Agriculture: natural capital assets and carbon sequestration

The arrival of the Environment Act 2021 followed the enactment of the Agriculture Act 2020, wherein a statutory framework for a completely new direction for rural and agricultural policy across the UK was created.

The Agriculture Act 2020 provides (among many measures) for the transition from the EU "payments-for-occupation-of-land" subsidy scheme to a domestic one, which gives "public-money-for-public-good". Although widely defined, the ‘public good’ includes a large number of environmental measures, which tie in closely with obligations imposed in the Environment Act 2021.

The new Environmental Land Management Scheme (ELMS) offers not only individual farm subsidies under the Sustainable Farming Incentive, but also more ambitious, wider scale projects under its Local Nature Recovery and Landscape Recovery elements.

Certain measures within both the Agriculture Act 2020 and the Environment Act comprise devolved matters and we are already seeing considerable divergence in policy between the four home countries of the UK. This will only increase as devolved governments make choices which reflect their own political priorities and landscape.

Rural landowners and businesses

Although virtually all of the measures in the Environment Act affect rural landowners and businesses in some capacity, the nature, biodiversity and conservation covenants sections are raising the most issues. Conservation covenants are set to come into existence as a legal structure on 30 September 2022, but, in the interim, section 106 agreements are being used instead in biodiversity gain arrangements with landowners.

The concept of natural capital has become familiar to rural landowners over the past decade and the moves to redirect agricultural subsidies towards schemes, which protect and enhance natural capital assets for wider environmental benefit, are starting to give these assets a greater financial significance.

The new biodiversity gain measures in the Environment Act take that process a giant step forward and when coupled together with the legal structure of a conservation covenant, we have a practical way to turn natural capital into significant income producing assets.

This, in turn, raises issues such as the need to have a standardised approach to auditing the stock of natural capital and to consider this alongside the conventional balance sheet.

Landowners and tenants have many questions about their role in the stewardship and exploitation of natural capital and its associated value. One of these is the fundamental issue of carbon and how an improved ability to sequestrate it might be treated in the context of the landlord and tenant relationship.

Carbon sequestration

For a market in carbon sequestration to operate efficiently, it is necessary to establish:

·        how much additional carbon has been sequestered by any specific measures taken;

·        who owns the sequestration potential and the underlying carbon;

·        legal mechanisms to quantify, define and transfer ownership of such potential; and

·        confirmation that the sequestration potential can operate within existing carbon credit systems.

Here, we are considering the ownership of the sequestration potential and not the valuation of any associated credits or tradeable instruments. This is about the ownership of the opportunity to lock up more carbon and any financial benefits that flow from that will be a function of the evolving marketplace.

Opportunities

In an agricultural context, the prime movers for carbon sequestration are plants and the soil they grow in. The scale of UK farming and forestry means it has a potentially huge role to play in taking CO₂ out of the atmosphere and locking it up. So, we need to consider the control and use of these natural assets to assess who can benefit from the process of increasing carbon sequestration.

A distinction must be drawn, however, between the ability to increase carbon sequestration and the existing bank of carbon stored in the soil and associated vegetation. It is the potential for increasing sequestration, which attracts the value, because that is the basis of the carbon credit market.

Obviously, ownership or ability to control the store and/or the potential may be different and that becomes very relevant in the context of the landlord and tenant relationship.

Freehold ownership

The fee simple absolute estate includes the soil, vegetation growing within it and the minerals lying in strata underneath it. If one considers that a freehold owner is entitled to remove mineral deposits, peat and even the topsoil itself from his land, then that provides strong evidence that carbon stored within these components of ownership is also owned by the freeholder.

But are such rights included within the definition of mines and minerals, as the freeholder might have severed such rights and conveyed them away? In Coleman v Ibstock Brick Limited [2008] EWCA Civ 73, the Court of Appeal considered the meaning of "minerals" in the context of a lease and found that it meant substances "exceptional in use, in value and in character" and did not mean the ordinary soil of the district.

That definition and the fact that carbon is in vegetation, root systems and topsoil in the main, points towards these rights not falling within the meaning of ‘minerals’. The location of the carbon in the topsoil and upper layers is also not consistent with the definition of mines and minerals, which are inevitably in strata of sub-soil beneath.

It follows that if the freeholder occupies the land, then they will also control the sequestration potential of the land, through their management and husbandry of it. Different considerations come into play if third parties are permitted to occupy.

As the market develops, we may well need legislation to clarify the legal nature of ownership of sequestration potential, or to resolve how they are dealt with in a leasehold context.

Landlord and tenant relationship

If a leasehold interest has been granted, the terms of the lease will be important in clarifying what, if any, ability the tenant has to influence or control carbon sequestration, without obtaining the landlord's consent.

In a rural context some of the relevant provisions will span the Agricultural Holdings Act 1986 (1986 Act), the Agricultural Tenancies Act 1995 and possibly the Landlord and Tenant Act 1954.

User clause

Most agricultural tenancy agreements will restrict the use of the holding to agricultural purposes only and so any carbon sequestration will have to be achieved within the definition of agricultural operations. So, increasing organic matter or varying crop rotations will probably be permitted, but the planting of trees or permanent crops (which is usually forbidden) will not.

Further, the tenant will often be under a positive obligation to comply with the Rules of Good Husbandry (ROGH) which (along with the corresponding Rules of Good Estate Management) are the last surviving remnant of the Agriculture Act 1947. The problem for tenants is that the ROGH and all definitions of agriculture in relevant legislation are aimed at maximising production of agricultural commodities and not the provision of environmental benefits.

This focus on production means activities like the creation of wild bird habitats, which utilise extensive conservation grazing, will not be possible because of the requirement in the ROGH to keep "permanent pasture properly mown or grazed and maintained in a good state of cultivation and fertility and in good condition" and "properly stocked."

However, carbon sequestration through husbandry, such as reduced or no tillage farming is squarely within the control and purview of the tenant, along with increasing soil biomass through increasing organic matter.

Entering agreements

The challenge for the tenant is then finding a scheme or commercial arrangement which monetises the carbon sequestration. For tenancies under the 1986 Act, an immediate potential problem arises from the annual periodic term of the tenancy, which does not sit with entering into long term agreements such as conservation covenants.

The standard alienation provisions of an agricultural lease are unlikely to prevent a tenant from entering into a scheme, as acts of carbon sequestration are unlikely to involve sharing possession or occupation of the holding. However, the tenancy agreement may include specific provisions, so should be reviewed.

Depending on the type of tenancy, there may well be a difference between the tenants’ freedom to enter government subsidy schemes and private payments for environmental services. Measures have already been taken in the Agriculture Act 2020 to ensure that 1986 Act tenants are not excluded from claiming government subsidies by the terms of any tenancy agreement.

Ben Sharples is a partner in Michelmores' Agricultural team michelmores.com