Futures Market for Ag Carbon Offsets under Mandatory and Voluntary Emission Targets

By Oranuch Wongpiyabovorn, Alejandro Plastina, and Sergio H. Lence


Increasing concerns about climate change have prompted actions, both by governments and the private sector, aimed at curbing the emissions of greenhouse gases (GHGs). An important number of such initiatives involve the trading of GHG allowances and offsets. An allowance permits its holder to emit a specified amount of GHGs, whereas an offset is a certified reduction in GHG emissions that can be used to compensate for GHG emissions elsewhere. Recently, carbon offsets have attracted the attention of decisionmakers in agriculture for their alleged potential to enhance farmers’ profits, as some agricultural activities can generate offsets by capturing GHGs (e.g., methane capture from manure management, soil carbon sequestration, and fertilizer use reduction). The purpose of this article is to provide some background information on these markets and discuss the potential of the futures market for GHG offsets recently launched by the Chicago Mercantile Exchange (CME) Group to act as a catalyzer of the market for agricultural offsets.

Mandatory programs to reduce emissions

According to the World Bank (2020), there are 31 emissions trading systems (ETSs) around the world. In these cap-and-trade systems, governments limit GHG emissions by setting a cap and distributing emission allowances among emitters, who can then choose between reducing emissions themselves or purchasing excess allowances (and sometimes offsets) from others.

The world’s largest carbon market is the European Union (EU) ETS, which is a mandatory cap-and-trade system covering almost 5% of the world’s annual GHG emissions (World Bank 2020), and includes all EU member states. The EU ETS currently covers three GHGs, namely carbon dioxide (CO2), nitrous oxide, and perfluorocarbons, from power generation, energy-intensive industry, and commercial aviation sectors. The program is now in phase IV (2021–2030), in which the goal is to reduce emissions by at least 40% compared to the 1990 level, and the cap on emissions decreases annually at a linear reduction factor of 2.2%.

In the United States, there are currently two government-sponsored programs to limit GHG emissions, namely, the Regional Greenhouse Gas Initiative (RGGI), and California’s cap-and-trade program. The RGGI was established in 2005 to regulate emissions from electric power plants in eleven northeastern states: Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey (withdrew in 2012, rejoined in 2020), New York, Rhode Island, Vermont, and Virginia. The RGGI does not directly regulate agriculture and forest emissions, but conservation activities to reduce emissions and store carbon from these sectors can generate offsets that can be sold to the capped sectors. In particular, the only agricultural activity permitted as an RGGI offset is methane capture from manure management.

California’s cap-and-trade program, launched in 2013, places a cap on GHG emissions from the state’s power, industrial, and transportation sectors. The program only allows agriculture offsets from capturing of methane from livestock manure and rice (Murray 2015). Offsets for California’s program can be generated outside the state, whereas RGGI only allows offsets within the region.

At the national level, the 2009 American Clean Energy and Security Act proposal intended to establish an emission cap-and-trade program that would cover seven major GHGs from large emitters, petroleum fuels producers and importers, and gas distributors (PEW Center 2009). Using offsets from agriculture and forestry sources would be allowed to meet compliance. However, the bill never materialized partly due to lack of support in the Senate and the recession with prolonged high unemployment rates (Weiss 2010).

Voluntary programs to reduce emissions

In parallel to the programs implemented by governments to reduce GHG emissions, a large number of initiatives have been launched to curb emissions on a voluntary basis. A prominent example of the latter was the Chicago Climate Exchange (CCX), which was established as a voluntary carbon emissions trading program in 2003. The CCX market not only included activities in the United States, but also many corporations and institutions in eight Canadian provinces and sixteen other countries. CCX members were legally bound to meet GHG emissions reduction requirements. Participants below their emissions thresholds could sell the surplus allowances and participants above their thresholds could purchase them. In addition, agricultural offset projects, from methane collection and soil carbon sequestration, were eligible to offset excess emissions. However, the minimum scale to trade carbon offsets in the CCX market was 10,000 metric tons of CO2-equivalent GHGs (CO2e), which translated roughly into 25,000 acres in conservation practices (Ribera and McCarl 2009). Therefore, aggregators that charged 8%–10% of carbon credits at market price on a yearly basis managed most agricultural projects (Ribera et al. 2009). The scale required to supply carbon credits to the CCX severely limited the interest from the agricultural sector.

Although the price of carbon offsets traded in the CCX peaked at $7.40 per CO2 metric ton in May 2008, the price plummeted to $.10 per metric ton in August 2010 (Griesinger 2010). The problem of the CCX was that the verified emission reductions achieved exceeded the compliance requirement, so the carbon offsets were oversupplied (ICE 2011), which prompted the collapse in their price and the eventual closing of the trading platform at the end of 2010.

Futures markets based on mandatory ETSs

Trading carbon credits in a spot market can involve large price risks, as demonstrated by the CCX experience described in the preceding section. Hence, it should not be surprising that several futures markets have emerged for allowances and offsets. By far, the most successful of such markets has been the one at the Intercontinental Exchange (ICE) for futures contracts on EU Allowances (EUAs). EUA is the official name for the emission allowance of the EU. The holder of one EUA is allowed to emit one metric ton of CO2e. EUA futures have been trading at ICE for more than a decade, and are a well-established market, with daily volume averaging 32 million EUAs in 2020, and open interest of 1 billion EUAs (i.e., 1 gigaton of CO2e) as of the end of September 2020 (ICIS 2020). By comparison, the EUA cap was 1.816 gigatons of CO2e in 2020, and the EU’s overall 2018 GHG emissions were estimated at 3.9 gigatons of CO2e (ICAP 2021).

Futures market based on voluntary programs to reduce emissions

In contrast to the success of the EUA futures market at ICE, futures markets for allowances and offsets based on voluntary programs to reduce emissions have encountered very limited interest. In March 2020, the CME Group began trading CBL Global Emission Offset (GEO) futures contracts. The aim of this futures contract is to help manage risk in carbon prices and establish a global pricing benchmark for the voluntary emissions offset market (CME Group 2021a). In August 2021, the CME Group also started trading futures contracts for offsets generated from agriculture, forestry, and other land use, called Nature-Based GEO (N-GEO). To ensure the transparency of N-GEO futures, only the offsets from Verra’s Verified Carbon Standard for Agriculture, Forestry, and Other Land Use projects and/or the Climate, Community, and Biodiversity Standards are accepted for trading (CME Group 2021b).

As of August 20, 2021, the average prices of GEO and N-GEO futures are $5.11 and $7 per one metric ton of CO2e, respectively. Trading volumes in August 2021 averaged 198 and 503 contracts per day (equivalent to 0.2 and 0.5 million metric tons of CO2e) for GEO and N-GEO futures, respectively, with open interest of 835 and 6,092 contracts at the end of the month.

Is there a future for futures based on voluntary programs?

Given the success of ICE’s futures market for EUAs, an interesting question for the US agricultural sector is whether one can expect a similar success for the recently created CME N-GEO futures market. The answer would be particularly relevant for the agricultural sector because such futures could help catalyze the overall market for agricultural offsets.

To respond to the question just posed, it is critical to understand the drivers of the success of the EUA futures market at ICE. First, the definition of an EUA implies that it is perfectly standardized and homogeneous, thus representing an almost ideal “commodity” for futures trading purposes. Second, the EU ETS scheme, which has been made operational by the creation of the EUAs, is the world’s largest ETS program, covering almost 5% of the world’s annual GHG emissions (World Bank 2020). Hence, the potential size of the market for EUAs is quite large. Finally, and perhaps most importantly, the EU has demonstrated a commitment to make the cap on emissions binding. For example, in response to the substantial drop in GHG emissions caused by the 2008–2009 financial crisis—which resulted in an oversupply of allowances—the EU implemented reforms to the ETS program to avoid the collapse of the EUA price (ICIS 2020). More recently, the annual shrinking of EUA allowances has substantially driven up the EUA price, from below $10/EUA in 2018 to around $60/EUA in September 2021. The cap established by the EU is meant to be binding, which not only supports the price of the EUAs, but also makes it volatile. Price volatility is essential to attract speculators, which are critical to improve the liquidity of the futures market.

In contrast to the mandatory EU program underlying the ICE EUA futures contracts, participants in voluntary programs have incentives to strategically set emission reduction targets that can be achieved at relatively low cost, and avoid imposing stringent caps upon themselves. Thus, voluntary programs lack “hard” caps by design. This feature implies that it is very difficult for prices in a voluntary N-GEO market to rise much or be highly volatile, thus reducing their attractiveness for speculators. In addition, the amount of offsets involved in the voluntary N-GEO program is quite small compared to the number of allowances established by the EU ETS. As a result, one should not expect the market for N-GEO offsets to be as deep as the one for EUAs. Most importantly, however, during times of reduced economic activity (e.g., as in the great recession), emission caps are likely to become non-binding, which would drive their price to zero and make their market collapse. Further, volunteer firms’ lower incentives (and ability) to participate at precisely such times, because of the financial distress probably faced by many of them, would compound this negative effect. These differences between the ICE EUA futures and the CME N-GEO futures suggest that it is reasonable to be skeptical about the latter’s ability to become a highly liquid market that could serve as a pricing benchmark for voluntary agricultural offsets.


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Suggested citation:

Wongpiyabovorn, O., A. Plastina, and S. Lence. 2021. "Futures Market for Ag Carbon Offsets under Mandatory and Voluntary Emission Targets." Agricultural Policy Review, Fall 2021. Center for Agricultural and Rural Development, Iowa State University. Available at www.card.iastate.edu/ag_policy_review/article/?a=127.