Unlocking carbon offtake agreements: a guide for buyers and project developers

Unlocking carbon offtake agreements: a guide for buyers and project developers

There is a step change underway in both supply and demand sides of the carbon market. This comes with uncertainty and risk. A carbon offtake agreement, when done right, can be a powerful strategic tool for both carbon project developers and carbon buyers

Unlocking carbon offtake agreements: a guide for buyers and project developers

Carbon offtake agreements, a tool to manage uncertainty and risk

There is significant interest among organisations looking to secure long-term supply of quality carbon credits. It’s a growing trend seen by both our advisory and transactions teams.

And it’s no surprise.

Uncertainty and risk are inherent in our race to net zero – just as they are in any fast moving and large-scale change management program

The world is gambling on the vital optimism to reach our global goal of net zero by 2050. Billions have been pledged globally to develop new emissions reduction projects and support the infrastructure for further investment.

Demand for high quality carbon projects is also on the rise. From businesses captured by tightening national emissions reduction schemes and from growing voluntary demand.

In short, there is a step change underway in both supply and demand sides of the carbon market.

This is where a carbon offtake agreement, when done right, can be a powerful strategic tool for both carbon project developers and carbon buyers.

To build a high-integrity climate portfolio, sustainability leaders will need to hedge against future supply risk, emissions risk and the associated price risk. While project developers will need help securing funding and proving market certainty.

In this article we cover:

  • A brief introduction to carbon offtake agreements
  • Drivers behind the growing interest in carbon contract innovation
  • Key considerations when entering a carbon offtake agreement
  • Other methods of engaging carbon markets

What is a carbon offtake agreement?

A carbon offtake agreement is a contractual arrangement between a carbon project developer and a buyer. It details the volume of carbon credits the buyer agrees to purchase over a set period and the terms of the transaction.

The structure of this agreement is similar to a power purchase agreement (PPA) that many are familiar with. Like a PPA, a carbon offtake agreement often spans several years and is usually drawn up with the help of a market advisor who can help explore, structure and negotiate the deal mechanics.

Both buyers and sellers benefit:

  • Buyers can secure a consistent supply of high-quality credits from projects of choice, manage price risk, and possibly influence project development
  • Project developers can secure revenue early, which helps in financing and scaling projects

High-level mechanics of a carbon offtake agreement

  1. The project developer creates a project that reduces or removes carbon emissions from the atmosphere
  2. The buyer agrees to purchase a specified volume of credits over several years at an agreed commercial structure
  3. Once the project generates carbon credits, the buyer receives them as outlined in the agreement

Drivers of carbon contract innovation

Uncertainty around future price and supply of quality projects is driving carbon contract innovation. We consider each in more detail.

  • Uncertainty around future access to quality projects

    Project quality is a critical consideration for most buyers. Organisations want to ensure their carbon investment has a meaningful positive impact on the environment and local communities.

    As such, considerable time and resources are allocated to project selection and associated due diligence process.

    Buyers who engage with new or early-stage projects and commit to significant volumes can secure supply of right-fit carbon credits, limit ongoing due diligence cost, and have a rare opportunity to help shape project attributes, such as some co-benefits.

    Doing so may also help unlock supply that may not otherwise have been there. Early buyer engagement at scale can also help project developers get new, and often capital intensive, projects off the ground.

    Securing funding early also helps developers avoid the need to cut costs, which can have a potential negative impact on project quality.
  • Uncertainty about future price of quality projects

    As the world increasingly puts a price on emissions, organisations of all sizes must understand their carbon footprint and the associated commercial exposure.

    This is critical for high emitting and hard-to-abate industries, where many organisations are captured by government emissions reduction schemes such as the Safeguard Mechanism here in Australia.

    But it is also important for those taking voluntary action. Forward-looking organisations are prioritising emissions reductions while proactively planning how to manage residual emissions over time.

    However, predicting the future price of carbon credits that meet an organisation’s specific purchasing criteria is difficult to do with a high degree of certainty.

    Several well considered models exist – including this unique, method-specific ACCU price forecast  – but ultimately, they are only as good as their underlying assumptions, and none will be 100% correct.

    It is however well accepted that projects perceived to be of higher quality, usually come at a significantly higher price.

    Long-term contractual arrangements such as carbon offtake agreements allow buyers to create a hedging strategy to manage future supply and price risk.

    The inherent future price uncertainty is also a challenge for project developers when developing their business case and securing funding. A project with a long-term offtake agreement may not need external funding, or the external funding will be easier to secure.

Key considerations and tools for creating a carbon offtake agreement

Carbon buyers and sellers will find value in a similar process when approaching a long-term carbon offtake agreement. It’s also important that both also understand the different tools available to help shape the structure of the agreement.

Steps in approaching a carbon offtake agreement

  1. Understand your risk profile and qualitative preferences

For buyers this means understanding both the financial risk and reward balance as well as the profile of project developers you are willing to consider. Criteria for choosing project developers may include track record, certifications and accreditations, and country of origin.

Buyers also need to detail the qualitative preferences for the types of credits they are looking for. Selection criteria may include methodology, location and co-benefits.

For project developers this means having a clear financial model and an understanding of the types of partners they would ideally like to work with. For example, some developers may choose to focus on the compliance buyer that may not value project co-benefits as much as the voluntary buyer.

While other developers will take the time to understand the complex voluntary buying preferences, and associated price premiums, and develop projects that cater to this demand. We explore this further in our method specific supply, demand and price forecast for the ACCU market.

  1. Define your strategy

For buyers this means understanding your residual emissions position over time and deciding your hedge strategy. You do not need to enter into an offtake agreement for 100% of your carbon credit requirement. In fact, the most risk averse hedge is 50% short-term, 50% long-term.

In this scenario, you would plan to fulfil 50% of your carbon credit needs through a carbon offtake agreement and 50% of it on the spot market as and when required. Alternatively, if you like a project a lot, you can also consider committing to an up-front fixed price for 50% and a floating price for 50%, or consider other engagement structures.  

For project developers this also means deciding an appropriate hedging structure. Like with buyers, the 50% short-term, 50% long-term hedge may be safest, but this does depend on the overall investment requirements, for example how much capital is needed at different project milestones.

  1. Engage the market

For both buyers and sellers this means shortlisting potential counterparties the meet the above requirements and then structuring a deal that's aligned with the strategy and risk profile. It is helpful to engage commercial market experts to help you manage the end-to-end process.

The right advisor must understand the market, the needs and risks of both parties and how to best leverage the right contractual tools to structure the best deal for all involved. The CORE Markets advisory team frequently navigates difficult conversation that often break down in bilateral negotiations. Our extensive network and deep relationships help ensure that both buyers and sellers can find the right-fit partner.

Contractual tools commonly used in a carbon offtake agreement

A carbon offtake agreement does not need to be a ‘fixed price, fixed volume, over time’ arrangement. There are many contractual tools that can be used to effectively manage price and volume risk for both parties.

These include:

  • Price collars: A price collar details the price range within which the carbon credits will be bought and sold. The parties agree on a minimum price (floor) and maximum price (ceiling) for the duration of the contract. If the market price falls below the floor, the developer is protected. If the market price goes above the ceiling, the buyer is protected. Price collars help to manage price risk for both buyers and sellers.
  • Indexed pricing: Using an indexed pricing method, the price of carbon credits can fluctuate in line with an agreed external reference price. This may be a carbon market index or an agreed method-specific price benchmark. The CORE Markets carbon analytics platform provides various price points which are typically used as an index point in a carbon offtake agreement.
  • Volume flexibility clauses: This contractual tool allows variations in the quantity of carbon credits purchased based on changing circumstances. For example, if a buyer’s emissions decrease further than initially expected, the agreement can be modified accordingly.
  • Upfront payments: Carbon offtake agreements often include an upfront payment to help get capital intensive projects off the ground. This advance payment also typically provides the buyer with an opportunity to help shape the final product by having input into various project attributes.
  • Guarantees: Guarantees are usually designed to ensure that the developer delivers the carbon credits as outlined in the agreement. There are buyer guarantees also to ensure commitment and compliance. If either party does not meet their obligations, guarantees kick in, compensating the other party.
  • Break-out clauses: Break-out clauses are designed to create flexibility and provide an exit-strategy for both parties under specific circumstances. These include unforeseen events such as natural disasters or regulatory changes which make the agreement unfeasible.

Other models of engaging carbon markets to secure carbon credit supply

Carbon contract innovation is an important part of managing risk for both carbon credit buyers and sellers. As such, a growing number of organisations are considering tools such carbon offtake agreements as part of their carbon sourcing strategy.

But there are other ways to engage the carbon market to secure carbon credits.

Most organisations use a mix of models to engage the market and this strategy should always support the overall decarbonisation roadmap.

Understanding an organisation’s emissions position early allows sustainability and corporate leaders to explore various carbon sourcing options, beyond those immediately available on the spot market.

The various options we explore with our customers in our advisory work include:

  • Spot purchases: Purchases made for a required number of credits on an as-need basis
  • Forward contracts: Fixed forward purchases for a predetermined volume of credits a year for a short-medium term (e.g. 3-5 years)
  • Carbon offtake agreement: Usually a long-term contractual arrangement for a set volume of credits (around 10-15 years)
  • Equity investment: Taking an equity position in a project and securing a portion of credits created.
  • Developing own project: Creating and developing high-quality carbon project for own use and as a future potential revenue source.

Buyer key risks and benefits of each model are outlined in the table below.

When structured correctly, carbon offtake agreements allow buyers to reap many of the benefits of other longer-term carbon market engagement models, without the additional risk.

Manage carbon risk and opportunity through contract innovation

Carbon offtake agreements offer strategic advantages for both buyers seeking to secure long-term, high-quality credits and project developers needing financial stability.

By understanding and leveraging these agreements, and the many contractual tools available, organisations can better manage both risk and opportunity.    

While most organisations will use a mix of models to engage the carbon market, a carbon offtake agreement, when structured correctly, may allow buyers to reap many of the benefits of other longer-term models, without the additional risk

Speak to our market experts today about your decarbonisation and carbon sourcing strategy.

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