30 November 2021

There is a market for biodiversity - and it is expanding

In Europe, biodiversity is generally produced by millions of small landowners. For more biodiversity, a functioning market for biodiversity is a prerequisite. Forest certification forms essentially a voluntary market for biodiversity, where a "plus-sustainability" scheme has standards more ambitious than those required by law. In the following, we illustrate a market-based solution for biodiversity based on an existing plus-sustainability scheme. Our DHF-Model is currently being applied for biodiversity conservation on 5 million hectares as a first target.

By Olli Haltia, Tapani Pahkasalo, Dasos Capital Oy Ltd

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In a market economy, it is useful to consider biodiversity as a product which is produced by management effort. In Europe, biodiversity is produced by millions of forest and land owners, typically small-holders owning up to 50 ha of land. While such small holders tend to focus on the production of timber incentivized by a well-established roundwood markets, biodiversity remains a side product. Or it is even considered as a constraint to the cash-flow generating activity, and thus an extra cost.

Occasionally, incentive schemes have been established to encourage biodiversity production by forest owners – in Finland, METSO-programme is an example of such schemes which compensates a forest owner for the biodiversity produced. An innovative proposal has also been made to establish a pricing system for decaying wood as a "commercial" timber grade (decaying wood remaining in forest provides feeding for numerous insects, fungi and bird species). However, such individual schemes cannot replace a fully developed market – although they can complement it.

Forest certification forms a market for biodiversity

For more biodiversity, we need a functioning market for biodiversity. Fortunately, a market for biodiversity has, in fact, already been established: this market is called forest certification. Forest certification forms essentially a voluntary market for biodiversity which a forest owner may participate upon her own decision. Forest certification forms a "plus-sustainability" scheme for forest management where standards are clearly more ambitious than those required by law. Hence, the problem is not that we would not have a market for biodiversity, but the market remains incomplete and needs to be fine-tuned to function in a more adequate manner.

For such a plus-sustainability scheme to function at full power, the market has to compensate a sufficient price premium for forest products (e.g., packaging, engineered wood) which are manufactured based on wood raw material complying with such plus-sustainability schemes. The price premium is then made available to forest owners as a compensation for the produced biodiversity, a prerequisite for plus-sustainability.

It is beyond reach for forest owners to influence the premium paid for plus-sustainable forest products by the consumers of packaging, tissue and other fibre and solid wood products. The current trend seems to be, however, that consumers are becoming more aware of biodiversity, placing thus greater emphasis on plus-sustainability. There is a broadening market window for forest product manufacturers to tap the opportunity by more aggressive marketing of certified forest products.

Efficiency of Conservation

Whatever the premium for plus-sustainability might be, the production of biodiversity has to be efficient. Maximum amount of biodiversity should be accomplished for each additional euro invested. Nevertheless, with conservation having been largely an activity based on public resources, too little attention has been paid to efficiency.

Private sector driven biodiversity production is subject to budget constraint for two main reasons. First, the compensation for biodiversity is determined by the price premium for plus-sustainable forest products depending upon market's willingness to pay for biodiversity. As discussed above, we may see larger price premia and thus larger budget in future. However, efficiency should be maintained also with a broader budget.

Second, an owner of land will have to take into account an opportunity cost when deciding about allocation of land into biodiversity management. For example, the owner may have to consider a foregone revenue of timber production and wind power rent when allocating a piece of land into biodiversity production with no scope for future revenues from timber and wind.

Another aspect of efficiency is the environmental quality. Probably the most widely applied indicator for biodiversity is simply the area conserved. For example, forest certification pays remarkable attention to the quota of forest area being set aside for biodiversity. Much less attention is paid on biodiversity itself. However, the biodiversity sensitive areas are typically not evenly distributed, and therefore conservation efficiency suffers if there is no focus.

A related quality issue is the size of an individual conservation area. Larger conservation areas typically imply not only broader biodiversity but also larger number of individuals in each species, indicating vitality of broader genetic pools over smaller conservation plots.

Evolvment of an efficient conservation model with plus-sustainability premiums

DHF-Model: The Conservation Model of Dasos Habitat Foundation

DHF-Model considers a situation whereby a forest owner is contemplating to join a plus-sustainability scheme requiring to set aside e.g. 5 % quota of forest area for conservation. The forest owner with an average property of e.g. 30 ha needs therefore to evaluate whether the additional revenue gained from the plus-sustainability wood market compensates for the foregone revenue from 1.5 ha designated entirely for biodiversity production.

In many cases, the evaluation yields a negative outcome (note that less than 50 % of forests in Europe have been certified). A typical situation is that a forest owner finds only e.g. 0.5 ha suitable forestland for conservation whereas the remaining 1 ha needed has little biodiversity value but a high opportunity cost. Hence, the forest owner would reject the idea of plus-sustainability on rational grounds.

DHF-Model comes to forest owner's aid by offering an opportunity to outsource parts of strict conservation area. Here, the forest owner conserves 0.5 ha of own land whilst the remaining 1 ha is conserved by DHF on behalf of the forest owner. As a result, the forest owner has a chance to benefit of a plus-sustainability premium. Note that plus-sustainability scheme requires maintaining biodiversity values throughout the whole area. The forest owner is better off compared to staying out of the plus-sustainability scheme.

Dasos Habitat Foundation has established such biodiversity trading scheme in cooperation with Metsä Group (MG) in Finland. MG is owned by 100,000 forest owners with a total forest area of some 5 million hectares. MG-forests are in fact widely covered by forest certification - here, the target for the cooperation is to apply an additional form of plus-sustainability.

DHF-Model offers conservation areas to those MG-forest owners who do not have enough suitable forest land to conserve. In short, the set-up allows forest owners to optimize the degree of the conservation outsourcing. The key parameters include the plus-sustainability premium available and the opportunity cost faced due to conservation. DHF-Model employs a specific algorithm which accurately maximizes forest owner´s revenue by finding an optimal conservation pattern.

DHF-Model benefits the environment, forest owners and the wood processing industries

Applied in the context of sustainable forest management, DHF-Model generates fundamental benefits, not only to forest owners and wood buyers but essentially to the environment – and thus, to the society at large. The benefits stem from substantial efficiency gains.

First, DHF-Model expands the market of plus-sustainable wood by providing a new option for certification compliance. This allows wood buyers and forest product manufacturers to broaden their presence in the growing market for packaging, tissue and engineered wood products. DHF-Model forms also the lowest-cost route to procure a given amount of plus-sustainable wood raw material for processing.

Second, DHF-Model allows for a forest owner a competitive option to benefit of plus-sustainability premium – the difference is drastic especially in the situation where plus-sustainability scheme would not be profitable without the DHF-Model. Hence, the model increases forest owners´ revenue at all levels of premium – or compared to the situation that a forest owner would not join to the plus-sustainability scheme. As all conservation can be outsourced, it would make sense for a forest owner to join a plus-sustainability scheme even without any conservation by herself.

Third, a fundamental environmental benefit results from the fact that DHF-model lowers the (opportunity) cost by forest owners for conservation, encouraging to establish forest areas designated entirely for biodiversity. Very importantly, the model guides to allocate biodiversity conservation to areas with relatively high environmental value compared to timber production. Perhaps the most significant implication of the model is in the larger conservation areas. Consolidation of the outsourced conservation by small holders into larger conservation entities results in richer genetic pools. Thus, the scope for the trading conservation plays an important role in the reduction of fragmentation for conservation.

DHF-Model is illustrated in the illustration/graphic on page 17. In a situation where plus-sustainability premiums do not exist, there are only public conservation areas (a.). Being dependent on scarce public resources, the scale of conservation remains sub-optimal.

When plus-sustainability premiums are paid to forest owners with compliance, the incentive is sufficient for some forest owners to increase the conservation (b.). This applies to those with the best possibilities to do this, and whose costs do not exceed the revenue increase. Some new scattered conservation areas can be formed but the fragmented structure of European forest ownership results in scattered conservation. The scale of conservation still remains sub-optimal with too small size for an average biodiversity area.

An efficient DHF-conservation (c.) model includes the possibility of joining a conservation group where Dasos Habitat Foundation focuses solely on conservation taking care of an optimized scale of biodiversity management on behalf of other forest owners. This significantly reduces the private cost of conservation, enabling more areas to be conserved, more plus-sustainable wood to be produced and results in significantly larger and more valuable conservation areas.

Dasos Habitat Foundation has executed DHF-Model in Finland since 2020 based on private sector financing. After its first operational year, the established conservation area facilitates plus-sustainable forests of some 50,000 ha. Moreover, the conservation units established so far as single biodiversity management areas are 8 times larger than achieved by simultaneously executed public conservation programmes in the private sector forestry. DHF-Model has become probably the most significant privately financed venture for biodiversity in Europe.

There is huge potential and need to expand applications of DHF-Model across Europe - if not elsewhere. Based on experience accumulated in a short time, a couple of remarks can be made.

First, practically all biodiversity areas established by DHF-Model perform as very good forests for CO2 storage and sink – the conservation areas established by DHF have a volume of mature big trees more than 2 times compared to an average forestry area whereas the biological growth is also attractive. As a rule of thumb, most biodiversity areas count as an efficient means for carbon sequestration whereas the opposite is much less often true. Hence, carbon sequestration payments designated especially to biodiversity forests represent a positive spill-over incentivizing joint-production. This should be a first guiding principle when considering a compensation for forest-based carbon in the context of EU emission trading system or otherwise.

Second, European wind and solar power capacity is bound to grow manyfold over the next 10-20 years, or even sooner. Substantial part of the wind power capacity will be on-shore and placed on forestlands. The biodiversity footprint of wind power is becoming a major issue. Turbine sites, roads and grid lines cause deforestation when installed in forested regions. It is likely that the demand for "plus-sustainable" wind and solar electricity will grow - the biodiversity-compensated electricity is currently emerging as a "new" product.

In conclusion, the market for biodiversity is expanding rapidly. The vision of Dasos Habitat Foundation is to bring efficient conservation models into use, channel funds from the markets to nature conservation - and provide investors with a sustainable investment opportunity based on the attractive return/risk profile inherent with Natural Capital. In doing so, Dasos Habitat Foundation aims to conserve more valuable natural habitats.

Dasos Habitat Foundation is part of Dasos Capital Group. Dasos Capital Oy Ltd is an investment advisor to private equity funds investing in sustainable forests, wood-based construction and natural capital.Assets under management total over EUR 1.3 billion.

Dasos Capital is a signatory of UN PRI and a member of Finland's Sustainable Investment Forum (FINSIF) and a Partner of the Circular Bioeconomy Alliance (CBA) as well as supporter of the Task Force on Climate-related Financial Disclosures (TCFD).

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