Markets for Ecosystem Services

Valuing/Monetizing Environmental Services from Forests

Deborah Spalding Presentation to: IFS Mid-Career Program Yale University September 30, 2011

Forestland Values at a Glance

Traditional Values
Forests produce salable goods Values captured through markets for:

Natural resources (timber, agriculture, fuels) Land (shelter/buildings/real estate development)

A growing asset that can be passed along to the next generation

Forestland Values at a Glance

Environmental and Other Values

Forests also produce public goods/services

Water Carbon Biodiversity Air quality Aesthetics

These values are at risk when property is not protected or ownership changes

Ways to Protect Ecosystem Services

Prescription (regulation) Property rights (may be tradable) Penalties (taxes and fees) Persuasion (outreach) Payments

Payments for Ecosystem Services

Traditional markets do not fully compensate landowners for environmental values on their land Goal of ecosystem credit market:

Help conservation and sustainable management compete with other land uses Reward landowners who keep environmental services in production Mitigate human impacts on the environment Improve land use practices and landowner behavior

Major Types of Markets for Ecosystem Services

Carbon Wetlands Water (quantity/quality) Biodiversity / Habitat

What Makes a Market?

Established product

Bushel of corn, ton of sawtimber, barrel of oil

Sufficient numbers of buyers and sellers Information transparency (volume and price) Price driven by supply and demand Mechanism for settling transactions Delivery risk on the supplier Do markets for ecosystem services function as real markets?

How to Approach Ecosystem Markets

What is the underlying asset/good to be sold?

Hectare, functional unit, linear foot, pound of nitrogen, nesting pair, mtCO2e? Is there rule of law backing a regulatory market?

Who is in charge?

Global, federal, state, local, voluntary, or some combination?

Oversight agencies Global, regional, state, watershed, habitat zone, or some esoteric methodology? Before / concurrent with / after restoration efforts and results have been verified

How are the market boundaries set?

When do credits become available?

How to Approach Ecosystem Markets

Is the project worth it?

How clear (and efficient) is project approval process? How much does it cost to implement? When do I get paid? Are these payments sufficient to justify ecosystem services as a land use? Regulatory risks Project risks Financial risks Reputational risks

What are the risks and are they manageable?

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Two Major Types of Markets

Compliance markets

Demand is set by regulatory targets Weights and measures established Use of standards, registries and/or exchanges Example: markets under Kyoto Protocol, EU rules, US wetlands

Voluntary markets

Demand is more feelings based or speculative Weights and measures may be unclear No clear ways to address non-compliance (beyond contracts) Example: Voluntary Carbon Market (VCM)

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Why We Care About Forest Carbon

Greenhouse Gas Emissions by Activity
24.6%

Electricity & Heat Land Use Change Transportation Agriculture Industry Other Fuel Combustion Fugitive Emissions Waste Industrial Processes
12Source: WRI, Baumert et al, 2005

18.2% 13.5%

13.5%
10.4% 9.0%

3.9%
3.6% 3.4%
0% 5% 10% 15% 20% 25%

Land Use Change: Emissions by Type

18.2% 18.3% -1.5%

-0.5%
2.5% -0.6%

-5%
13Source: WRI, Baumert et al, 2005

0%

5%

10%

15%

20%

Two Main Types of Carbon Credits

Allowances

Emissions rights issued under a cap and trade system Authorization/paper based credits issued by regulatory authority Example: Credits issued under the European Unions Emissions Trading Scheme (ETS)

Offsets

Project based credits created by activities that reduce emissions or sequester carbon Agriculture, Forestry and Land Use Change (AFOLU) projects generate offsets Example: Credits issued under Kyotos Clean Development Mechanism (CDM)

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Requirements for Carbon Projects

Determine a baseline Demonstrate additionality

Carbon sequestered must be incremental to what is considered business as usual Project must not simply redirect emissions

Prevent leakage

Ensure permanence
Use of conservation easements Use of temporary credits

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Size of Global Carbon Market

16The World Bank, State and Trends of the Carbon Market 2011, Washington DC, p.7.

CDM Carbon Offsets (by Location)

17 State of the Voluntary Carbon Market 2011, Washington DC, p.11.

2010 Carbon Offsets (by Type)

18 State of the Voluntary Carbon Market 2011, Washington DC, p.7.

Forestry Offsets: Whats Allowed

Compliance Markets

Kyoto

Re/Afforestation (A/R) under CDM program

But temporary credits only

Avoided deforestation and managed forest projects not allowed

Northeastern US Regional Greenhouse Gas Initiative (RGGI)

Afforestation only in model rule

Land must be non-forested for 10 years Requires legally binding, permanent conservation easement to ensure maintenance of forested state

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No transactions recorded to date

Efforts to expand to forest management, products

Opportunities Outside Kyoto

Voluntary markets have emerged
Over the counter (OTC) / bilateral transactions Exchanges (Chicago Climate Exchange (CCX))

Greater demand and flexibility for landowners

Strong public support for forests in efforts to combat climate change Less institutional bias against forestry offsets Less bureaucratic approval process

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Lower transaction costs

Growth Trends in Voluntary Markets

21 Hamilton, K., et al., Building Bridges: State of the Voluntary Carbon Markets 2010, June 14, Ecosystem Marketplace, Washington DC.

Average Prices for Voluntary Carbon 2010

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Expanding Forestrys Role in Markets: REDD

REDD: Reduced Emissions from Deforestation and Land Degradation

Emerging from lack of CDM support of avoided deforestation projects Designed to protect forest conversion in countries with high levels of forest loss, largely from agriculture Driven by approval of key methodologies for large scale forest conservation 85% of carbon trades by nonprofit sector were forestry 66% of public sector carbon trades were forestry

Large increase in voluntary transaction volumes in 2010

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Growth in REDD Markets

REDD comprised 45% of voluntary trades in 2010

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Forestry Offsets: Whats Allowed

Climate Action Reserve (CAR)
Comes out of Californias emission reduction efforts Becoming a respected global standard Greater flexibility in forestry projects

Afforestation/Reforestation (A/R) Improved forest management Avoided conversion

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CAR Forestry Protocols

Reforestation
Sub-optimal stocking Less than 10% canopy cover for 10+ years 20%+ disturbance related losses Minimum 30 year rotation No broadcast fertilization Available on public or private lands

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CAR Forestry Protocols

Improved Forest Management
Greater than 10% canopy cover Natural forest management practices No broadcast fertilization Public or private lands Eligible activities:

Increasing rotation age Increased productivity through thinning diseased and suppressed trees Managing against shrub cover Increasing stocks in under-stocked areas

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CAR Forestry Protocols

Avoided Conversion
Must demonstrate significant threat of conversion Address through conservation easement or transfer to public ownership No broadcast fertilization May allow tree planting and harvesting Private lands only

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Variations by Standard
Voluntary Carbon Standard (VCS)

Scope: A/R, forest management, REDD, cropland management, multiple land uses in one project Protocols similar to CDM = credibility Premium prices paid for credits Concerns about buffer reserve for permanence Transaction costs: two independent audits required Credits issued ex-post basis First VCS forestry credits issued September, 2010 in Tanzania

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Variations by Standard

Climate, Community and Biodiversity (CCB)

Considers wider social and environmental benefits Credibility in bilateral non-certified transactions Does not issue creditsmust use second standard High transaction costs Premium prices paid

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Tanzania Forest Carbon Project

10,814 hectares degraded grassland in the Southern Highlands Conversion to pine and eucalyptus Project covers two separate locations Will be a sustainable managed forest (harvesting allowed)
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Tanzania Project History

Started in 1997 as a CDM project Kyoto final rules allowed only projects started after 2000 Approached the voluntary market Achieved FSC certification Decided that all the voluntary standards except VCS lacked credibility
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Tanzania Project Highlights

10,814 hectares to generate 232,264 carbon credits Credit releases increase over time

40% credits held back as buffer reserve

Also met CCB standards 10% of the carbon credit sales to be given to local community to build schools and teachers homes Will provide 200 jobs to local community

No pricing disclosed
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Forest Carbon Market Challenges

Short term credibility

Questions among scientific community

Carbon sequestration process more complex Risk of disturbance loss

Long term credibility

What happens after Kyoto Protocol Hinges on US federal compliance market Project development costs often upfront Ongoing auditing and verification costs Brokerage fees Are local livelihoods protected?

Transaction Costs

Environmental justice

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Other Environmental Credits

Wetlands Biodiversity / Habitat Water quality

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Other Environmental Credits: Market Structure

No net loss of ecosystem function as legally binding rule Sequence of priorities:
Avoid Minimize Mitigate / Offset credit markets used here

Demonstrate additionality Ensure permanence

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Other Environmental Credits: Market Structure

Markets more locally based
Preserve hydrological integrity Maintain overall habitat viability Recognize diversity of ecosystems Reduces leakage risk

Legal structure may be global or national, but implementation is often regional or local
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Wetland Credit Market: US Example

US Wetlands Mitigation Banking
Sanctioned under US Clean Water Act Overseen by Environmental Protection Agency (National) Implemented by US Army Corps of Engineers (Regional Districts) Market defined by service territory

Hydrological boundary lines Credits can only be bought and sold within these lines

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US Wetlands Credits: What is Traded

Credits based on functional values
Flood attenuation Wildlife diversity Nutrient removal

More restoration achieved = more credits

Determined by credit ratio (acres/credit)

Requires set-aside funds to protect project Requires easement to protect property Payments occur upon project approval
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Biodiversity Credits: US Example

Sanctioned under Endangered Species Act Credits generated based on recorded nesting pairs or habitat zone designated by regulatory agency Land must be protected through permanent conservation easement Payments may occur before or after species recovery
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Water Quality Market: US Example

In a pilot phase Sanctioned under Clean Water Act Based on

Total Maximum Daily Loads

Maximum amount of nutrients (N or P) that can safely enter a water body

Temperature fish population

Reductions in nutrient loads create tradable credits

Planting riparian buffers Conservation tillage (agriculture)

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Water Quality Market Example: Costa Rica

A hydropower utility (Energia Global) wanted to protect streamflow and minimize sedimentation FONAFIFO was established to facilitate ecosystem services transactions Energia Global paid FONAFIFO $18/ha to give to landowners who maintained forest cover and managed sustainably FONAFIFO added an additional $30/ha payment to landowners

To compensate for lost revenues (i.e. from cattle ranching)

Total payment to landowners = $48/ha Administered by FUNDECOR (NGO)

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Added Benefits of Ecosystem Services

Source: Swiss Re via David Brand, New Forests Asset Management

Figures in AUD$ (Assume NPV based on 9% real discount rate)

Original investment
100 80 60 40 20

Timber & pulp

Carbon credits

Water credits / salinity

Renewable energy

Land leasing

Potential net gain

? ?
? 50

-60
0 -20 --40
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60

--60

Managing Risks
Regulatory Risks

Consistency in how rules are applied / Regulator experience Time required to gain approval What if the project is denied? Corruption Failure to meet ecological and budgetary goals Market supply and demand Credit pricing Project failure Credits sold to offset questionable/unpopular projects

Project Risks

Financial Risks

Reputational Risks

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Roadmap for Market Development

Ecosystem service market must be backed by rule of law Land rights and tenure rules must be clear and enforceable

Market boundaries must be well defined

WHAT:

what defines a credit?

WHERE: where must project be located? WHEN: when do landowners get paid?

Transaction costs must be reasonable Reserves or other stop gap measures must be in place to protect against project failure
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Roadmap for Project Development

Understand tradeoffs vs. other activities Ecosystem services permanently prevent land conversion to other uses Scale (small projects may be uneconomic) Issue with carbon and biodiversity Project may conflict with other goals Project may unduly tie up the land Are payments sufficient given the risks?

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Questions to Ask
Are ecosystem services a superior management goal given the site, and landowner priorities and needs? Are ecosystem credits a superior investment given other land use choices?

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