New data from the Brazil government shows that there has been a huge increase in deforestation within the Amazon during the past few months. Brazil’s National Space Research Agency (INPE)’s rapid deforestation detection system (DETER) recorded 593 square kilometers of forest was cleared during March and April 2011, an area of rainforest 10 times the size of Manhattan and a 473% increase over 2010 figures for those two months. Over 80% of this occurred in the southern-most state of Mato Grosso where most of the land ends up as cattle pasture or agricultural land.
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Brazil deforestation increases 473%
Timber Investment v Other Assets
Timberland investment has traditionally been the preserve of the private, non-industrial landowner, accounting for a staggering $150 billion globally. However over the last 20 years, institutional investors have discovered this ‘perfect’ asset and now own around $35 billion worth of timberland globally, in a combination of over 100 private pension, foundation, and endowment funds. Of that around $25 billion is invested in the United States, which represents both the world’s largest producer and user of timber. Pension funds such as Calpers, led the way in the 1980s, however it was the big university endowment funds such as Harvard and Yale that saw the true potential and invested heavily in a move to diversify their portfolios globally. Last year the Harvard Endowment Fund invested $500m in forestry and carbon credits in New Zealand.
So what makes timber such a popular asset with institutions and what are the fundamentals driving this perfect asset?
Timber can be classified as a specialised form of long-term bond. A forest that holds mature timber will generate cash each year through the harvest and sale of timber. These harvests can be modeled and forecasted with a reasonable degree of accuracy over many years. Since timber growth and subsequent harvests are scarcely affected by the movement of financial markets, forest investment can be structured to act and behave in many respects like a long-term bond.
Most view “timberland” as an investment in real estate. While traditional commercial real estate generates income from leasing, timberland derives its primary income from the sale of timber and more recently from carbon credits. However its tax that has been the major driver of forestry investment in the UK; if held for 2 or more years the forestry land can be passed on to family members with no inheritance tax. Timber harvest is also exempt from income tax making this especially popular as a wealth protection asset.
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The Rainforest Rush is on!
Although you may not be aware, all the World’s largest corporations are rapidly purchasing as much-endangered rainforest as possible. Why would they do this you ask? To which the simple answer is that they are all highly undervalued and so a very good investment!
All multi-national corporations have enormous global carbon footprints, and only in the coming years will this officially become a financial burden to them as global governments slowly enforce various methods of what is effectively an emissions tax. As the underlying unit of CO2 emissions is the carbon credit, and rainforests are the largest organic owner of carbon credits, the investment decision is an easy one.
With deforestation the root cause of around 20% of global carbon dioxide pollution, “reduction of emissions from deforestation and degradation” (REDD) projects should be accepted by the UNFCCC this December in Copenhagen. Once this occurs, implemented REDD projects will have carbon credit values within the Kyoto Treaty’s “Clean Development Mechanism” giving them enormous inherent financial value. Rather than wait for this decision most MNC’s have made their minds up, taken the bull by the horns, and are buying their stock at “pre-launch prices”. The Rainforest Rush is on!
As scientists worldwide perfect their analysis techniques including using satellite technologies, the carbon stock already stored and the sequestration rates of forests are being calculated and rainforests evaluated. It isn’t every forest of course. Only those that are officially endangered by a high risk of deforestation, in countries such as Brazil, Indonesia and Papua New Guinea, will pass the rigorous REDD standards.
Indonesia giant steps to Rainforest protection
Indonesia is recognised as the World’s largest greenhouse gas polluter through deforestation. With the release of CO2 in to the atmosphere through deforestation responsible for 20% of global greenhouse pollution, practically the largest single reason for global warming, Indonesia is in the limelight. Unfortunately with high levels of press exposure concerning illegal deforestation in Indonesia for the purpose of Palm Oil plantations, competing with potential food crops, the situation needs quickly addressing.
Reducing emissions from deforestation and degradation, or “REDD” as it is known, is one of the most crucial topics to be addressed by the UN in Copenhagen this December. It is widely accepted by experts that limiting the rise in global temperature to 2˚C above pre-industrial levels (the level at which widespread ecosystem breakdown is forecast) will be almost impossible without REDD.
Once the International Panel on Climate Change present their findings in Copenhagen to the World governments it is hoped that necessary financial mechanisms will be implemented that correctly incentivize 3rd World governments such as Indonesia to not only protect existing rainforest but replant new forests. Only then will the Kyoto Protocol’s effective successor have taken the crucial action in attempting to mitigate climate change.
Mean while, with over a billion tons of CO2 emissions from its forests and peatlands, Indonesia has pre-empted the UNFCC’s decision and officially issued national regulations on REDD. Now all forest stakeholders, be they private organisations, local authorities or indigenous people, can all acquire REDD permits for projects that prove they prevent CO2 otherwise entering the atmosphere.
Should a large %age of Indonesia’s current deforestation be prevented, and if REDD is accepted in to Kyoto’s existing CDM system, then the potential carbon credit trading value for Indonesia will run in to US$ bns. We can only hope that in Copenhagen this winter the World’s governments can reach an agreement for this vital solution to global climate change, and financially motivate everyone to protect their forests.
Timber investments stand strong through economic gale
In April 2009 timber prices had fallen 28% year-on-year, the biggest price decline in the last decade. Many investors baulked, however forestry investment still outperformed both real estate and equities over a three-year annualised basis, according to the Investment Property Databank. However experienced timber investors will ignore this knee-jerk reaction and remain confident with their knowledge and understanding of the fundamentals that separate the timber market from other investment classes that have suffered so much recently. With biological growth rates, relatively accurate forecasts can be made from historical data to predict a tree’s wood volume delivery rate. Considering the long slow and stable growth period between planting a seed to harvesting the asset, the timber market supply is therefore a relatively stable one. Only in the past decade as a result of the construction industry boom has some instability crept in to the demand-side of the market, rallying the market and driving prices faster than previously expected. Some believe that due to the halt in construction a knock-on effect will make timber market values plummet, however a few crucial factors need considering that will prevent this occurring;
Timber growth is a long slow process and a housing construction crash now will not affect today’s timber production cycle in any way. Wood will either be harvested and sold at current slightly lower market prices, giving investors a slightly lower IRR when considering the number of years the investment is made, otherwise it will be stored rather than sold. Neither of these actions will directly drive prices down.
Timber plantations and investments also have a much lower gearing level than that of all other financial instruments during recent years, such as COO for equities and mortgages for real estate. Lower gearing within both the supply and demand-side of any market directly results in a much less volatile price market. With very little credit entering the marketing, rallying and driving prices and attracting price speculation, and subsequently deserting and in turn deflating the market, timber prices are so much more stable.
One more crucial difference between the timber markets and other investment assets is the ability to create complex financial instruments. In the equity markets all number of derivative and option markets, hedge funds and funds of funds, have skewed the perceived true value of the underlying assets and enabled the derivative market to become more “valuable” than the asset itself. In the real estate world, the off-plan investment model was devised that was dangerously exacerbated by off plan financing, further enabling re-writing of short-term contracts and falsely inflating market prices.
PAPUA NEW GUINEA CARBON CREDITS SUSPENDED
Its not all good news in the evolution of the voluntary carbon markets. Papua New Guinea has the highest deforestation rates in the World, significantly affecting PNG’s and global carbon sequestration levels.
With illegal and legal logging rife in PNG and Indonesia, financial incentives are crucial to prevent further deforestation and motivate reforestation. Forests carbon credit value are already calculated and traded on the Voluntary Carbon Markets, however the Reducing Emissions through Deforestation and Degradation (REDD) initiative must be ratified at the United Nations Climate Change Conference in Copenhagen this December 2009 to make these valuations official and regulated.
In the mean time, considering the potential financial / carbon-offset value these forests may have in the future, developed countries are jostling for control over developing countries forests and reforestation opportunities. Should the carbon credits be accredited or not, distribution and sales of these credits is also a highly pursued market. In PNG suspicious government activity has cast a shadow over the future forest carbon credit market and even attracted the attention of Interpol. Peter Younger from Interpol told Reuters that he expected to see fraudulent trading of carbon credits, as organised crime infiltrates the systems of companies and countries in the developed world’s buying rights to the stored carbon.
The PNG government “Office of Climate Change and Environmental Sustainability” OCCES recently awarded two brokers the opportunity to sell $500m of carbon credits allocated to one rainforest “April Salome” in return for a payment of US$8m to assist the agency set-up. In the memo seen by Reuters, the officer requesting sign-off from the PNG Prime Minister also highlighted that the OCCES would receive 20% share of the brokers ongoing profit.
April Salome is expected to generate up to 1m tonnes of avoided carbon dioxide emissions, and with the voluntary market valuing these credits around $8/tonne, the annual revenue to be generated from the credit sales is significant. Whilst the PNG government have now stated that an “open tendering” system will be in place for brokers to win the business, one broker firm “South Pole Carbon Asset Management” claims to have all the legal documents giving it rights to sell April Salome. They are already selling the carbon rights despite the project not yet approved or validated by any third party according to Reuters.
With the UN Conference in Copenhagen still a long way off, this will be a very interesting summer and will hopefully show all the weaknesses the existing market has. Fingers crossed this will enable policy makers to make the critical decisions in implementing the right system to motivate a fully global movement toward forest protection and sustainable reforestation.
So money Doesn’t grow on Trees … ?
Or so the old adage goes …. but as we enter a new era, an era where Carbon is the most talked-about and most important commodity in the World, then suddenly this age-old saying now seems a little short-sighted.
With over 20% of the planet’s carbon stored in trees, global governments and organisations now recognise and acknowledge that the protection of the forests is absolutely vital in preventing devastating climate change. Not only do trees continue to capture and store Carbon, when destroyed by fire they release harmful CO2 in to the atmosphere. At last their value is now substantiated financially, with carbon credits in the Voluntary Carbon markets averaging over $6 per tonne of CO2 equivalent and the highest values being placed on reforestation projects at over $8/tCO2e. So not only good for the environment, growing trees is now at long last serious business.
Willow Rivers recommend investing in sustainable rainforests in Costa Rica, Indonesia, Malaysia and Sri Lanka not only for the carbon credit potential, but also for the actual goods produced. In conjunction with local governments these re-forestation projects grow teak and aquilaria, both forecast for thriving demand as global populations swell. Permits ensure the forests are sustainable aka as soon as harvesting occurs a rest-period is enforced followed by healthy re-forestation. With harvesting periods between 8 and 18 years, investors choose when to harvest portions of the forest so producing “waterfall returns” and mantaining maximum soil health. These types of forest investments can also be structured via SIPPS and are able to give additional tax advantages.
Further than carbon credits and actual sustainable wood harvesting, even further values are being placed on forests by some organisations such as their rainfall production, water storage and weather moderation capabilities. Whilst the relevant values are yet to be justified and proven, there is no doubt that the future is looking good for trees.
RTC3 - Indonesia first country to go REDD
As our 3rd story on the Road to Copenhagen, we focus again on Indonesia which is now the first government to formally enact regulations governing a UN-backed REDD (Reducing Emissions from Deforestation and Degradation) scheme.
Under the Indonesian regulations, foreign parties can now join with local companies to develop REDD projects, delivering Carbon Credits to the owners. REDD projects are not yet officially accepted within Kyoto’s CDM scheme for emission reduction credits, and can only be traded on the voluntary carbon markets, however it is hoped that in Copenhagen this December that decision will be reversed.
Indonesia is the Worlds 3rd most rain forest covered country, and as such holds an enormous resource in the carbon-sinking trees. Deforestation problems exist within Indonesia due to the popular and lucrative Palm Oil production, the plantations for which are often on cleared rain forest. It is hoped the ratification and acceptance of REDD as a genuine CDM mechanism will stop this deforestation before too late.
“Carbon Conservation” is working with the Aceh government in Indonesia on “Ulu Masen”, the World’s first independently validated REDD project covering 1.87m ha. How the credits generated will be traded, and what the Indonesian government will receive as a levy, are yet to be decided. Most importantly, with 20 REDD projects under development in Indonesia, progress is atleast under way.
Sustainable forests keep the rain falling
Research recently published in New Scientist magazine has shed new light on the way our planets weather is formed. Meteorologists have suggested that the world’s forestry is acting as a gigantic pump, generating tremendous winds that push rainfall all over the globe.
Forestry has a long-standing relationship with rain - nearly 50% of all precipitation that falls on a typical tropical rainforest is evaporation from the trees. This in turn keeps the air above the canopy moist and with strong winds arriving from the ocean, more and more rain is generated; hence the name ‘rainforest’. But now two Russian scientists claim that the forests themselves are in fact creating more wind pumping the moisture across the planet.
In a very brief explanation the process is as follows; 1) Vapour from forests and oceans condense to from droplets and clouds. 2) The gas takes up less space as it turns to liquid, lowering local air pressure. 3) The pressure is lower over coastal forests, which suck in moist air from the ocean, generating wind which pumps the moisture further inland. 4) This process continues over and over again covering new sections of forest and pushing rain and moisture further and further inland.
If these scientists are correct then government attitudes to forestry and climate change may be changed forever. To justify their hypothesis the meteorologists point to areas of the world like West Africa and Northern Australia which don’t have coastal forests - where the climate becomes increasingly drier as you head inland. This is in stark contrast to the parts of the globe that have forestry running from the coast to the interior, where rainfall is consistent from the coast all the way inland.
With climatologists already concerned about the effects of deforestation on our planet, this news will further validate their fears. However, the good news is that by re-planting forests then these powerful woodland pumps can spread rainfall across our continents once again.
Sustainable Forestry investments such as those offered by Ecogen Investments in Malaysia and Sri Lanka are conducted in careful conjunction with the local governments. Land is leased to Oxigen Plantations who plant and manage Teak and Aquilaria trees, two woods predicted for high future demand. Investors receive waterfall returns over 4 years < 16 years, depending on when the trees are harvested, and investments can be made through the UK SIPP structure to give taxation benefits. With the progression of REDD projects in many dense forest countries such as Indonesia, many believe these forestry projects will be accepted by the CDM and so also yield profitable carbon credits for owners of Sustainable Forest projects such as this. After harvesting, new trees are planted, ensuring the forest is sustained.
REDD in Action from Brazil to Kenya
Companies like ImageTree and centres like Woods Hole Research Centre in the US are providing two of the Worlds largest populations, Indonesia (4th) and Brazil (5th), with hope for reaching their carbon reduction goals. As two of the largest Green House Gas emitters, ranked 3rd and 4th respectively in the World, Indonesia and Brazil both have serious deforestation problems which cause the majority of their carbon emissions. Whilst we still have until Dec 09 in Copenhagen to find out what the COP decide to do with regards to any implementation of REDD policies, it is at least certain that some REDD activities and incentives will commence soon. Once the best form and methods of REDD implementation is decided, whether at a project or government-level and whether via the carbon market or an incentivized fund method, it will only be a matter of time before REDD activities become the norm. Very soon the REDD-related technologies behind forest carbon level analysis and deforestation rate assessment, protection and prevention, as such developed by ImageTree and Woods Hole Research Centre, are sure to be in high demand by global governments in the future.
Meanwhile in other areas of the World some countries are ploughing ahead with their REDD plans despite the certainty of the final outcome. In Kenya for example the Kenya Forest Service (KFS) have now signed a deal to protect their 80,000 acre natural wildlife area, with the entire project funded by sale of the land’s carbon credit values in the Voluntary Carbon market, as certified by the Voluntary Carbon Standard (VCS). For many of the twelve nations to originally receive funds from the World Bank’s Forest Carbon Partnership Facility the time to act is now!