Will Forest Carbon Markets Thrive, or Get Lost in the Woods?
For thousands of years, we have been planting and growing trees without difficulty. It’s simple, and forest carbon business strategy can be, too. In fact, it’s core to what I’m trying to teach the MBA/MS students in my course at the Erb Institute this semester: If the world’s best available technology for removing carbon dioxide from the atmosphere is employing the natural photosynthetic capacity of natural forest management, we can too.
But in many ways, we are all unable to see the forests for the trees.
Even though the global carbon market grew to $136 billion with 8.3 billion tons of carbon dioxide traded in 2009, less than 0.1 percent of that was based on removing existing carbon dioxide out of the atmosphere using photosynthesis. While it is very important to engage in developing a low-carbon economy, it is equally important to remove existing carbon dioxide out of the atmosphere, especially since this is, in fact, a key to mitigating climate change.
Forest carbon offset projects -- whether planting trees, improving harvesting techniques, or not cutting trees -- have some unique characteristics that may make these assets a unique investment asset class. Investors can make debt and equity investments in forest carbon offset companies while they can also invest in spot and forward transactions of the mtCO2e produced by these forest carbon offset projects.
According to the Department of Energy, U.S. demand alone for forest carbon offsets could grow at least 100 times by 2020 (PDF), depending on the scenario. And although forest carbon offsets are emerging as a new alternative investment asset class, the market has been stagnant for the past several years.
What can be done to avoid market failure while promoting rapid market growth?
Limit Risky Business
Overall the risks in the sector are long-date project finance risk, such as currency convertibility, expropriation, political risk, climate change risk, local community risk, and model risk.
These risks are framed by the various investment options available from which to garner forest carbon offset asset returns, including venture capital investment in LLCs, private placement and public equity, sovereign and municipal debt, commercial lending, long-dated options on tons from sequestration, and direct sales to institutional and retail sectors. The sector has specific legal and regulatory risks framed within fee simple property ownership within timberlands, private ownership, and community forests.
In this model, often a sale or investment in forest carbon offset assets becomes a first lien on the property as a risk mitigation tool against project non-performance or malfeasance.
It is, of course, recommended that all project proponents conduct independent title search on water, timber, oil and gas, mineral, and development rights coupled with a specific understanding of the conversation around sub-national and national project rights within the growing forest carbon partnership facility, United Nations Forum on Forests, UN REDD, and other international regulatory pre-compliance and compliance frameworks.