUs in association with funds, but only in government linked contracts.

h) Biodiversity credits are traded in association with carbon credits

Government indicators

When trading biodiversity credits, government revenue response is modest.

Carbon credit trader indicators

Adding biodiversity credits to the traders' portfolio increases revenue by 5% to 6%, with an improved IRR.

Landowner indicators

Adding biodiversity to landowners’ trading has a significant impact on revenues and IRRs.

Synopsis

In sum, biodiversity credit values, at the current emerging levels, may have a muted positive impact on returns to traders but would be beneficial to landowners.

i) PCU real price increase is reduced from 2% to 0.01%

Government indicators

A negligible real increase in PCU prices has a large negative impact on government revenue.

Carbon credit trader indicators

Negligible real price growth has significant negative impacts on Fund IRRs for traders. However, if traders are not involved in PCU production, then there is a significant positive impact on IRRs and Benefit Cost ratios due to lower PCU prices.

Landowner indicators

Lower PCU price increases significantly reduce landowner revenues – declining between 45% to 48%.

Lower PCU price increases make Funds not viable, but have low negative impacts on government contracts, which buffer landowners.

Synopsis

In sum, little or no real price increases for PCUs place government revenue at risk when government trades credits. Similarly, funds are at risk without robust price increases.