Forest Investors Grapple with Sustainability
Investor interest in forestry is building, driven by climate change concerns, shifting and growing markets for forestry products – and the good, old-fashioned portfolio diversification benefits of an asset class which weathered the financial crisis much better than most and which offers stable long-term returns. But, argue sustainable finance experts, barriers to monetizing the environmental attributes of the sector remain high – both retarding investment but also generating opportunities for early movers.
“The backdrop for the sector is good,” says Mark Campanale, a director at Four Elements Capital, ahead of a major conference in London on sustainable investment opportunities in forestry and biomass in May. “Climate change politics and legislation is tending to favour biomass as a sustainable energy source and is prioritizing addressing deforestation” in the international climate negotiations.
“On top of that, pension funds and policy-makers are looking at the role of forestry in the investment mix,” he adds, with initiatives such as the UK’s Prince Charles’ Rainforest Bonds Project exploring whether long-term bonds could be raised from institutional investors to finance rainforest protection.
“The macro position is that, if we are ever going to get our carbon targets met, forestry will play at enormous role,” says Alice Chapple, director of sustainable financial markets at Forum for the Future, a London-based environmental think-tank. Chapple, also speaking at the Forestry, Biomass & Sustainability event, adds that, in the wake of the financial crisis, investors “are recognizing that [forestry] is a store of value, there’s a real asset there”.
Of course, forestry investment captures a wide range of activities. At one extreme are conventional investments in North America or Scandinavia that are as much about the land value as the management of the timber. While the large US timber investment management organisations rarely market themselves as “sustainable” investment, most commercial forestry in the advanced economies of the West operates on a sustainable basis, says Kimberley Tara, CEO of FourWinds Capital Management, which manages the $575 million London-listed Phaunos Timber Fund.
“It’s not to do with the investor’s intent, it’s because of the sustainability of the asset class,” she says. “All institutional-grade properties are managed to very high sustainability standards … but it’s typically not the driver of the investment decision.”
But a growing cohort of investors are looking at the asset class through a sustainability prism – and here, too, a number of approaches are being examined. These range from seeking to exploit growing demand for biomass for power, through to efforts to reduce deforestation in the tropics.
Marko Katila, a partner at Finnish investment advisor Dasos Capital, which has raised some €100 million into a targeted €300 million fund, says that his firm “focuses on the word sustainability”, and emphasises efforts to enhance returns from their investments using “the delivery of ecosystem services – carbon and other environmental aspects”.
However, he also stresses that “we pay a lot of attention to diversification based on the end-use market, and we see new demand drivers,” notably the use of biomass for bioenergy. “We see it as a mega-trend – the shifting of the entire economy from one based on traditional fossil fuel to a more biomass-based economy.”
Moreover, this is not just a story in the industrialised world. “It’s happening everywhere – Latin America, Europe, the US, a country like China.” But he cautions that, especially in Europe, forestry investments relying purely on selling biomass to the energy sector are not viable. “It needs to be one revenue stream among others.”
Campanale believes that the biomass supply chain is ripe for consolidation and integration – presenting opportunities to investors. He believes there is space for institutional investors to come in and attempt to “hoover up” the various actors along the supply chain, integrating forest owners, wood chip suppliers, pellet makers, etc. “There are big plans for biomass power plants, but right now there is no dominant supplier, and lots of small players.”
But, while biomass-for-energy is driven by climate change concerns, it remains a conventional forest product. What, then, of the environmental services that forests offer, and which investors are hoping to monetize?
Phaunos explicitly states that its investments, around the world, are chosen using an “ethically and socially responsible investment process”, and Tara talks about identifying environmental revenue streams such as carbon sequestration and water rights. However, she notes that they often have a “very different risk/return profile than from growth of trees … if carbon credits are driving your core return, they are also driving your risk levels.” And a steady 10-12% annual return suddenly becomes a lot more volatile. “People go into forestry because it is low risk.”
Katila at Dasos agrees: “We’ve adopted a very cautious approach to investing in assets where part of the revenue is expected to come from carbon. Forest carbon markets are very volatile and risky.” The failure of the Copenhagen climate talks to lay the foundations for binding emission reduction targets after 2012 has also helped to deter investments.
One of the few areas of progress at last December’s Copenhagen climate talks was in calling for the development of a so-called “REDD+” mechanism, to generate carbon credits from reducing deforestation and degradation. Behind the scenes, considerable progress was made, but the publication of additional details fell victim to the wider failure of the talks.
But, while methodologies are under development for the voluntary carbon market – via the Voluntary Carbon Standard and the American Carbon Registry – how REDD+ would work in the UN climate context is still very unclear.
Speaking at an Environmental Finance webinar in late April, Leslie Durschinger, CEO of San Francisco-based advisory firm Terra Capital Partners, warned than most REDD projects are currently not viable without donor funding, although she noted that aid agencies such as USAID are ramping up their resources dedicated to the issue.
“There are a lot of people knocking on doors in Washington and Norway hoping to get backing for REDD projects,” says Campanale, given support from the US and Norwegian governments for REDD. “However, I’m not seeing many getting backed with private capital.”
Chapple at Forum for the Future cautions that, for many NGOs, “there’s a feeling that we shouldn’t rush into REDD … I’d like to see a lot more pilots going on,” she said.
For all the challenges, some early movers see REDD as a potentially enormous new market, with any federal carbon trading scheme in the US likely to favour REDD credits, and with a global, UN-backed market seen as the ultimate goal. But, as with existing carbon markets, the returns are uncertain and the risks high.
The issues covered in this feature, and more, will be explored at Environmental Finance Publication’s Forestry, Biomass & Sustainability conference, in London on 13 & 14 May.