Humans have cleared nearly one third of the planet’s forests since the 1750s, triggering profound changes in the environment and reducing carbon dioxide (CO2) drawn from the atmosphere to the land. Meanwhile, increased commercial activity creeping into formerly forested areas is often not attractive from carbon or biodiversity perspectives either.
Does it matter? Absolutely.
“We are totally dependent upon the natural world,” wrote the legendary broadcaster and natural historian Sir David Attenborough in the foreword to The Economics of Biodiversity: The Dasgupta Review, an independent, global review commissioned by the UK Treasury in 2019.1 “It supplies us with every oxygen-laden breath we take and every mouthful of food we eat. But we are currently damaging it so profoundly that many of its natural systems are now on the verge of breakdown.”
Forests sequester around a third of man-made carbon emissions (see Figure 1 for forest flux) and cool through transpiration. Acting “like giant air conditioning units”,2 they are an essential part of the hydrological cycle, helping groundwater recharge and drawing it up to form clouds.
This raises critical questions. Will offset schemes (where companies and investors purchase certificates to compensate for man-made emissions elsewhere) prove effective mechanisms for carbon sequestration? And can investors ever be sure the carbon lock-in they expect takes place, while being sensitive of wider ecosystem concerns?
Figure 1: Forest carbon flux estimate
Source: ‘Global Forest Watch’, January 2021
A ‘natural’ pathway?
There is now a flood of initiatives calling for forest protection and mass-scale nature restoration from governments and non-governmental organisations around the world.
Figure 2: Natural climate solutions (NCS) carbon offsets - questions of scale
Source: ‘Carbon Offsetting: A Piece of the Decarbonisation Puzzle?’, Morgan Stanley, February 2020
These nature-based projects are getting attention from companies committed to net zero but aware their emissions will be difficult or impossible to trim. Voluntarily buying offset certificates offers a fast track to shrink carbon footprints, removing carbon at low cost (US $3 to $5 per tonne) with one click.3
While offsets allow individuals and companies to weigh environmental gains against their own footprints, the projects are often unrelated to the activities that produce carbon in the first place. In addition to certificates from projects that generate carbon sinks (for example in forestry, the largest sector by certificate value),4 there are also offsets available from those that avoid emissions (including renewable energy projects) or slow them (such as peatland restoration).
We know it will be very difficult for many businesses to get all the way to net zero
“We know it will be very difficult for many businesses to get all the way to net zero, much less carbon negative, without tapping into the offset market,” said Bill Winters, CEO of Standard Chartered Bank, chair of the taskforce on scaling voluntary carbon markets. “The offsets are the most convenient and efficient way to migrate tens of billions of dollars that need to move from banks like mine into the hands of those who can actually remove carbon from the environment.”5
In 2020, the flow of corporate funds into voluntary offsets continued, despite COVID-19 affecting aviation and tourism, according to Ecosystem Marketplace.6
Now companies in multiple sectors are taking part; from EasyJet (accessing credits from forestry regeneration schemes in South America and Africa)7 to Microsoft (mainly funding forestry, as well as soil carbon sequestration, bioenergy, biochar and direct air capture).8
Fast track or off track?
But the question from those concerned with environmental, social and governance (ESG) risks is whether the fast track will ultimately prove the best track. The recommended pathway set out in the Oxford Principles for Net Zero Aligned Carbon Offsetting advocates focusing on emissions reduction first, then carbon removal, then long-lived storage; leaving offsets as a last resort.9
The concern is that in the rush to present a green face to the world, many companies are simply leapfrogging to the final phase.
Only two per cent of carbon projects had a high chance of delivering “real, measurable and additional” emission reductions
In the past, there have been problems ensuring environmental criteria are met. A damning analysis by the Institute for Applied Ecology in 2016 assessed a number of carbon projects under the Kyoto Protocol and concluded the majority fell short.10 Only two per cent had a high chance of delivering “real, measurable and additional” emission reductions; the prospects were low for 85 per cent.
“Think about the people that are watching this time, who were not watching before,” Winters said. “Our owners are watching. Our regulators are watching. To the extent these commitments make their way into financial reports, auditors are watching….”
One option is for companies to address carbon management themselves through insetting (see Figure 3). This involves a different philosophy, taking full ownership of carbon-generating activities, seeking to reduce them and then balancing residual emissions right across the value chain. Effectively, it brings carbon management in-house. It is less popular than offsetting, although a lack of official data makes it difficult to scale. It is slower and more difficult to administer, but it ensures emissions are addressed head on.
Figure 3: Offset or inset? Assessing responsibility for carbon management
Source: Aviva Investors, May 2021
For those that choose to inset, there may be financial implications as carbon markets evolve. “Carbon offsets have a price,” says Stanley Kwong, Aviva Investors’ associate director of ESG for real assets. “If we are to meet the targets of the Paris Agreement, the current price is too low. If carbon offset certificates become credible units of exchange in achieving net zero, the price could rise, but no one knows how soon or by how much.”
Investing in outcome-oriented forestry
For real asset investors, forestry is one of the few established commercial areas to invest within NCS. Although there are still measurement challenges, the majority have been addressed. Valuing land, monitoring carbon sequestration and anticipating cashflows can all be carried out with a reasonable degree of accuracy.
Demand for wood products is growing in both emerging and developed markets
Wood products are needed for construction and packaging, particularly with the recent move away from plastics. There is new demand coming onstream for wood pellets for use in the energy sector, too. With demand growing in both emerging and developed markets, conditions are in place for long-term return generation in an asset class that is not closely correlated with mainstream investments. There are risks attached, but the investment is asset-backed, and hazards like fire can be mitigated through careful management.
To put this in context, the S&P Global Timber & Forestry Index has seen annualised returns of 7.6 per cent over the past ten years,11 around two per cent less per year than the S&P Global Broad Market Index. But for those with an eye on sustainability and net-zero targets, the total return may be less important than wider environmental and sequestration considerations.
Reference to frameworks like the one designed by the Forest Stewardship Council (FSC), an international, non-profit organisation, should help ensure best practice, whatever the approach.
FSC certification gives independent assurance that high standards of responsible forest management are being met
“FSC certification gives independent assurance that high standards of responsible forest management are being met,” says Amy Willox, forestry outreach manager at the FSC.
Existing commercial planting can generate positive cashflows from the outset, for the simple reason the trees are already there. But a better carbon outcome can be achieved through afforestation – establishing a forest or area of trees where previously there was none.
“Remember you won’t be able to access the carbon certificates straight away,” Kwong explains. “It is very different from buying an offset, which is an immediate one-time transaction. The whole approach means you need to be very long term in your thinking, because trees take time to grow. The volume of sequestration depends on local factors as well as the species mix and will not step up until about year 15 after planting.”
Figure 4: Indicative natural sequestration rates (tCO2e)
Source: WCC, May 2021
The land managers held up by the Woodland Carbon Code (WCC), the body responsible for verification and transparent record keeping in the UK, highlight a 40 to 100-year timeframe, rather longer than most farmers or investors usually have in mind.
Asking the Earth?
Assigning value to carbon – albeit at levels too low to achieve anything close to the Paris target – is already bringing important changes. More focus is now needed on carbon metrics, the detail of sequestration schemes, offsets and insets, and land management. With the carbon cycle out of kilter, there is a window of opportunity to use natural pathways better and keep carbon leakage in check.