Harvesting natural capital benefits from land

In recent years considerable attention has been paid to the potential for land in Scotland to generate benefits by utilising and enhancing, rather than diminishing, our natural capital. Renewable energy, carbon sequestration through planting trees or restoring peatland, rewilding, ecotourism and regenerative agriculture are all being discussed. At the same time, biodiversity policy calls for the establishment of a market for responsible private investment in natural capital.¹ Detailed studies have identified the social and economic impacts of “green” investment² and ownership of land³, while market reviews have shown the effect of natural capital considerations in increasing the demand for, and price of, certain rural land, especially for woodland creation.⁴ Less attention, though, has been paid to the legal vehicles through which external investment can be directed.

 

The most basic approach is simply for the investor to acquire ownership of the land, but as is the case for all the ways in which investors may be seeking to benefit from land, that requires more by way of capital and commitment to management than may be available or desired. Other mechanisms short of ownership are available and this paper, based largely on discussions with practitioners engaged in such transactions⁵, provides a brief overview of what is being done to link investors and landowners and some of the issues to be addressed.

 

There are many possible arrangements, not least depending on whether the physical operations necessary to deliver the carbon or other gains are to be undertaken or managed by the landowner or will be largely the responsibility of the investor. A key feature in all cases is the longevity of the projects involved, lasting for many decades⁶, so catering for future uncertainties and changes is essential, in particular envisaging what will happen when any human party dies or any corporate party is bought over or ceases to exist. Lessons learned from windfarm developments are being applied to other forms of natural capital investment, but distinct aspects need to be considered.

 

The main driving force for investment at present is the benefit to be obtained from carbon capture, by undertaking projects that ensure carbon is taken from the air and sequestered in plants or the soil. In exchange for payment from the investor, the landowner commits to managing the land in a way that delivers the required benefits over an extended period. Primarily, this is crystallised through the marketable credits that can be obtained through the operation of the Woodland Carbon and Peatland Codes⁷, which recognise the benefit gained in storing carbon by creating new woodland or restoring healthy peatland. Meeting the requirements of these schemes through a project registered at the UK Land Carbon Registry produces carbon credits that are a widely recognised asset of commercial value.

 

The eligibility and verification requirements under the Codes provide assurance that genuine gains are being achieved without double-counting and offer a standard way of calculating the scale and monetisation of these benefits. These assurances mean that those seeking carbon credits to offset their own emissions, or for trading with others, have confidence in the “product” and its future recognition (including in the event of the future introduction of mandatory offsetting or taxation arrangements) and in its saleability, and therefore they are willing to invest.

 

The absence as yet of any similar scheme for biodiversity credits is a major obstacle to attracting investment for biodiversity projects, although the arrival of the requirement for Biodiversity Net Gain for new developments in England may help to stimulate progress.⁸ Likewise, the extent to which other forms of vegetation and land use (including expanding areas of sea-grass) might also play a part in capturing and storing atmospheric carbon is not yet reflected in a way that produces recognised credits likely to attract investment.

 

Where investors are interested just in balancing their own emissions, whether for their internal carbon calculations or more generally as part of a commitment to better environmental performance, there is potential for the project design to depart from the requirements and metrics of the Codes. This added flexibility must, however, be balanced with the risk that any credit generated will not be recognised by others. This may become a problem if any mandatory requirements are introduced on the basis of the more widely accepted schemes or if the particular investor ceases to be involved, whether through a change of policy or change of circumstances such as a takeover or insolvency. The investor may end up getting little for their investment or the landowner left committed to a long-term project that is producing no meaningful returns.

 

The long-term nature of the projects means that arrangements have to be in place to ensure that both parties stick to their commitments despite any changes affecting the parties. An individual landowner may die or sell the land within the duration of a project, while the investor may seek to sell on their side of the deal or, in the case of a corporate body, be bought over or wound up; and insolvency could affect either party. Leases have been considered as the basis for the arrangements but rejected, not least because of complications in providing vacant possession (when the parties may want the current landowner to stay in occupation) and potential liability to Land and Buildings Transaction Tax calculated on the value of the carbon credits produced being counted as rent.⁹

 

In property law, real burdens offer one way of creating long-term restrictions on how land is used, but these are available only in limited circumstances, and not usually to those without neighbouring land.¹⁰ Even in the case of those entities able to make use of the more generous availability of conservation burdens¹¹, the limited extent to which a burden will be able to detail the management required to ensure the delivery of the benefits in line with the relevant Code has meant that this approach has not been followed, or not on its own. Moreover, the potential to apply to the Lands Tribunal for Scotland to have any burden discharged or amended¹² counts against relying on this approach to provide long-term guarantees that the land will be managed so as to deliver the carbon gains expected. Instead, reliance is placed on standard securities that offer long-term guarantees, capable of surviving changes of ownership, and can be drafted as needed to meet the relevant requirements. Whereas the Codes require the landowner merely to inform any new owner of the commitments involved in a project¹³, the terms of a standard security can offer the investor a way of ensuring that any new owner is bound by the commitments necessary for the project and ensure that the investor has notice before the land changes hands.

 

The economics of any project depend on various factors. A crucial point is that the exact size of the return on the investment is not certain. Only after the scale of the carbon sequestration has been verified in accordance with the details of the Codes¹⁴ will the precise number of credits gained be determined, and the value of these is at the mercy of what is still a developing and therefore potentially volatile market. At present all of the benefits from woodland creation are “bundled” together and form a single asset, but in future a “stacking” approach may be possible, allowing credits arising from other ecosystem services (e.g. the benefits for biodiversity or managing water resources) to be sold separately.¹⁵ The market currently operates on the basis of the timber and the carbon credits also being treated together rather than as separate assets.

 

How the financial costs, benefits and risks are balanced between investor and landowner is a matter of negotiation, including whether payments should be based on fixed sums, a fixed number of credits or a share of the total number of credits eventually achieved. Projects will require both substantial initial costs (for tree planting or adjusting drainage for peatland rewetting), which the investor might be expected largely to meet, but also long-term maintenance, which provides a reason for the investor not making the full payment to the landowner up front but rather paying in instalments to ensure both carrot and stick for the continued care of the land. Where a sharing of credits is the basis, provision can be made for the landowner’s share of the credits registered in the investor’s name in the UK Land Carbon Registry to be held in trust as a protection in the event of insolvency.

 

Uncertainty also arises because any long-term project has to contemplate future risks, especially when the benefits being sought depend on the natural environment where the results of our inputs can never be guaranteed. Fire or disease can devastate even the best designed and managed new woodland, resulting in no carbon benefits being produced despite the money and effort invested. Both Codes make some provision for such risk. The Woodland Carbon Code requires the landowner to “replant[…] or undertak[e…] alternative planting should woodland area be lost due to wind, fire, pests, diseases or development”.¹⁶ Similarly, the Peatland Code requires the owner to “restore the peatland should the peatland suffer from fire, pests, or disease.”¹⁷ The risks posed by flood or drought are not included here, despite the increasing risk from extreme events arising from our changing climate.

 

Several features and options exist to deal with risks. In the first place both Codes provide for a “buffer”, whereby a proportion of the credits is retained within the national scheme to cover unavoidable carbon losses.¹⁸ This means that although the gains available from any project will be less than the total amount of carbon that is sequestered, some of the biggest risks are catered for in a standard way rather than leaving any individual party exposed in the event of unforeseen failure. The parties may want to hold back some credits as a further hedge to cater for any issues arising between themselves, and to cover fluctuations in the value of carbon units. Caps on liability may also be discussed (e.g. the landowner’s risk being limited to the sums received). Insurance may also be considered, but it is not always available and in particular the uncertainty over the final number of credits that will be (or would have been) created may be an obstacle to full cover.

 

Any woodland creation project is likely to depend on forestry grant support to be viable.¹⁹ Failure to win approval is thus a further risk to be considered; indeed, some plots have come back on the market after the intended woodland projects were not approved. The time taken to get approval also needs to be factored in, but it can be used as a bonus for the original occupier who may be allowed to continue in occupation (for grazing etc.) for an extra season or two.

 

Tax is a further area of concern and not all of the consequences are clear for natural capital projects. The special treatment of forestry is well understood, with exemptions from Income Tax for the sales of timber and from Inheritance Tax, but there remain arguments over whether the value of credits based on new woodland fall within the timber provisions for Capital Gains Tax. Uncertainty over future taxation, such the VAT treatment of carbon credits and associated costs, is a risk, which may be specifically allocated in the arrangements being made.

 

Beyond the parties directly involved, any project will have many impacts on the local community, especially if farmland is converted to woodland, with potential for both positive and negative effects.²⁰ Consultation and engagement with the local community is expressly called for under both Codes²¹ and is also required under the Scottish Land Rights and Responsibilities Statement.²² There is also potential, following the model of windfarms, for some community benefits to be paid to those living in affected areas.²³ In relation to community acquisitions of land, the potential income from carbon credits may be significant in strengthening the financial future of an acquisition, but on the other hand, by increasing the value of the land may raise the obstacles to purchase.

 

The interest in capturing the potential of the land to generate natural capital benefits is likely only to increase, not least because Scottish Government policy seeks to give private investment a bigger role in financing the transformation in land use necessary to tackle the climate and biodiversity crises we face.²⁴ If funds are to be attracted for what is still a very new form of investment, there must be legal and financial structures available to allocate risk and reward and to provide security, taking account of the long-term nature of the enterprise. Ways of doing so are being found at present but there is scope for legislators, financiers and lawyers to think creatively in designing further mechanisms through which all parties can benefit from managing the land in the different ways needed to meet today’s demands.

 

Colin T Reid

University of Dundee

 

[Endnotes]

 

1  Scottish Biodiversity Strategy to 2045: Tackling the Nature Emergency in Scotland (Scottish Government, 2023), p46

2  A McKee et al, The Social and Economic Impacts of Green Land Investment in Rural Scotland (Scottish Government, 2023)

3  J Robbie and G Jokubauskaite, Carbon Markets, Public Interest and Landownership in Scotland (Scottish Land Commission, 2022)

4  R McMorran et al, Rural Land Markets Insights Report (Scottish Land Commission, 2022); I Merrell et al, Rural Land Market Insights Report 2023 (Scottish Land Commission, 2023)

5  Particular thanks go to Stuart Greenwood and Richard Leslie of Shepherd and Wedderburn.

6  Under the Codes discussed here, this is at least 30 years for peatland and up to 100 years for woodland.

7  Woodland Carbon Code: Version 2.2 (UK Government, 2022); and Peatland Code: Version 2.0 (National Trust for Scotland as nominee for the UK National Committee of the IUCN, 2023)

8  Environment Act 2021, ss98–101, schs14–15 (after several delays, a start date of 12th February 2024 has been announced)

9  Land and Buildings Transaction Tax (Scotland) Act 2013, sch19

10  Title Conditions (Scotland) Act 2003

11  Ibid, ss38–42; and Title Conditions (Scotland) Act 2003 (Conservation Bodies) Order 2003 (SSI 2003/453; as amended)

12  Title Conditions (Scotland) Act 2003, s90

13  Woodland Carbon Code (n7), s2.1; and Peatland Code (n7), s2.4 [As no other version/year information was provided here, I’ve assumed it is correct to link back to endnote 7 (n7), but author to confirm? Query applies to all subsequent refs. to Woodland and Peatland Codes, below]

14  Woodland Carbon Code (n7), s3; and Peatland Code (n7), ss1.8 and 3

15  Woodland Carbon Code (n7), s1.6

16  Woodland Carbon Code (n7), s2.3

17  Peatland Code (n7), s2.4

18  Woodland Carbon Code (n7), s2.3 (20% of a project’s net carbon sequestration must be allocated to the buffer); and Peatland Code (n7), s2.3 (15%)

19  forestry.gov.scot/support-regulations/forestry-grants

20  McKee et al (n2), s4.2

21  Woodland Carbon Code (n7), s2.4; and Peatland Code (n7), s1.4

22  Scottish Land Rights and Responsibilities Statement 2022 (Scottish Government, 2022), Principle 7

23  McKee et al (n2), p33; and Delivering Community Benefits from Land (Scottish Land Commission, 2023)

24  Scottish Biodiversity Strategy to 2045 (n1); and Scotland’s Third Land Use Strategy 2021-2026 (Scottish Government, 2021), p6