The world of forest investments is potentially on the verge of a seismic shift that could revolutionize the carbon markets. Most large-scale institutional investment in forests to date has focused on commercial forestry, including timber and forest products. In recent years however, under the REDD+ initiative, the international community has moved closer to reaching an agreement on placing a carbon value on standing forests as a means of preventing deforestation and degradation. The potential scale of this market is making the investment community sit up and take notice.
Forest carbon markets are not new. In fact, forest carbon has a long history and was amongst the first offsets ever created. However, despite strong growth, it is still a small proportion of the global carbon market. In 2008, the forest carbon market was estimated at US$37 million Citation[1], but despite more than quadrupling by 2010, it was still only a paltry $177.6 million Citation[2]. By contrast, wood removals alone generated approximately $100 billion a year from 2003 to 2007 Citation[3]. A future compliance-based global market for forest carbon under the auspices of REDD+ would be a step change in scale, and could make forest carbon rival in size to the global carbon market, which in recent years has grown from $11.0 billion to $141.9 billion, from 2005 to 2010, respectively Citation[4].
Forest carbon has had a limited impact on the global carbon market for a number of reasons. First, it is ineligible for inclusion in the largest trading scheme, the EU ETS, which represented approximately 84% of the global carbon market value in 2010 Citation[4]. A primary reason for its exclusion was the issue of permanence, defined as “the longevity of a carbon pool and the stability of its stocks” Citation[5]: illegal logging or natural disturbances can lead to forest carbon emissions even after credits have been issued. To address this, temporary credits specific to forest-related activities are issued under the Kyoto Protocol. However, demand for such credits has been low: why buy temporary credits when permanent ones are available at low prices? Finally, while forest carbon is eligible under the Kyoto Protocol’s CDM, it is restricted to afforestation/reforestation schemes. By 2010, 3.5% of Kyoto carbon credits by reported value were arising from land-use change and forestry projects under the CDM Citation[2].
Most forest investment has therefore taken place in the voluntary carbon market instead, driven mainly by socially responsible and philanthropic investors. Forest carbon is attractive for corporate–social responsibility purposes. Forests are visually attractive and appealing, and investments under appropriate standards can provide additional co-benefits (e.g., protection of biodiversity and poverty reduction). An international agreement on REDD+ would not only drastically change the scale of forest carbon investment, but also the type of investors. The scale of investment required is unlikely to be met from public sources alone given current national budget deficits, recessionary pressures and donor fatigue. Private investment is clearly needed but this requires a shift in emphasis towards financial return as an investment driver, besides corporate–social responsibility.
Given these trends, we argue that academics can help support this nascent market. In addition to providing expertise on critical issues of governance, institutions and policies (e.g. propoor equity, access, control and land tenure), they must share expertise on forest risks. Overcoming political barriers and reaching an international agreement on REDD+ are only part of the challenge. Halving deforestation by 2030 calls for approximately $17–33 billion annually Citation[6]. Additional data is therefore needed to: support the development of financial instruments; attract sustainable, large-scale private investments; and direct them to where they are most needed to ensure forest preservation. We propose ways in which academia can contribute.
Provide better information on the risks of forest investments
Private investors in compliance markets play by different rules than those in the voluntary market, seeking out appropriate risk-adjusted returns with a low emphasis on nonfinancial benefits. Therefore, underpinning this market is a need to provide better information on the risks of forest investments – to allow investors to model their returns and also to support the development of financial products to mitigate risks; for example, insurance and guarantees, REDD+ must be international to be effective and limit leakage elsewhere. In some countries, risks may be too high to attract investment, but their identification will facilitate the development of targeted mechanisms to reduce risks and leverage private investment.
Provide stable methodologies
One of the biggest barriers to attracting private investors will be regulatory stability. Agreeing on a standard methodology to carbon estimation in particular is critical as private investors need certainty. Constant revision of methodologies in line with the latest science would generate uncertainty in future revenue streams, as projections on the volume of carbon credits would be subject to change and would deter investment.
In particular, retrospective revision (i.e., once investments have been made) could be particularly damaging. Retrospective reduction of feed-in tariffs severely damaged investment in the Spanish solar market, as existing investors faced reduced profits. A particular challenge for the forest carbon market is that research could estimate an increase or decrease in the volume of carbon. Investors would potentially want to benefit from any increase, but not a decrease. Academic involvement must focus on developing a conservative estimate for carbon that balances accuracy with the need for stability.
Develop a more accurate global picture of forest vulnerability to disturbances
In order to attract private investment to an international compliance market for REDD+, lessons need to be learned from the relative success of the voluntary versus CDM forest carbon markets and the permanence of carbon credits must be ensured. Current forest carbon standards favor the use of buffers as a means of addressing permanence; that is, a certain percentage of the calculated carbon is set aside and not used for carbon credits as a buffer against forest loss. The level of such buffers varies. In some instances it is a fixed amount, for example the CarbonFix Standard sets aside 30% (20% is for a general pool and 10% project specific. The project specific buffer may be waived in certain circumstances), while in others it varies according to a project-specific risk assessment (e.g., verified carbon standard). The level of these buffers has a direct bearing on the potential commercial profitability of the project. Accurate calculation of buffers is therefore critical. Too high a buffer and it may not attract investment, too low and target carbon reductions may be in jeopardy.
Academia must help develop a more accurate global picture of forest vulnerability to disturbances including fire, drought, wind, ice and earthquakes, as well as anthropogenic interference. In particular, it is important to identify early areas at high risk of deforestation and vulnerable to disturbances. Under a system of varying buffers, this could direct investment away from such areas that arguably could benefit most from REDD+. As before, having adequate data to identify areas at higher risk is a prerequisite for developing cost-effective means to reducing that risk; for example, guarantees and insurance. Conversely, improved understanding of risks may allow buffers to be reduced in some instances.
Such risk information would also be useful in existing commercial forestry. Insurers argue that many forest managers involved in commercial forestry do not take out insurance but prefer to self-insure in the belief that actual forest losses are typically less than 1%. Well-managed forests may, in some instances, be less vulnerable to certain disturbances than natural forests. However, both are vulnerable to extreme events predicted to increase in frequency as a result of climate change.
Disseminate this knowledge in a format of potential use by the finance sector
Currently, research has tended to focus on understanding drivers of forest loss, as well as on investigating and quantifying the risk of fire, wind and pests, and the impact of these disturbances on carbon and biodiversity. Limited effort has been given to disseminating this knowledge in a format of use to the finance sector. While a large proportion of existing academic research may be poorly applicable to finance, a small but relevant proportion could make a significant contribution.
In the financial world, risk entails two components: how likely something is to happen and the impact if it does. Existing academic research is often distinct for each of these components. For example, many foresters and ecologists investigate the impact of disturbances such as wind, fire and drought on forest carbon, whilst others, such as climate scientists, investigate the likelihood of such disturbances occurring. There is a need for interdisciplinary work to bring these two components together so that finance can identify the likely impact on potential investments of such disturbances. Similarly, the scale and intensity of disturbances is also important: the vulnerability of a forest to a 50-knot gale is very different to that of a hurricane. Likewise, the impact of a fire also depends on the scale and intensity of the event. This information needs to be combined into an overall risk indicator.
Research projects tend to be concentrated in specific locations that may not correspond to the location of a proposed investment. It may be necessary; therefore, to develop estimates for areas that have not been studied. This could be done through the use of smaller projects to develop models on the vulnerability of a particular species or forest type to a given disturbance. Combining such models with remote sensing data that identifies species or forest types could be one way to develop global risk models. This would likely require the collaboration of a number of academics.
Link historical data to climate change scenarios
Finance typically uses historical data to estimate future risk and losses. Climate change presents an additional challenge, as historic data on disturbances are poor predictors of the future. For short-term investments, climate change may not yet influence investment decisions; however, additional scenarios may need to be built to identify the risks for longer-term investments. Climate change may also reduce the risks to some forests while increasing those to others.
Conclusion & future perspective
In conclusion, academia can contribute in many ways to a better understanding of the risks to forest propositions worldwide and has an opportunity to support the development of forest carbon markets. In the first instance, this could be done through the development of standardized methodologies for carbon assessment and better information on the risks to forest carbon from natural hazards and anthropogenic interference, but this information needs to be presented in the right way to be of use. To attract investments, key risk components need to be identified and brought together at a scale usable by finance. While the quantification of risk may be complex, its presentation must be relatively simple or investment may be driven elsewhere.
The financial sector is used to dealing with similar risks and uncertainties already: natural disturbances already affect commodities markets. However, the impacts on forests are very different and require new information. A catastrophic event for agriculture would typically only destroy 1 year’s crop, but would have a greater impact on forests given longer rotation periods. Such considerations can be factored into investment decisions but only if they are understood.
The University of Edinburgh, in collaboration with various private partners, is setting up a UK forest finance risk network (NERC-funded, NE/I022183/1) to facilitate the exchange of information between academia and finance on forest risks (relating to natural disturbances and anthropogenic interference). The first stage will be to identify existing expertise and provide further clarification on finance requirements. Over time this will lead to new collaborations and funding opportunities and the development of new tools. It could also bring financial investment in tools of mutual interest; for example, better satellites for remote sensing. For this to happen there needs to be a change in mindset in terms of willingness to engage with finance and in terms of the financial sector to engage with academia. The need is urgent and must begin now, or else academic involvement may ultimately focus on ex-post analysis of why forest carbon markets are deficient – surely an outcome that is in nobody’s interest.
Financial & competing interests disclosure
The research underpinning this editorial is supported by NERC and the Forest Finance Risk Network. The authors have no other relevant affiliations or financial involvement with any organization or entity with a financial interest in or financial conflict with the subject matter or materials discussed in the manuscript apart from those disclosed.
No writing assistance was utilized in the production of this manuscript.
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