Summary/Abstract
Options are derivative contracts that give the purchaser the right to buy (call options) or sell (put options) a given underlying asset at a particular price at a future date. The purchaser of a put option may exercise the right to sell the asset to the issuer at any point in the future before the expiration of the contract. These rights may be contracted directly between two parties (i.e. over-the-counter), or may be sold publicly on formal exchanges, such as the Chicago Board Options Exchange. If the latter, they are called tradeable put options (TPOs) because they can be bought and sold by third-parties via a secondary market. The World Bank has a Pilot Auction Facility for methane and carbon mediation which uses TPOs in carbon-relevant markets, giving producers (of e.g. forest restoration) a floor price for their product. This enables long-term producer planning.
This paper discusses the potentially broader use of these options contracts in carbon dioxide removal (CDR) markets generally and at scale. The paper concludes that they can, if priced correctly, encourage rapid investment both in CDR technology and in operational capacity. TPOs could do this without creating the same type of systemic risk associated with other instruments (e.g. long-dated futures). Nevertheless, the widespread use of such instruments potentially creates novel risks. These include the political risk of premature closure (conventionally rendered as ‘counting your chickens before they are hatched’); and the economic risk of overpaying for carbon removal services. These instruments require careful structuring, and do not inoculate the CDR market against regulatory disruption, or political pressure. Accordingly, the paper notes the potential for the development of TPO markets in CDR, but we urge caution in respect of identified risks.