The private sector and REDD: “Turning liabilities into assets”

REDD-Monitor, 4 December 2008

International Emissions Trading Association (IETA) was by far the biggest “NGO” at last year’s climate conference in Bali. In Poznan, IETA has hired a building inside the International Trade Fair where the climate conference is taking place. With sponsorship to be in Poznan from BP, Shell, Enel, AES, Chevron, TÜV SÜD, SGS and the Industrial Technology Research Institute, IETA is no ordinary NGO. It is, in its own words, dedicated to “the establishment of effective market-based trading systems for greenhouse gas emissions by businesses”. On day three in Poznan, REDD-Monitor visited IETA’s side event on “REDD in the voluntary markets: Lessons Learned”. Needless to say, IETA is in favour of trading carbon from forests.

Presentations came from Martin Schroeder of TÜV-SÜD, Johannes Ebeling of EcoSecurities, Ralph J Strebel of Carbon Conservation, Martin Berg of Merrill Lynch Commodities and Anna Lehmann of Sindicatum Carbon Capital.

While there was much to disagree with in the presentations, in particular the blind faith in carbon trading, some interesting information came out of the side event.

Martin Schroeder of TÜV SÜD arrived late, because of a delay to his flight. “This is like CDM,” he joked, “the auditors are always late, but finally they arrive.” He spoke about recent trends in the voluntary forest-carbon projects and markets. While the negotiations are continuing, the voluntary market is moving ahead. “There is an urgent need for consensus on global best practices in REDD methodologies,” he said.

Ecosecurities’ Johannes Ebeling noted that the drivers of deforestation can actually be a long way from the forest. He gave the example of the strong link between deforestation and agricultural prices. Since 2000, the rise in the price of soy, for example, has driven deforestation in Brazil.

Ebeling acknowledged the risk of leakage — an increase in emissions outside of the project area because of project implementation. There can be market leakage, for example if better forest management reduces the amount of logging and causes the price of timber to increase, this would in turn lead to more logging. “It’s very challenging to determine how far you should go to monitor leakage,” he said. “It’s probably never going to be possible to monitor leakage precisely.”

But he concluded that “Climate change demands fast action” and that we should therefore start REDD projects now. He didn’t mentioned that the carbon trade was designed precisely to avoid the need for emissions reductions and thus to avoid meaningful action on climate change.

Ralph J Strebel of Carbon Conservation and Martin Berg of Merrill Lynch Commodities spoke about the Ulu Masen project in Aceh province in Indonesia. Strebel noted that his company considers large scale REDD projects to be the way forward, because they are easier to implement than smaller projects. He mentioned alternative livelihoods for local communities, which included growing crops such as cocoa, jatropha or coffee and developing small hydro project. “Some of these are more controversial than others,” he said. Strebel concluded that forests are a “Convenient solution to an inconvenient problem. It can be 20% of the problem or 20% of the solution.” It sounds like Strebel is looking forward to Al Gore’s arrival in Poznan next week.

Merrill Lynch’s Martin Berg explained why Merrill Lynch was involved in the Ulu Masen project. Climate change is a global problem, he told us, with between 18 and 20 per cent of emissions coming from forests. The difference between REDD and afforestation projects is that REDD is reducing the source of emissions. Merrill Lynch has “transaction experience”, for example with carbon credits from wind power projects. “We think this is the right project at the right time,” Berg said.

According to Berg, the Ulu Masen project will result in 3.4 million tons of avoided CO2 emissions per year over the 30 years of the project. “We have included a 30% buffer of reserve credits, against leakage,” he said. The project is “everything that the voluntary market wants at the moment.”

Anna Lehmann of Sindicatum Carbon Capital worked on overseas aid forestry projects before becoming a carbon financier. She noted that forestry projects are complex and that the World Bank, for example, has spent more money on infrastructure than on forestry. “We face the same problems,” she said, before listing some of the problems: property rights, indigenous peoples’ rights and cultural land use rights.

“Forestry credits need to be fungible with other credits in the market,” she said. Permanance is the key issue, she told us. “Creating permanent compliance REDD credits is the key to getting forestry sector into the market.”

But she seemed to question her own optimism that “permanence can be achieved” when she talked about leakage. With a reforestation project, she explained, risks can be addressed at project level. “But with REDD,” she said, “there are many factors outside the project.” As an example, she talked about the logging ban in China, which has led to increased deforestation in Laos and Vietnam.

She talked about “Turning liabilities into assets,” which sounds to me like a recipe for a series of new sub-prime investments. “Forest protection needs to be profitable,” she said.

“Two events are putting question marks on future developments in the voluntary market,” Lehmann said. The first is the election of Barack Obama, which means that a federal scheme is now being designed. She asked whether it makes sense to invest in the voluntary market now, before we know what this federal scheme will look like. The second is the financial crisis, “which is becoming an economic crisis”.

She noted that the compliance market for offsets is currently small. The EU is looking at 1.7 billion tons of CO2 between 2008 and 2020, and the Dingell-Boucher Bill in the US allows for about 4 billion tons of CO2 between 2013 and 2025. On the supply side, Eliasch Review estimates that halving deforestation by 2020 could produce 3.5 billion tons of carbon credits a year. This would flood the market. “The potential REDD volume is too large to be absorbed into the market,” she said.

Lehmann’s solution to this problem was that forests should be considered as a sector, like, say, cement, oil or aluminium and that REDD needs to be part of a global cap and trade scheme. We should not be afraid of not having data — the cement industry in China has poor baselines as well, she noted. “We should find ways of acting conservatively.” Buffers of carbon credits will create permanence, she said.

During the questions, Martin Berg of Merrill Lynch mentioned a meeting taking place in London with a “form of steering committee” on the Ulu Masen project, including lawyers. “The legal aspect of these projects is tricky,” he said. This may prove to be something of an understatement. The seller has to have the legal right to sell the carbon credits from the project and there is no legal precedent for this. No country in the world has any experience on proving legally that a seller has the right to sell carbon from forests, Berg said.

How international leakage is to be measured is a good question, he said. “Those questions will come up when the negotiations come up with a national level approach. We’re not there yet.” He added that “What is needed is a regulatory framework which is stable for the next ten years or longer. It must be clear what a REDD credit is, where you can buy it, how you can sell it and whether it is fungible.”

Without such regulations, “It’s highly speculative to get involved,” he said.

“Carbon markets sometimes sound like a ploy of the private sector to get rich,” Ecosecurities’ Johannes Ebeling acknowledged. “But carbon markets value perfomance based payements — unlike public finance which could end up increasing corruption.”

“We can’t only rely on markets,” Ebeling added. “Markets do what is profitable. They won’t fund capacity building. So we need both.” Just to make this point clear, I’ll repeat it. The private sector is asking for public money to address the problems such as land rights, indigenous peoples’ rights, mapping forest cover, good governance in the forest sector and so on — in order that the private sector can profit from trading forest-carbon.

So here’s a “highly speculative” market, based on an imaginary commodity that is affected by a wide range of factors outside the forest sector (like agricultural prices, for example). The market is based on shaky data, huge uncertainty, an as yet non-existent legal framework and the potential to flood the market, causing the price to crash. Any takers?

“I guess in some ways it’s akin to subprime,” said Mark Stuart, a colleague of Ebeling’s at Ecosecurities, in the wake of the firm’s stock crash in spring 2008. “You keep layering on crap until you say, ‘We can’t do this anymore.’”

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