Can peat restoration attract private investment?

Governments are looking to recruit private finance to support development of natural capital

The governments of the UK and its constituent nations have ambitious plans for the development of our natural capital, with targets and programmes for planting woodland, restoring peatland and halting depletion of biodiversity. These objectives have been adopted partly to meet UK Net Zero objectives - damaged peatland is a big source of emissions and new woodland is a significant carbon removal opportunity. There are also benefits in the form of ecosystem services like flood prevention.

Achieving these goals will be costly, estimates are in the billions of pounds. Nature restoration is largely a public good and will need government support to be achieved. Public finances are under heavy pressure, so rather than placing the whole burden on taxpayers, governments are looking to recruit private finance to support development of natural capital.

Pension funds and other investors may be willing to deploy their capital to co-finance woodland planting or peatland restoration, generating investment returns from the sale of carbon or biodiversity credits.

In previous articles, I have discussed the sources of investment capital suitable for financing such projects; and considered whether carbon-credit-oriented forestry can deliver the returns investors require. This article considers whether peat restoration can do so too.

Peat restoration

Peat is the world's second biggest carbon sink after the oceans, storing twice the carbon of the world's forests. The UK has 2.6m hectares of peat covering 10% of its land area.

Damaged and dry peat decomposes, emitting stored carbon. 80% of UK peat is damaged, so peat is a big source of UK emissions, generating some 15-20m tCO2/year. This is 4% of UK and 13% of Scotland's total. These percentages will rise quickly as other sources of emissions are abated.

Stopping peat emissions is key to meeting UK Net Zero commitments. The UK's governments have ambitious abatement plans, but they are underdelivering in several areas including peat restoration. The UK is restoring around 15k hectares (ha) per year, but the 7th report of the Committee on Climate Change says 49k ha/yr is needed.

The Peatland Code (the body that regulates peatland carbon credits) divides damaged peat bog into two main categories:

• Drained peat: tens of thousands of drainage ditches have been dug over the last 150 years or so to make peatland more useful for sheep farming and grouse shooting. Ironically, much of this was funded by the Ministry of Agriculture Fisheries and Food in the 1950s to increase food production. The Peatland Code estimates this dried out peat emits 3 tCO2/ha/yr according to Code's calculator. These drains now need to be blocked to allow the water table to rise and rewet the peat. This will stop the peat from decomposing across large areas. 'Grip zipping' isn't particularly technical or expensive work, but there are perhaps one million hectares to fix.
• Actively eroding peat: Natural weathering; grazing and trampling by sheep and deer; and burning moorland to increase grouse production all expose peat (in gullies, ridges (hags) and bare flat areas), which then decomposes, emitting carbon. Fixing this requires careful groundwork, changing the slope of gully walls, reprofiling hags, covering and revegetating bare patches, as well as keeping the herbivores away. This work is labour intensive and often occurs in hard to access areas. This is much more variable in its emissions. The Code uses an average of 14.3 tCO2/ha/yr. Actively eroding peat emits much more CO2/ha, but there are far fewer hectares.

Given the vast area of damaged peat in the UK, fixing it will be a large undertaking.

How much will it cost? In 2019 the Office of National Statistics estimated that it will cost between £8bn and £22bn to restore all of UK peatland, so perhaps £10bn-28bn adjusting for inflation. That's a big sum at a time when fiscal budgets are tight.

Of course, given rising social cost of carbon, the payback period for abating 15-20m tCO2/year of peat emissions is short and the long-term carbon saving immense.

Nevertheless, tight budgets mean the government wants private finance to do more of the heavy lifting, with future revenues generated by sale of Peatland Code carbon credits. Is this likely?

Generating returns from peatland restoration

Here are the steps required for restoration of a 200ha drained peat bog in Scotland based on a project I have studied.

1. Buy site - £2,000 per hectare
2. Bid for a Scottish Peat Action grant to recover 80% of restoration costs
3. Restore the site (survey, drain blocking, hag reprofiling etc.) - £1,800/ha
4. Validate with the Peatland Code - cost £30/ha
5. Maintain restoration for subsequent decades, control herbivores, remove seedlings etc. - £40/ha/yr
6. In Year 5, the first verification of Peatland Code units (PCUs) - cost £40/ha
7. Every 5 or 10 years, verify newly created units - cost £40/ha + inflation

The Peatland Code's calculator estimates that this site, once repaired, will yield a little less than 3 verified PC carbon units ha/yr, so c. 60,000 PC units for 200ha over the 100 year project.

To assess the investment returns available from selling verified PC units from this project, I have built a discounted cash flow model. Revenues depend entirely on the sale of PCUs, so are a function of the price these credits achieve in the marketplace.

I used three carbon price scenarios:

• Low - £25/unit now, £30 in 2030, £100 in 2050
• Medium - £25, £50, £150
• High - £25, £100, £300

The low scenario gives an internal rate of return of 5%, the medium one 8% and the high carbon price scenario gives an IRR of 13%.

Most pension fund investors will require a significant risk premium for this kind of project, and perhaps an illiquidity premium as well. From my discussions with investors, I think pension funds are looking for IRRs in the 8-12% range for this kind of project. If so, peatland restoration clears the bottom 'hurdle rate' in the Medium and High scenarios and manages to clear the top rate only in the High scenario.

For any given carbon price, peatland tends to offer higher IRRs than forest carbon projects, based on similar modelling for these projects. This is because peatland has lower net costs per carbon unit than forest, and revenues come much sooner (no waiting 20 years for trees to grow), which is important when you're discounting at 10%. Though, as we will see it may not be reasonable to assume peatland and woodland units will trade at similar prices.

The structural supply and demand mismatch in the Peatland Credit market

Which carbon price scenario is the most plausible? Carbon credit prices are a function of supply and demand, so to answer this we need to understand how these factors might evolve.

• Credit supply: if the UK continues to pursue its commitment to achieving Net Zero, it will be necessary for UK governments to implement policies to incentivise or require peatland to be restored. While the 49kha of annual restoration recommended by the Committee on Climate Change may not be achieved, if governments succeed in restoring 20-30kha per year, this will generate an additional annual flow of perhaps 60-90,000 PCUs to the market. It is important to realise that is cumulative. Each year another 60-90k is added to the annual flow, resulting in an exponential expansion of credit supply.
• Credit demand: demand for credits largely comes from companies looking to offset their emissions and is voluntary. Companies are emitting tens of millions of tonnes a year in the UK and could, in theory choose to offset a proportion of it using Peatland Code units. However, so far corporate demand for peat units has been patchy. This is partly because companies are nervous about voluntary carbon markets, given various scandals relating to under-delivered credits, mainly in forest-related markets in the global south. They are also nervous about being accused of greenwashing.

Partly because of greenwashing fears, companies have turned to standards to guide their use of carbon credits. Around two thirds of FTSE 100 corporates are signatories to the Science Based Targets Initiative (SBTI) and use its Net Zero Standard to govern their carbon offsetting programmes. The SBTI standard raises two problems for credit demand, one general and one specific to peat.

The general problem is that the SBTI standard says that companies should not begin to use offsets till the end of their Net Zero carbon mitigation journey. For most companies this will be close to 2050, though a few have set an earlier date. This means that there will be little UK corporate demand for offsets for 20 years or more.

SBTI recognises this problem and has proposed in their consultation on version 2 of their standard a change that will bring some demand forward into the 2030s.

The peat-specific problem is more intractable. SBTI's standard says that only credits linked to carbon removals (e.g. direct air capture or forest sequestration) can be used to neutralise residual company emissions (i.e. be used for corporate offsets).

Peatland Code units, however, are awarded not for removing carbon but for avoiding emissions. A drained peat bog emits three tonnes of carbon each year. When it is rewetted, these emissions will be avoided. It is true that in the long run rewetted peat might start sequestering new carbon (i.e. removals), but the rate at which it will do so is likely to be very slow: less than one tonne per year. These removals are currently not included by the Peatland Code because the science is highly uncertain. In any case, PCUs are not removal units and SBTI signatories will not be able to buy them for offsetting purposes.

SBTI does allow corporates to buy a wider range of carbon credits to offset 'Beyond Value Chain Emissions'. This, in theory, will generate some demand for PCUs, but this is going above and beyond Net Zero and few corporates are likely to do it.

Overall, this raises fundamental questions about where demand growth for PCUs will come from. This is a particular problem, given the potential exponential growth in supply of PCUs. Absent intervention by policy makers, it is hard to see demand scaling at the exponential rate required to match this supply.

This in turn makes it difficult for pension funds to be optimistic that PCU prices will achieve the carbon price scenarios needed to justify capital investment in peatland projects. The most secure way to resolve this problem would be for government to intervene somehow to ensure a strong and growing source of demand for PCUs.

Note

I sit on the advisory board of the Woodland Carbon Code. The views I express are my own, not those of the organisations I work with.

Authors

Dr Craig Mackenzie

Senior Lecturer in Sustainable Enterprise, University of Edinburgh Business School