Playing REDD without losing your shirt

Reducing emissions from deforestation will be a crucial part of a post-2012 climate change agreement – and carbon finance is likely to play its part. Martin Berg and Andrew Hedges consider how early movers might position themselves

Forestry is back on the international climate change agenda. In particular, reducing emissions from deforestation and degradation (REDD) appears either to excite or antagonise carbon traders, policy-makers and NGOs. REDD is set to contribute a vital part of the financing needed to put a brake on deforestation, and help tackle global warming. But, in such an uncertain policy environment, how can investors get involved without burning their fingers?

Emissions from deforestation account for roughly 18% of annual global greenhouse gas (GHG) emissions or about 8 gigatonnes of carbon dioxide equivalent (Gt CO2e) a year, as roughly 25 hectares of tropical rainforest are destroyed every minute. Management consultancy McKinsey & Company estimates that REDD could contribute 5.9Gt CO2e of emissions reductions or almost a third of the 2020 lower-cost reduction potential.

These figures underpin the widespread recognition that any successor to the Kyoto Protocol needs to include a mechanism to reduce deforestation rates. Climate change negotiators seem to agree, and included REDD in the Bali action plan at the 2007 meetings under the UN Framework Convention on Climate Change and the Kyoto Protocol – with the objective of providing positive incentives for developing countries to curb their emissions from deforestation and forest degradation.

Most observers believe that a REDD mechanism will be part of a successor to the Kyoto Protocol in some shape or form

There are several reasons why REDD projects can be attractive to investors. First, they have the potential to generate a significant amount of emission reductions at relatively low cost.

Second, unlike other forestry projects, they have similar characteristics to mitigation projects in that they decrease a source of emissions by conserving forest rather than creating a ‘sink’. The accounting for REDD projects should therefore not be very different to, for example, emission reductions created through the displacement of fossil fuel by a renewable energy project.

Third, REDD projects will have significant co-benefits for biodiversity and human development by maintaining habitats for rare species and an alternative income for rural and indigenous people. REDD projects therefore offer a unique opportunity to combine significant carbon emission reductions with the conservation and enhancement of forest carbon stock.

Most observers believe that a REDD mechanism will be part of a successor to the Kyoto Protocol in some shape or form. The debate has shifted from whether or not REDD should be included, to what type of REDD mechanism might be included and, most importantly, how it can be financed. At present, however, much of the work and discussion at the level of the international climate change negotiations is focusing on defining key concepts, developing accounting rules, identifying capacity needs and collating estimates of the financing required.

Financing discussions, meanwhile, have focused predominantly on the need for international funds to be aggregated and directly distributed to developing countries for capacity building (in key areas such as monitoring, reporting and verification). Those discussions do not assume that the best means to achieve REDD is via a reformed Clean Development Mechanism (CDM) or other new carbon credit finance tool. Having said that, it is a possibility. The conclusions from a recent meeting in Bonn included an option for REDD under a reformed CDM along with language flagging that the permanence of emissions reductions associated with REDD could be addressed not just through temporary credits but also via buffers (setting aside surplus credits to take any losses into account), insurance and alternative means.

A possible outcome on REDD at the international level is therefore the inclusion of some form of near-term financial mechanism to support REDD capacity building. Such mechanisms are likely to operate at the government-to-government level and the capacity of them or future mechanisms to generate carbon credits from REDD projects will, if included, take some time before becoming operational.

For private sector investors interested in making early-stage investments in REDD, it is critical that the design of any government-to-government near-term funding mechanism does not preclude later development of carbon credits as a financial incentive. It is also key that such a mechanism encourages and rewards private sector actors to invest in sub-national pilot projects that act as a proving ground for later national programmes.

The recent draft bill from US Congressmen Henry Waxman and Edward Markey, (the American Clean Energy and Security Act 2009) provides an encouraging example. It sets out mechanisms to build capacity in developing countries at a national level in a manner grounded in the use of carbon credits. For instance, the bill recognises that, prior to moving to a system where carbon credits can be issued for emission reductions achieved at a national level, there is a role for sub-national pilot projects. Importantly, it provides for these pilot projects to be issued with US emission allowances (after appropriate discounting for uncertainty).

Notwithstanding the ongoing uncertainty around REDD, several investments in REDD projects are on the way. Most projects are developed to generate voluntary carbon credits, with the hope that they become showcases for a REDD mechanism or can be grandfathered into an emerging REDD regime or an US emissions trading scheme. The winning formula appears to be the use of the Voluntary Carbon Standard (VCS) in combination with the Climate, Community and Biodiversity (CCB) project design standard. The VCS methodology aims to select a baseline, to address leakage (the risk that a project merely displaces deforestation), to ensure adequate verification with remote sensing devices and to deal with catastrophic events. The CCB standard focuses on how the project supports local communities and conserves biodiversity.

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To date, no project has been validated under both the VCS and CCB standard, but the first VCS methodology has been submitted by Terra Global for the Oddar Meanchey project in Cambodia and two projects have completed validation under the CCB standard. The first project to receive validation under the CCB standard was the Ulu Masen Ecosystem in Aceh, Indonesia, developed by Carbon Conservation, Fauna & Flora International and Merrill Lynch. The second is the Juma Development Reserve project in the state of Amazonas in Brazil.

So what should investors and developers bear in mind, if considering a voluntary sector sub-national REDD project?