Overcoming barriers to the engagement of supply-side actors in Scotland's peatland natural capital markets - Final Report

1 Executive summary

Reed MS¹, Stevens B¹, Jensen E¹, Merrel I¹, Grandemange Y², O'Halloran F², Frere-Scott J², Glendinning J¹

¹ Scotland's Rural College (SRUC)

² Finance Earth

The Dasgupta Review underscores the need for significant investment in nature-based solutions to combat biodiversity loss and climate change. Peatlands are crucial for water, flood control, biodiversity, and carbon storage, but require extensive restoration to meet Scotland's net-zero goal by 2045. Despite the commitment of £250 million public funding from Scottish Government, more funding is needed to meet peatland restoration targets. Private finance could help meet this need, but there are a number of barriers to scaling up restoration activity via markets for responsible investment in natural capital.

1.1 Aims and approach

This project sought to understand the motivations and preferences for supply-side actors (defined as landowners, managers, and anyone with decision-making power to restore peatlands) to engage in Scotland's peatland natural capital markets, along with their perception of risks, barriers, opportunities and potential solutions to the challenge of responsibly scaling these markets to meet restoration targets. The research considered attitudes towards both public (e.g. Peatland ACTION) and private investment in peatland restoration, including different approaches to blended finance (defined as any combination of public and private funding within the same project). This was done through a combination of pre-interview surveys (n=54), interviews (n=38), workshops (n=3) and financial modelling.

1.2 Literature review

Evidence from previous research suggests that supply-side actors' engagement with peatland natural capital markets is shaped by a range of factors, including:

• Concerns that existing market models may benefit intermediaries more than landowners, and issues around the compatibility of post-restoration restrictions on land management with other economic activities;
• Future uncertainties including eligibility for future agri-environment schemes, inheritance tax implications, and the need to retain carbon for insetting purposes; and
• Project management risks including cashflow problems, concerns about restoration works failing and liabilities for long-term maintenance.

The literature also highlights the importance of individual and social factors, such as values, place attachment, risk perception, and social norms, in shaping supply-side actors' decisions. Material factors like land tenure, land holding characteristics, and costs versus benefits also play a role. It is important to integrate these insights with a broader understanding of values and beliefs about the natural environment and wider moral and environmental justice perspectives when communicating the risks and benefits of engaging with peatland carbon markets.

1.3 Scenarios

Four peatland restoration finance scenarios were explored in the research. These are summarised below and in Table 1. Two scenarios representing options currently available to supply side actors:

• Current scenario A: capital works of restoration funded by Peatland ACTION without carbon finance via the Peatland Code; and
• Current scenario B: capital works of restoration funded by Peatland ACTION with carbon finance via the Peatland Code.
  • To retain Peatland Carbon Units generated via the Peatland Code, Peatland ACTION can fund up to a maximum of 85% of the project's lifetime costs (i.e., capital works of restoration and ongoing maintenance costs), with 15% of funding sourced by the project owner, potentially via the sales of carbon units.

Two scenarios representing potential future blended finance mechanisms that combine carbon finance via the Peatland Code with publicly funded capital and / or maintenance payments:

• Potential scenario C: 50% of capital works of restoration and first 10 years of maintenance costs funded by Peatland ACTION with carbon finance via the Peatland Code;
• Potential scenario D: First 10 years of maintenance costs funded by Peatland ACTION with carbon finance via the Peatland Code. Publicly backed price floor guarantee that ensures a minimum price for carbon, allowing applicants to sell to Government at the agreed price if carbon prices fall below a pre-agreed price floor, while allowing them to sell into a rising market if prices increase.
  • In the potential scenarios, the costs not funded by Peatland ACTION are financed by the project owner, either from own funds or by accessing private investment (debt finance).

1.4 Responses to scenarios

There were positive responses and constructive feedback on the current funding model, where this included carbon revenues via the Peatland Code (current scenario B), and the inclusion of private finance mechanisms, where these included measures to reduce market risk (e.g. a price floor guarantee) and maintenance payments (potential scenario D). Although the current scenario B combining Peatland ACTION with carbon finance via the Peatland Code potentially generated the highest financial returns for peatland carbon projects, it was perceived as higher risk than the two new private finance scenarios by supply-side actors. Although current scenario B has lower upfront cost, unknown maintenance costs and exposure to carbon market fluctuations were causes of concern, with the integration of a price floor guarantee significantly reducing project risk, to supply-side actors, shifting this risk to government (see Table 2 for a detailed comparison of findings between scenarios).

1.5 Policy options

Based on feedback from surveys, interviews, and workshops, two proposed mechanisms could support peatland restoration while responsibly scaling peatland carbon markets. These two mechanisms are not mutually exclusive and can coexist, accommodating different preferences within the market:

1. Retention of current Peatland ACTION funding:

• This approach retains the existing Peatland ACTION funding model, with or without accreditation to the Peatland Code.
• It allows those who prefer not to engage with peatland carbon markets or private investment to continue accessing restoration funding.

2. Blended finance option within Peatland ACTION:

• This option suggests the introduction of a blended finance approach for Peatland Code projects within Peatland ACTION.
• It introduces a price floor guarantee for Peatland Carbon Units (PCUs).
• It also provides funding for ongoing maintenance costs and advice based on site assessments by Peatland ACTION officers.

Proposed blended finance mechanism: To create an efficient funding and financing model for peatland carbon projects, build market integrity and attract private investment in peatland restoration, a proportion of existing public funding (Peatland ACTION) would be repurposed to:

1. Establish a price floor guarantee for PCUs. A price floor guarantee shifts risk away from investors and project developers to government by ensuring a minimum price for PCUs over a fixed period. If market prices fall below the floor price, projects can sell PCUs at the guaranteed price. If market prices are higher, projects can benefit from the higher prices. Examples of similar mechanisms include the UK Feed-in Tariff and the Woodland Carbon Guarantee; and

2. Provide annual maintenance grants. A portion of Peatland ACTION funding would be allocated as annual maintenance grants to support ongoing project maintenance costs. These grants may be conditional or outcomes-linked, ensuring that specified restoration goals are met.

3. Provide subordinated Capital to a proposed Scotland Carbon Fund. The SCF would provide upfront financing for peatland restoration projects by aggregating private capital. It would leverage public capital from the Scottish Government to attract private investors, reducing risk through a first-loss guarantee.

These new measures would be offered in parallel with the existing funding available through Peatland ACTION. Further analysis will be required to assess whether Peatland ACTION capital grants should be fully removed from the blended finance mechanism or gradually phased out (as carbon market prices increase).

Although these new measures may act to sufficiently de-risk and reward landowners to engage with peatland carbon markets, this may be more successful when combined with a degraded peatland tax. There are a number of other enabling factors that could also increase the pipeline of projects coming to market.

Enabling factors: Based on the results of the research, to ensure the success of these mechanisms, additional considerations include:

• Simplifying the application process to any new schemes offered and aligning to Peatland ACTION and Peatland Code processes, including providing clear comparisons;
• Addressing concerns about greenwashing by implementing buyer integrity tests;
• Exploring options for maintenance payments to reward good stewardship;
• Considering the introduction of a degraded peat tax, following the polluter pays principle, which could be controversial but may incentivize engagement with the new mechanisms and increase supply of restoration projects to market; and
• Developing a communication strategy that tailors messages to different stakeholders' values, uses trusted intermediaries, and provides outcome scenarios for various landholdings.

The proposed policy options aim to responsibly scale peatland restoration in Scotland by increasing the supply of peatland restoration projects to market. To do this, this report recommends combining public funding with private financing mechanisms that can de-risk engagement with peatland carbon markets for both landowners and investors. This solution has the potential to help Scottish Government meet and potentially exceed its peatland restoration targets as part of its net zero ambitions for the land use sector. As peatland restoration markets scale, this solution would enable Scottish Government to increasingly target public funding to sites that are difficult to restore on a commercial basis.