Cap and Trade: Impacts of H.R. 2454 on U.S. Agriculture

Cap-and-Trade Impacts of H.R.2454 on U.S. Agriculture Presented at the Commodity Classic March March 3, 2010 2010

GHG Emissions from Capped Sectors (MMT CO2e) - 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 Emissions with Cap-and-Trade = "The Cap" 2032 2033 Emission Projections without Cap-and-Trade (EPA) 2034 2035 Cap-and-Trade Overview 2036 2037 2038 2039 2040 2041 2042 2043 2044 2045 2046 2047 Emission Reduction 2048 2049 2050 1

Cost Drivers for Agriculture Basics Carbon Cap declines Carbon price increases (free today) Energy prices increase Fuel and fertilizer prices increase = Cost of production increases Freely distributed allowances to fertilizer industry help offset fertilizer price increases until 2035 3

Cost Drivers Three BIG Questions 1. What is the carbon price? - Future energy demand - Alternative energy supply - Offset supply 2. What is the impact on energy prices? Cap and Trade Energy Price Impact (relative to reference case) (nominal $) EIA Base 2020 2030 2035 Carbon Price 31.75 64.83 92.64 Diesel (cents/gallon) 32.57 78.31 122.20 3 Natural Gas ($/thous.ft. ) 1.47 3.81 6.81 3. How does that impact cost of production?... 4

U.S. Wheat Production Cost Impacts – (Avg. Farm) Production Cost Impacts (relative to reference) 25.0 Added Fertilizer Impact - (zero allowances) Fertilizer 20.0 Transport (Farm-Elevator/Processor) $21.06 / 7.3% Fuel,Lube, and Electricity 15.0 ($/acre) 10.0 $9.52 / 4.1% 5.0 $3.64 / 1.9% $2.67 / 1.6% $1.67 / 1.3% - 2015 2020 2025 2030 2035 $ per Acre / % of Reference Case Variable *Does not include fuel or fertilizer efficiency increases beyond that assumed in the reference case. Source: Informa Economics, EIA and ERS The cost of cap-and-trade to the average wheat grower = $4/ac by 2025 and $21/ac by 2035. Key Policy Message: Fertilizer allowances are critical. 5

Example: Prairie Gateway Wheat Farm Budget -2025 350 Revenue 300 Costs Increase due to C&T 250 Net Net Revenue Net Revenue Revenue Other $112/acre $108/acre $105/acre 200 $/Acre Seed 150 Repairs 100 Fuel, lube, and electricity 50 Fertilizer 0 2025 Ref 2025 C&T 2025 C&T (no fert. allowances) Nominal$ 6

Cost Impacts Relative to Corn and Soybeans Fuel,Lube, and Electricity Fertilizer Transport (Farm-Elevator/Processor) Added Fertilizer Impact - (no offset assumption) 60 Cost of Production Impacts, $/acre (cost above reference case) 50 40 30 20 10 - Corn Wheat Soybeans Corn Wheat Soybeans Corn Wheat Soybeans w/Fert. Offset Assumption 205 bu/acre 48 bu/acre = 53 bu/acre = 215 bu/acre 50 bu/acre = 56 bu/acre = 226 bu/acre 52 bu/acre = 59 bu/acre = Yield Scenario/$perBu Impact = $0.03/bu $0.08/bu $0.05/bu = $0.09/bu $0.19/bu $0.1/bu = $0.22/bu $0.4/bu $0.19/bu % Reference Variable Costs 1.2% 1.9% 1.2% 3.7% 4.1% 2.1% 7.8% 7.3% 3.3% 2025 2030 2035 7

Conclusions Impact on wheat production costs is less than corn but more than soybeans. Impacts are minimal in the short-term; up until 2025. Fertilizer allowance assumptions are critical. On a regional basis: Short-term: impacts are higher in the Prairie Gateway due to energy used for irrigation. Long-term: regions (e.g., Prairie Gateway and Northern Great Plains) and farmers with lower nitrogen based fertilizer usage will be at a distinct advantage. 8

Benefits: Carbon Offset Opportunities

Carbon Offset Credits – What are they? C&T creates a tradable market for GHG emissions Agriculture is not a capped sector under C&T However, by reducing carbon, agriculture can sell a carbon offset credit for every ton of GHG emissions reduced. Sell these credits at the market carbon price to capped sectors. Capped sectors use these credits just like allowances. 10

How do I get carbon offset credits? Carbon Sequestration Rates - Mt CO2e/ac 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 Afforestation of cropland /1 CROPLAND: Land-Use Changes Croplands shifted to perennial grasses Conservation Buffers/2 Restoration of wetlands Conservation to No-Till /3 Pasture Grazing Production Practice Improved crop rotations and winter cover crops Changes Elimination of summer fallow Average High Maximun Improved fertilizer manager Use of organic manure and byproducts /4 Improved irrigation management Afforestation of pasture Management Land Rangeland management Improved use of fertilizers Use of organic manure Planting of improved species Grazing management Source: USDA, CCX, DOE, Informa Economics Key Policy Message: Methodology used to calculate SRs can have large impact on net farm revenues and potential cropland acreage shifts. 11

What is the Revenue Potential? Practice Sequestration Rate 2012 2015 2020 2025 2030 2035 Mt CO2e/ac Carbon Credit - $/Acre * Afforestation of cropland /1 1.90 25 38 62 100 160 255 Croplands shifted to perennial grasses 1.25 19 25 41 66 105 167 Conservation Buffers/2 0.70 11 14 23 37 59 93 Restoration of wetlands 0.37 6 7 12 19 31 49 Conservation to No-Till /3 0.66 10 13 22 35 56 89 Improved crop rotations and winter cover crops 0.29 4 6 10 15 25 39 Elimination of summer fallow 0.15 2 3 5 8 12 20 Improved fertilizer manager 0.15 2 3 5 8 12 20 Use of organic manure and byproducts /4 1.28 20 26 42 67 108 172 Improved irrigation management 0.15 2 3 5 8 12 20 Afforestation of pasture 1.48 23 30 48 78 125 198 Rangeland management 0.37 6 7 12 19 31 49 Improved use of fertilizers 0.55 8 11 18 29 46 74 Use of organic manure 1.28 20 26 42 67 108 172 Planting of improved species 0.73 11 15 24 39 62 98 Grazing management 1.10 17 22 36 58 92 147 Carbon Price (nominal$/CO2e) 19 25 41 66 105 167 * Sequestration rates are discounted by 20% to reflect potential reversals. Source: USDA, CXX, DOE, IEA, Informa Economics. Key Policy Messages: (1) Limitation on # of Re-enrollment periods will significantly impact potential revenues in the out years (2) Ability to stack carbon credits could add significantly to potential revenue opportunities 12

Average No-Till Carbon Sequestration Rate by Region and Major Crop Northern Great Plains Northern Great Plains Northern Crescent Northern Crescent Basin and Range Heartland Heartland Basin and Range Fruitful Rim Fruitful Rim Eastern Uplands Eastern Uplands Southern Seaboard Southern Seaboard Prairie Gateway Prairie Gateway Mississippi Portal Mississippi Portal No Till Sequestration Rates (CO2e Tonnes per Acre) 0.61 Corn Soybeans Wheat Cotton © 2009 Informa Economics, Inc. 13

Distinction between Continuous and Rotational No-Till US Rice Northern Great Plains Northern Crescent Cotton Heartland Basin and Range Wheat Fruitful Rim Eastern Uplands Soybeans Southern Seaboard Prairie Gateway Corn Mississippi Portal 0% 10% 20% 30% 40% 50% 60% 70% Key Policy Message: Addressing additionality - Distinction btw continuous and rotational 14

Wheat Net Impact: Benefits of no-till – Costs 60 Net Impact for Adopters (no adoption costs) 50 Net Impact for Non-Adopters Net Revenue Impact ($/acre) 40 30 20 10 - (10) (20) (30) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 Cost for non-adopter (no offset revenue): $4/ac by 2025 and $21/ac by 2035. Net Gain for no-till adopter (no adoption costs): $25/ac by 2025 and $51/ac by 2035. 15

Wheat Net Impact: Benefits of no-till – Costs 60 Net Impact for Adopters (no adoption costs) 50 Net Impact for Non-Adopters Net Revenue Impact ($/acre) 40 Net Impact for Adopters (w/ est. no-till costs) 30 20 10 - (10) (20) (30) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 Adopting no-till does not come without a cost (e.g., yield drag, equipment investment, risk). Net Gain for no-till adopter (with/ est. adoption costs): $17/ac by 2025 and $47/ac by 2035. 16

Wheat Net Impact: Benefits of no-till – Costs 60 Net Impact for Adopters (no adoption costs) 50 Net Impact for Non-Adopters 40 Net Impact for Adopters (w/ est. no-till costs) Net Revenue Impact ($/acre) Net Impact for All Wheat (w/ est. no-till costs) 30 20 10 - (10) (20) (30) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 Not every wheat farmer will be able to practice no-till. Net Industry Gain (w/ no-till as only offset): $4/ac by 2025 and $35/ac by 2035. 17

Example: Prairie Gateway Wheat Farm Budget 350 Carbon Credit 300 Net Net Revenue Revenue 250 $121/acre $118/acre Revenue Net Revenue $112/acre Costs 200 $/Acre No-till Costs 150 100 Increase due to C&T 50 Production Costs 0 2025 Ref 2025 C&T 2025 C&T (no fert. allowances) Nominal$ 18

Wheat Net Impact: Benefits of no-till – Costs Conclusions (no-till) Wheat has a larger potential gain than corn but smaller than soybeans. On average, U.S. wheat producers could benefit by approximately $35/acre from cap-and-trade by 2035. Some farmers/regions will not benefit to the same degree as others --- benefit will primarily be driven by the carbon SR. 19

There are opportunities other than no-till Practice Sequestration Rate 2012 2015 2020 2025 2030 2035 Mt CO2e/ac Carbon Credit - $/Acre * Afforestation of cropland /1 1.90 25 38 62 100 160 255 Croplands shifted to perennial grasses 1.25 19 25 41 66 105 167 Conservation Buffers/2 0.70 11 14 23 37 59 93 Restoration of wetlands 0.37 6 7 12 19 31 49 Conservation to No-Till /3 0.66 10 13 22 35 56 89 Improved crop rotations and winter cover crops 0.29 4 6 10 15 25 39 Elimination of summer fallow 0.15 2 3 5 8 12 20 Improved fertilizer manager 0.15 2 3 5 8 12 20 Use of organic manure and byproducts /4 1.28 20 26 42 67 108 172 Improved irrigation management 0.15 2 3 5 8 12 20 Afforestation of pasture 1.48 23 30 48 78 125 198 Rangeland management 0.37 6 7 12 19 31 49 Improved use of fertilizers 0.55 8 11 18 29 46 74 Use of organic manure 1.28 20 26 42 67 108 172 Planting of improved species 0.73 11 15 24 39 62 98 Grazing management 1.10 17 22 36 58 92 147 Carbon Price (nominal$/CO2e) 19 25 41 66 105 167 * Sequestration rates are discounted by 20% to reflect potential reversals. Source: USDA, CXX, DOE, IEA, Informa Economics. Fertilizer Management = + $20/ac by 2035 Elimination of Summer Fallow = + 20/ac by 2035 20

Examples of Other Offset Opportunities Elimination of Summer Fallow/Cover Crop Benefits $20/acre carbon payment (2035). Reduced erosion If using a cover crop, Reduction in weed, pest and disease pressures If cover crop is a legume, can help fix nitrogen in the soil $39/acre carbon payment if using a cover crop (2035) Costs Reduced moisture – summer fallow is often used to store water in soil prior to seeding Planting costs if using a cover crop 21

Examples of Other Offset Opportunities Improved Fertilizer Management Benefits $20/acre carbon payment (2035). Costs Improved fertilizer management could include: Systems to better match supply and demand Sub-surface applications Use of ammonium nitrogen sources not mobile forms of nitrogen such as nitrate and urea Use of advanced fertilizers, examples: Slow release fertilizers Stabilized nitrogen fertilizers A nitrification inhibitor 22

Conclusions – Carbon Offset Opportunities There are a number of potential revenue opportunities available to farmers under C&T. If structured properly, C&T could benefit a large number of wheat farmers. However, not everyone will benefit to the same level. Legislation is not open or closed to additional opportunities. 23

Top Policy Issues Allowances to fertilizer industry are critical in keeping production cost impacts down Methodology used to calculate SRs can have large impact on net farm revenues and potential cropland acreage shifts. Clearly establish minimum set of offset practices. The Bill should establish the current list of offset practices as a minimum set – not as examples. Limiting the number of offset credit periods in which a producer can re-enroll their offset practice will limit offset credits available to farmers in later years when the cost impact of cap-and-trade is greatest. 24

Renewable Electricity Standard

Renewable Electricity Standard (RES) C&T creates a federal RES, which requires 20% of electricity by 2020 to be from renewable sources. Creates increased demand for wind, solar and renewable energy crops. Potential to increase revenues, in certain scenarios. Currently enacted state RESs mitigate demand increase due to C&T. 26

Reference Scenario (No Cap-and-Trade) Reference Case Renewable Electricity Generation 900 Wind 800 Solar Wood and Other Biomass Municipal Solid Waste 700 Geothermal Generation (billion kwh) Conventional Hydropower 600 500 400 300 200 100 0 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 2028 2030 Source: EIA 27

Biomass Contributes Largest Share of Increase under C&T Additional Renewable Energy Generation by Source (Basic - Reference) 250 Electricity Generation (billion kilowatthours) Wind Solar Wood and Other Biomass 200 Municipal Solid Waste Geothermal Conventional Hydropower 150 100 50 0 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 Source: EIA Infrastructural issues limit further wind expansion. Other gov’t programs, such as BCAP improve biomass economics 28

RES Impact on Agriculture 2020 Total Renewable Electricity Increase 171 billion kwh 2020 Biomass 161 billion kwh = 32 million tons; Electricity: $15.7 billion Additional Energy Crop Acres 1.6-4.8 million Scenario Assumptions: Energy crops account for 50-75% of biomass increase Energy crop yields of 5-10 dry tons/acre 29

Specific Case Study Kansas Wheat – Switchgrass Example 2011 2012 Year 3-10 SWITCHGRASS CASH FLOW Yield 1.50 4.59 6.70 FARMGATE COSTS (includes labor) Establishment Costs ($/acre) 52.40 13.44 - Establishment Costs 209.62 53.76 - BCAP 157.21 40.32 Production Costs ($/acre) 65.34 164.40 283.80 Farmgate Costs ($/acre) 117.75 177.84 283.80 GROWER REVENUE Grower Payment ($/acre) 39.40 110.27 250.68 Grower Payment ($/ton)* 26.27 24.02 37.22 BCAP Payments ($/acre) 39.40 110.27 36.26 BCAP Matching Funds 39.40 110.27 BCAP Annual Payment ** 36.26 Carbon Payment ($/acre) - 20.06 31.37 Grower Revenue ($/acre) 78.80 240.61 318.31 NET RETURNS Net Return ($/acre) (38.95) 62.77 34.52 * Based on a delivered feedstock price of $50/ton ** Payments distributed through 2017 30

Specific Case Study Kansas Wheat – Switchgrass Example Average Annual Return ($/acre) NPV 2011-2020 Prairie Gateway Wheat @ Avg. Yields 56.89 409.17 @ Yields 20% below Avg. 11.94 87.70 Switchgrass Base Scenario (Delivered Feedstock =$50/ton) 30.00 221.50 Delivered Feedstock =$60/ton 111.82 799.09 Delivered Feedstock =$40/ton (52.16) (359.27) 31

Acreage Shift Implications

Acreage Shift Assessment 1. Early on, the majority of the acreage shifts due to afforestation will likely come from pastureland. 2. Initially, the majority of cropland shifts will be to perennial crops, with the exception of certain regions where barriers to entry for forestry are lower. Increased demand for forage and energy crops (RES, RFS, and pasture shift) Less risk Additional income stream Lower start-up costs Cultural reasons – “Farming as a way of life” 33

Acreage Shift Assessment 3. As the carbon price increases, particularly in the years beyond 2035, more cropland can be expected to go into forestry. 4. Yet, even at higher carbon prices (up to 2035), prime cropland will not shift to forestry or perennial crop production. 5. Regions and crops with larger net returns can expect to see less acreage shifting to these alternative carbon crops than regions with lower net returns. Wheat acreage can be expected to decline the most relative to corn and soybeans 34

Potential Carbon Revenue Opportunities for Livestock

Enteric Fermentation Enteric fermentation emissions are twice as large a market as GHGs from manure. Ruminant animals are the source for over 95% of enteric fermentation emissions = Greater potential to gain carbon credits for emission reductions. GHGs must be lowered through increased efficiencies in production, changing feed rations, or adding additives to the feed ration. Potential to reduce enteric fermentation via an additive is approx. 25% . Feedlots that feed steers for 150 days would receive $2.24 per head revenue by adding an additive. Cost of additive? 36

2007 CH4 Emissions from Enteric Fermentation Dairy Horses 23% 3% Beef 72% Sheep 1% Swine 1% Goats 0% Source: USDA “Inventory of U.S. Greenhouse Gas Emissions and Sinks: 1990 –2007” 37

Manure Management Dairy and swine have the greatest opportunity to reduce the GHG emissions through manure mgmt. Most feedlots and poultry operations are dry collection systems. Limited opportunity from runoff of dry systems. The two main methods to reduce GHG off of manure: Methane digesters Large investment costs currently limit its adoption to large operations. Future energy prices will influence economics of methane digesters. Burning/flaring off the methane Less capital intensive Doesn’t generate energy byproduct. 38

Industry Revenue Opportunities Dairy has the greatest opportunity to capture carbon revenues via C&T legislation. Poultry operations have few opportunities Swine operations will have some opportunities to benefit via manure mgmt changes. Feedlots will have some opportunities to benefit via reductions in enteric fermentation emissions Cow/Calf sector – landowners have more options – reduces supply to feedlots 39

EPA Regulated Scenario

EPA Regulated Scenario Background Under the Clean Air Act (CAA), any entity that has the potential to emit more than 100 tons of a regulated pollutant must obtain a permit to operate. In 2007, the Supreme Court, in Massachusetts v. EPA, ordered the EPA to determine whether heat- trapping gases harmed the environment and public health. On December 7, 2009, the EPA announced its determination that GHGs "threaten the public health and welfare of the American people," 41

EPA Regulated vs. C&T Scenario Cap-and-Trade is more efficient than direct regulation = Higher production cost impacts. Direct Regulation does not offer agricultural producers additional revenue opportunities from carbon offsets. EPA regulations could result in the direct regulation of agricultural producers’ GHG emissions; whereas, current cap-and-trade legislation excludes agriculture from GHG emission regulations. 42

Wheat Net Impact: Benefits of no-till – Costs 60 Net Impact for Adopters (no adoption costs) 50 Net Revenue Impact ($/acre) Net Impact for Non-Adopters 40 30 20 10 - (10) (20) (30) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 43

EPA Regulated Scenario Cost Impacts 2025 Example At minimum – impacts presented for cap-and-trade 2025 = $3.64/acre increase Plus … No fertilizer allowances (adds $3.39/acre) No offsets to mitigate carbon price or as a revenue opportunity Inefficiency cost – direct reg. is less efficient than market based approach Direct ag regulation adds a cost of compliance Production cost impacts could potentially be multiple times more than that of cap-and-trade, with no offset revenue opportunity. 44

Final Thoughts and Conclusions

For additional information, please contact : Juan Sacoto Senior Vice President; juan.sacoto@informaecon.com Crystal Carpenter Consultant; crystal.carpenter@informaecon.com

Cap-and-Trade Impacts of H.R.2454 on U.S. Agriculture Presented at the Commodity Classic March March 3, 2010 2010

Cap and Trade: Impacts of H.R. 2454 on U.S. Agriculture

by American Farmland Trust on Apr 13, 2010

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Cap and Trade: Impacts of H.R. 2454 on U.S. Agriculture Presentation Transcript

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