In the Spring 2013 edition of “Silviculture”, John Betts made a compelling argument that British Columbia might be long past due for a forest inventory update. He also reasonably argued that before we embark on such an initiative, we should review and possibly revise our inventory goals, before we start measuring.
This came on the heels of Dirk Brinkman’s piece in Silviculture’s Fall 2012 edition, in which he argued that although global carbon quota and credit markets had, so far, failed to produce “a fresh source of funding for reforestation”, that potential should still exist.
See the connection?
The keys to attracting carbon credit financing to reforestation are: revising our forest inventory goals; committing to updating our inventories and related forest carbon stock and flow forecasts every five years; publicly reporting events that might have material impacts on these forecasts on a near real-time basis, and, most importantly, ensuring that the methods we use to quantify forest project carbon credits are consistent with and directly linked to the published and regularly updated forest inventories.
But will the cost of putting the capacity in place to get these things done generate a reasonable return for investors? Brinkman reported that carbon credit revenues might add 1% to 2% to the typical 6% internal rate of return (IRR) on forest plantation projects in temperate regions. Let’s put this in context. While oil and gas and mineral resource-based industries might generate significantly higher IRRs over select 2- to 5- year intervals, after we net out the impact of preferential tax treatment for capital invested in resource extraction—much of which preferential treatment is scheduled for elimination over the next few years under Canada’s existing federal budget—the 10- to 15- year rolling average IRR for investors in most oil, gas and mineral plays is in the 3% to 7% range.
In other words, investment in forest management should, all other things being equal, already be attractive to well-informed investors with long-term views, if not make them downright giddy! So why aren’t they?
Some would argue that few long-view investors do have the appetite for the risk associated with either reforestation or carbon credit markets, let alone a combination of the two. But investors do not shy away from risk. They shy away from inestimable risk. Inestimable risk is unmanageable risk.
Risk of fires, pest infestations and land use policy changes, combined with what appear to be interminable material changes in carbon accounting methodologies and carbon credit price volatility, are significant. But they should be manageable. To discuss how to manage these risks, let’s deal with natural hazard and forest inventory risk first, and then carbon accounting risk.
At this time natural hazard risk impacts on fibre supply and carbon stocks are not quantifiable within an acceptable uncertainty range, largely because fibre supply estimates are so unreliable and so infrequently updated. Expert analysis suggests that the estimation error in our current (now quite dated) fibre supply estimates might be as much as 30% to 60%. The estimation error in the existing fibre supply estimates can overwhelm any uncertainty in our ability to forecast natural disaster events.
With the evolution of satellite and aerial imaging and soil/site sampling methodologies that we have witnessed over the last decade, we are now in a position to publish and regularly update our forest inventories at a scale and reliably enough to support carbon credit verification, at a cost that is not prohibitive.
Assuming, solely for purposes of illustration, that forest management could generate an incremental 10 cubic meters of net new fibre cover per hectare per year, averaged over 25-35 years of land management, and that 50% of the incremental fibre is carbon (whether the cover is in the form of pine trees or switchgrass), if we hiked the Province of British Columbia’s recent $8.4 million per year forest inventory and research budget to, say, $25 million per year, that translates into administration costs equal to: 48 cents per hectare of British Columbia certified forest area, per year: or $1.15 for each hectare of BC forest that is currently available for harvest, each year. Even if carbon credits trade for only $7/TCO2e, at only 1% to 2% of the market price for credits, such a massively expanded forest inventory and research budget represents a very small administration cost for carbon credit trade.
Today, in fact, accepted forest carbon project validation and verification procedures typically eat up 30% to 60% of the gross market price for forest carbon credits. These forest carbon marking-killing transaction/overhead costs are primarily due to the deficiencies in and infrequent updating of our forest inventories and fibre supply forecasts. In the absence of regularly updated, reliable and relatively high resolution forest inventories and forecasts, significant resources have to be committed to craft and re-validate reasonable (but still highly theoretical, and too often highly politicized) forest carbon “baselines” to enable carbon credit quantification to proceed. Forest and carbon market leaders should enter into partnerships with our governments to jointly design, execute and publish new forest inventory/monitoring initiatives with a view to displacing current cost-prohibitive carbon credit-generating project validation exercises and reducing combined project validation and verification costs from over 40% to under 5% of a low benchmark price for carbon.
The price most carbon market participants are willing to pay for forest project carbon credits is lower than that which they are willing to pay to reduce greenhouse gases in their own operations, develop renewable energy supplies and/or buy carbon credits from fuel switching, alternative energy and energy efficiency projects. The current price discount for forest project carbon credits largely (but not completely) reflects uncertainty that derives from complex, confusing and ever-changing “widely-accepted” forest carbon baseline and credit quantification methodologies.
Even the most respected, market-friendly guidance documents that carbon market leaders present to potential forest project investors stress that forest carbon baseline and credit quantification methods will continue to change, quickly, for the foreseeable future. Investors are advised to “anticipate” changes in quantification methods. Most of the time, the direct result of this legitimate warning is that investors elect to put their money elsewhere.
It is not necessary to scare investors away from forest management projects that have such significant potential to store incremental carbon.
Once we have put in place the capacity to produce and regularly update highly credible, comparatively high resolution fibre supply forecasts, as well as a commitment to the timely publication of a best estimate of the potential impacts (within wide uncertainty ranges) of unplanned events on existing fibre supply forecasts, we can potentially dispense with a large portion of the costly carbon baseline-setting and project validation processes that eat up too much of the limited carbon credit price available to forest managers.
But reliable forest inventories and fibre supply forecasts, by definition, incorporate assumptions about harvest rates, fires, pest infestations and carbon stock changes due to forest preservation. Once those assumptions are disclosed and updated, say, every 5 years, the related published fibre supply forecasts define the baselines against which incremental forest project carbon stock gains can be measured. More important than the role the published inventories and forecasts will play in reducing eligible project validation and verification costs, this procedure can mitigate if not eliminate the discount that carbon market participants currently assign to forest project credits.
When investors know that the official forest inventories and forecasts will be updated every five years, they will employ tried-and-true contracting and risk hedging tools to anticipate and address risks associated with changes in the fibre supply forecasts that might occur. The inventory and forecasting process does not need to eliminate investor risk. It needs to position investors to quantify, predict the timing of and hedge against risk.
Carbon credit accounting methods that are not anchored in a transparent, predictable, credible and accessible forest inventory and forecasting procedure fail on two fronts: they are cost prohibitive and, by their very nature, they scare away investors. In Canada, we can get the structure of forest carbon markets right, ahead of all other jurisdictions. And it should cost us less than $1.25 per tonne of incremental carbon stored to get the ball rolling. With this infrastructure in place, we can reasonably expect to see forest management IRRs bloom at carbon credit prices well below British Columbia’s existing $30/TCO2e carbon tax rate.
Aldyen Donnelly is the President of WDA Consuting Inc. which focuses on: development, adoption and commercialization of new technology, especially as it relates to achieving energy efficiency and greenhouse gas reduction objectives; development of commercial responses to emerging and anticipated public policy; major project development and environmental impact assessment; sustainable development reporting; and the development of corporate training programmes to enhance staff abilities to assess and address environmental risks and challenges. She can be reached at [email protected]gemco.org.