What About Permanence Risk?

Every conversation about nature-based carbon ends in the same place. What if the forest burns, or the soil is ploughed, or the mangroves are cleared? What if, in other words, a carbon claim is not permanent?

Finance has a name for a hazard that cannot be eliminated but can be measured. It calls it risk, and the risk of non-permanence (called reversal risk) is not a reason to stay away from carbon. It is what capital markets exist to allocate and price.

Hold a raw credit and the risk is yours, silently. No document says so, no price is attached, and there is no way to hand it to anyone else. If the environmental benefit is reversed, the credit forfeits its value. The risk is not absent. It is unpriced and unassigned, the worst of both worlds.

That changes when carbon is wrapped inside a financial security, because the sovereign’s covenant can then be carried into terms that are binding. An authorization is negotiated, so it can say who stands behind a reversal event and to what extent. One country may accept full replacement, another may share it with the producer, and a third may accept none, with the buyer pricing the difference. Nobody has to wait for a single global rule on reversal liability, because each transaction settles the question for itself, and the market compares the answers as prices.

There are two variants of reversal risk. One is physical: climate change and anthropogenic land use change. The other is sovereign: the country that gave the covenant does not honor it. Both are already measured by people who do it for a living. Physical reversal is a hazard question, and the catastrophe models that price wildfire, drought, and storm exposure for insurers grade it here. Sovereign reversal is a credit question, priced the way a country’s debt is priced.

Because both are documented, both can be rated, so a buyer sees the physical risks associated with a given carbon unit and the standing of the sovereign behind it, and pays accordingly. Both can also be insured: reversal cover has the same shape as crop failure or property damage, and political risk cover has existed for decades. Whoever holds the position decides how much of either risk to keep and how much to lay off.

None of this stops a reversal, but it makes the consequence of one an allocated, priced, survivable event rather than a silent hole in a portfolio.

That is what makes permanence quotable. A market maker will not warehouse a risk with no owner and no price. It will warehouse one that is allocated in proper documentation, insured where needed, rated, and marked like any other position.

Which is the whole argument. The parts exist, the law is settled, the accounting works, the demand is legislated, and permanence risk can be allocated. What is still missing is a price that reaches into the future.

Next up: Where Is the Curve?

Part of No New Parts, a sixteen-part series by Andrew Gilmour.