Running an ERF project includes a number of different risks. They are summarised below, followed by sample sensitivity and threshold analysis for example projects.

10.2.1 Categories of risk

Risks in a carbon farming project fall into a number of broad categories.

Policy risk

Carbon farming under the ERF depends upon legislation, and there is currently considerable uncertainty about the future form of carbon policy. Recent events in Australia have shown that specific policies can change rapidly. Policy risk will affect both the quantity of ACCUs that can be earned and the prices of those ACCUs.

Market risk

In many cases, ACCU prices could be determined on markets. Under the ERF, this will be through auctions for the purchase of ACCUs. Because different sellers with a wide range of supply costs can enter those markets, this represents a risk from the carbon farming perspective.

Technical risk

Technical risks are risks inherent in the technical measurement (or modelling) of many carbon farming projects. In many cases, the amount of abatement is unknown in advance and so represents a risk to the project.

Project risk

Like any project, a carbon farming project is subject to the general risks of any new activity, particularly risks of cost overruns or time delays in implementation.

10.2.2 Quantity of abatement (number of ACCUs) generated

Despite the substantial effort that goes into constructing a methodology, the number of ACCUs that will ultimately be generated by a project is not known in advance with certainty.

Various things could go wrong during the project, and there may be regional differences in the impacts of implementation. The methodologies contain a number of mechanisms to help manage this risk:

• In general, they use conservative assumptions about the amount of abatement that can be achieved.

• Sequestration methodologies contain a 5% ‘risk of reversal buffer', which reduces the number of ACCUs generated by the project.

• The methodologies, and the ERF in general, require very careful record-keeping. The records can be used to monitor abatement and to make appropriate adjustments if it seems to be going astray.

The business case for an ERF project should carefully consider the implication of different outcomes for the number of ACCUs that could be generated. This may be particularly important for sequestration projects, for which credits are generated over a period of time and which rely on the growth performance of trees or on actual performance in soil sequestration.

10.2.3 The price of ACCUs

The ultimate price at which ACCUs can be sold is not known with certainty at the beginning of a project. There are a number of options for managing this risk:

• Understand the sensitivity of net project benefits to changes in ACCU prices. What is the minimum price required for the project to break even? How does that price compare with recent contracted or spot prices?

• How does that sensitivity relate to known prices in existing carbon markets? If the project requires prices that are much higher than those currently observed, there could be a significant downside risk implicit in the project.

• Certain forms of business arrangement may allow for the hedging of risks. For example, some aggregators may offer a fixed price for a sequestration project. Clearly, there is a cost to this: the price offered could be lower than the final market price for ACCUs. However, hedging is an important mechanism for managing downside risks.

10.2.4 Unexpected changes in project costs

It is possible that unexpected costs could emerge during the project. This is particularly the case for sequestration projects, in which unforeseen events (drought, fire and so on) might lead to the loss of carbon stores. Re-establishing the carbon stores (as required under the ERF) would involve additional costs.

Some of this sort of risk is partially managed by making conservative assumptions in calculating the likely extent of abatement.

For sequestration projects, it may be appropriate to explicitly include estimates of losses from unforeseen events in the original project plan. In many regions, the incidence of drought or other events can be calculated from the historical record.

As with price uncertainty, it may also be appropriate to use mechanisms for spreading project costs across a number of different entities. This may include some of the more collective or cooperative business models discussed in this manual.

10.2.5 Risk in the context of the overall farm enterprise

Any farm enterprise faces a number of different risks (often, but not always, climate related). It is generally good practice to structure the activities within the enterprise so as to minimise overall risk (for a given level of return). In this sense, new activities can increase or decrease the overall risk of the enterprise. New activities that increase overall risk need to bring with them an increase in return to compensate for that risk.

The same broad principles are true for ERF-related activities, which can increase or decrease overall risk to the farm enterprise:

• ERF activities tend to increase risk to the extent that their risks correlate with other risks on the farm. For example, broadacre farming and ERF sequestration projects are both susceptible to drought, so their risks are correlated.

• On the other hand, the co-benefits of some ERF activities (lowering salinity, for example) may mean that they are able to reduce risks within the overall enterprise. The contribution of the ERF project to overall risk (relative to return) depends on the particulars of the enterprise and the methodology.

In late 2020 the CER released new information on risk from fire. The guidance document, which outlines the obligations ERF vegetation project proponents have to take reasonable steps to protect stored carbon on their projects, is titled "Reducing the risk of fire and preserving sequestered carbon in Emissions Reduction Fund vegetation projects", and is available here.

10.2.6 Downside risk

Downside risk refers to the worst thing that can happen in a project—if many things go wrong, what is the financial cost? Understanding downside risk is crucial in business planning, as it helps in the assessment of how much risk the farmer is prepared to bear.

In the examples below, downside risk is shown in the range of outcomes from the illustrated projects.