Forestry's Growing Role in Carbon Finance

One of the bright spots at the Copenhagen climate change summit could be the establishment of a scheme to protect forests and their carbon-absorbing capacity

The world of climate change is full of acronyms. The United Nations Framework Convention on Climate Change is better known as UNFCCC. The Clean Development Mechanism, which allows Western companies to fund eco-friendly projects in emerging economies to offset their emissions, is shortened to CDM. And various carbon credits worldwide are referred to as EUAs, CERs, and VERs. If policymakers get their way at the Copenhagen summit, another acronym will enter the fray. On deck is the so-called REDD, or Reducing Emissions from Deforestation and Forest Degradation.

The project's title may be unwieldy, but REDD could be one of the few successes to come out of Copenhagen. The principle is simple: Because deforestation accounts for about one-fifth of annual increases in carbon dioxide, countries—especially in the developing world—could be paid not to cut down trees. The investment would then be used to offset CO2 output in the West. That would extend existing carbon financial instruments, worth billions of dollars each year, to vast tracts of forests in countries like Brazil and Indonesia.

"We need to move ahead with REDD," says Kevin Conrad, executive director of the Coalition for Rainforest Nations (CfRN), a lobbying group of developing countries. "Deforestation is a serious threat to emerging economies."

An Achievable Goal

Paying to protect forests sounds like a no-brainer, but many hurdles could still fell REDD before the project gets under way. Billions of dollars will be needed, but policymakers and private lenders haven't decided who should pick up the tab. Analysts warn cash could be lost to corruption or flawed projects without necessary checks and balances, such as a transparent financing mechanism. And carbon traders fret that millions of new forestry credits could undermine existing global carbon markets, which have a combined value of roughly $120 billion.

"The inclusion of forestry projects in emission trading systems runs the risk of devaluing other emissions credits," says Louis Redshaw, head of environmental markets at investment bank Barclays Capital (BCS).

Despite the concerns, policymakers are banking on REDD as one of the bright spots at the Copenhagen summit. That's not surprising. Politicians are unlikely to agree to binding global carbon reductions at the meeting, so have turned their attention to more achievable goals. Funding forestry projects, which could cost between $5 billion and $8 billion annually until 2020, may fit the bill—and would give world leaders a much-needed climate change victory.

Public and Private Participation

With so much political capital invested in REDD, analysts expect financing for forestry projects will fall into three phases. First, Western governments could fund individual programs in emerging economies. That would include monitoring systems to track whether trees are being protected, as well as cash handouts to landowners to avoid further deforestation. The UN and several Western governments already are paying for pilot projects in places like Bolivia, Papua New Guinea, and Tanzania. And the assistance, which may be tied to other development goals, could last up to a decade.

"In the beginning, REDD would have to be government-to-government aid," says Kristian Tangen, senior expert at consultancy Point Carbon. "It would focus on reforms so the financing is well spent."

The second stage would bring private financing into REDD but would maintain government support to shield investors from corruption or projects that fail to protect forests. As part of the hybrid structure, REDD-based carbon credits—financial instruments that can be traded to offset companies' CO2 footprint—would gradually be included in the global carbon markets. That's particularly true for the proposed U.S. federal cap-and-trade scheme, which has a large provision for forestry offsets. The European Union's market, the world's largest carbon scheme, currently doesn't allow forest credits but could come on board after 2012.

Forestry Bonds

After forestry projects are well established, governments may turn REDD over to the private sector. Individual companies would then be able to finance forestry projects in emerging economies to offset their carbon emissions. And investment banks and project developers, who are already active in similar schemes linked to green energy in the developing world, also might fund projects. That would create carbon credits, which could be sold on global financial markets for a profit.

Already, financial players are lining up business opportunities. Abyd Karmali, global head of carbon markets at Bank of America Merrill Lynch (BAC), says the longevity of forestry projects, which should last over 50 years, could match the goals of many institutional investors. He envisions a type of forestry bond linked to carbon credits sold in global markets that could offer a stable rate of return with limited investment risk. "It would offer investors the chance to be active participants in the fight against climate change," he says.

The widespread use of forestry bonds is still some time off, but world leaders meeting in Copenhagen hope the financial instruments will eventually become well known. Says CfRN's Conrad: "For REDD to work, we need access to private capital. That's conditional on getting a forestry deal done at Copenhagen."

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Issued by:  Business Week

Author: Mark Scott

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Issue date: December 3, 2009

Link to Article: Origin of this text