4. Market evolution

4.1. Early days: voluntary projects
4.2. UNCED and early generation Joint Implementation projects (1992-1994)
4.3. Activities Implemented Jointly pilot phase: more uncertainty (1994-1996)
4.4. The Kyoto protocol and its aftermath (post 1998)

During the last ten years, forestry-based carbon offsets have evolved from a theoretical idea to a market mechanism for accomplishing global environmental objectives. We are still a long way from an organised market with prices defined according to supply and demand forces. However, there has already be seen some evolution from the initial voluntary schemes and bartering transactions common in the early 1990’s, to a market mechanism for accomplishing binding commitments under the Kyoto Protocol. To date more than 40 forestry projects have been established with the main objective of fixing carbon or preventing its release to the atmosphere (Moura-Costa and Stuart 1998), with at least 14 based on reforestation or other tree-planting activities (Table 1).

Table 1: Carbon offset projects involving tree-planting activities implemented to date. The list is comprehensive until 1997, but a series of initiatives have been conducted since then which have not necessarily been registered with official Activities Implemented Jointly registration bodies.

Project name	Date proposed/ initiated	Estimated Carbon offset (1000 t C)a	Area (ha)	Host Country	Investor country	Project description
AES - Care	1990	10,500	186,000	Guatemala	USA	Agroforestry
Face Malaysia	1992	4,250	25,000	Malaysia	Netherlands	Enrichment planting
Face-Kroknose	1992	3,080	16,000	Czeck Rep.	Netherlands	Park rehabilitation
Face Netherlands	1992	885	5,000	Netherlands	Netherlands	Urban forestry
Face-Profafor	1993	9,660	75,000	Ecuador	Netherlands	Small farmers plantations
RUSAFOR-SAP	1993	79	450	Russia	USA	Plantation forestry
Face Uganda	1994	6,750	27,000	Uganda	Netherlands	Forest rehabilitation
Private Forests Project (PFP)	1996	open ended	open ended	Costa Rica	open	Reforestation, forest protection, and management
Klinki forestry	1997	1,600	6,000	Costa Rica	USA	Reforestation with klinki
Burkina Faso	1997	67	300,000	Burkina Faso	Denmark	Fire wood community forestry
Scolel Te	1997	15	13,000	Mexico	UK/France	Community forestry
New South Wales State Forests and Pacific Power	1998	69	1,041	Australia	Australia	Reforestation
NSW and Tokyo Electric Power Company (TEPCO)	1999	130 to 5,200	1,000 to 40,000	Australia	Japan	Reforestation
Australian Plantations Timber	1999	3,075	25,000	Australia	undefined	Reforestation

Source: Moura-Costa et al. 1998.

a. These figures relate to the average storage capacity of the planted stands, which may not reflect the amount of carbon credits which different policy regimes will authorise to be traded.

4.1. Early days: voluntary projects

The first company interested in the possibility of compensating for greenhouse gas emissions through the planting of trees was the American electricity company AES (American Electric Systems), who invested US$2 million in an existing social agroforestry scheme in Guatemala, managed by CARE, an international poverty-relief NGO. The objective of the project was to plant 4.5 million trees over a 10-year period on 186,000 hectares. Re-evaluation of the project, in 1994, showed that these initial objectives were not met (Faeth et al., 1994). In a later stage, AES invested another US$5 million in two other projects in South America.

In the early 1990s, the Dutch Electricity Board (SEP), a consortium of five electricity companies in the Netherlands, created the Face (Forests Absorbing Carbon-dioxide Emissions) Foundation. The mandate of the Face Foundation was to promote the planting of enough forests to absorb an amount of CO₂ equivalent to the emissions of a medium-sized coal-fired power plant (400 MW) during its 40-year life time (Face Foundation 1994; Dijk et al., 1994). In this way, SEP would be able to build a new power plant in the Netherlands, with no net emissions to the global atmosphere. A budget of US$ 180 million was allocated to Face, for the establishment of a portfolio of forestry projects in different parts of the world.

These initiatives illustrate the first transactions for CO₂ emission mitigation worldwide. They were voluntary in nature, since there were no legislation requirements for polluters to reduce greenhouse gas emissions. Projects were established anticipating changes in environmental legislation, while capitalising in the public relations value of projects. In the case of AES, their first projects did not even have any contractual arrangement for carbon credit allocation and transfer, and they were never submitted as Joint Implementation initiatives. This voluntary aspect was somewhat reflected in the low average price paid for carbon sequestration that averaged US$0.01/ton C.

4.2. UNCED and early generation Joint Implementation projects (1992-1994)

In 1992, the Framework Convention on Climate Change was proposed at the UNCED meeting in Rio, and the concept of Joint Implementation (JI) of activities to reduce greenhouse gas emissions or promote the absorption of atmospheric CO₂ was put forward.

Although not officially endorsed by the convention, this promise of credit transfer through JI activities has led a series of companies to engage in JI-type activities. One of the first to move was the Face Foundation, with a 25,000 ha enrichment planting initiative in Malaysia (see Box 2; Moura-Costa et al. 1996). This was followed by four other projects involving the reforestation of degraded pasture land by small farmers in Ecuador (1992), rehabilitation of an acid-rain degraded park in the Czech Republic (1992), urban forestry in the Netherlands (1993), and rainforest rehabilitation in Uganda (1994). Another American utility, SAP, initiated a reforestation project in Russia. Approximately US$120 million were committed to the implementation of these projects during this phase, with an average of US$ 4.50 paid per ton C, a substantial increase from the previous phase.

BOX 2: THE INNOPRISE-FACE FOUNDATION RAINFOREST REHABILITATION PROJECT (INFAPRO) This is a cooperative venture between Innoprise Corporation, a semi-government forestry organisation which has the largest forest concession in the state of Sabah, Malaysia, and the Face (Forests Absorbing Carbon-dioxide Emissions) Foundation of the Netherlands. The latter organisation was set up by the Dutch Electricity Generating Board to promote the planting forests to absorb CO2 from the atmosphere to partially offset the emissions of their power stations. The objective of the project is to rehabilitate 25,000 ha of logged forests by enrichment planting and reclamation of degraded areas using indigenous tree species such as dipterocarps, fast growing pioneers, and forest fruit trees, over a period of 25 years (Moura-Costa 1996a and Moura-Costa et al. 1996). The total investment committed by the Face Foundation amounts to US$15 million over 25 years. In the pilot phase (1992-1994), 2,000 ha of logged-over forests were planted as an initial trial of the effectiveness of this system. The planting phase will be extended for 25 years and the forests maintained for 99 years. The long-term nature of the project should enable the maintenance and silvicultural treatments required to sustain growth rates during the project life. It is expected that at the end of the first 60-year growth cycle, these forests will be exploited for timber, which will belong exclusively to Innoprise. However, timber harvesting will have to be done in a careful way, so that a healthy residual stand can again regenerate into a well-stocked forest. This maintains the carbon pool for the Face Foundation, which has the exclusive rights to the carbon sequestered through the 99 years of the project. It is expected that the project will sequester at least 4.25 million tonnes of carbon (15.6 million tonnes CO2) during its lifetime at an average cost of US$3.52 per ton of carbon (US$0.95 per ton CO2). The project will also produce over 4 million m3 of hardwood sawn timber, worth about US$800 million, which belongs to the Innoprise Corporation. Given that Innoprise is fully owned by the Sabah Foundation, a semi-government organisation with the mandate of improving people’s welfare in the state of Sabah, it is expected that the project will generate considerable social spin-offs. Additionally, during its initial 25-year planting phase, the project will directly generate 230 jobs, for various activities such as field planting, silviculture, nursery work, mapping and geographical information systems, computing, financial control, and research. It is important to note that 90 % of the project’s budget is spent on personnel.

4.3. Activities Implemented Jointly pilot phase: more uncertainty (1994-1996)

With the establishment of the AIJ pilot phase in 1994, there was a reduction in investments in carbon offset projects. Because of the lack of incentives for investor participation, as no carbon credit transfer was allowed, the results of the AIJ pilot phase were not representative of the full potential of JI in terms of international investment and greenhouse gas reductions (Stuart and Moura-Costa 1998). Only four new tree planting projects were initiated between 1996 and 1997, with a much reduced level of investment of US$4 million. These included: a 6,000 hectare reforestation project with klinky trees in Costa Rica; a 13,000 hectare community forestry project in Mexico, financed by the International Automobile Association; and a community forestry project for woodfuel production in Burkina Faso, financed by the Government of Norway through the World Bank. At the same time Costa Rica initiated the development of its large national carbon offset programs (see Box 3), including the Private Forestry Project (PFP), and attracted US$2 million from the Government of Norway.

BOX 3: THE COSTA RICAN SYSTEM OF DIRECT PAYMENT FOR ENVIRONMENTAL SERVICES In 1997 Costa Rica launched two national level innovative forestry-based carbon offset programmes. Commercialisation of CO2 reduction credits is done through the sale of Certified Tradable Offsets (CTOs), the first security-like instruments backed by carbon offsets, which are issued by the recently created Costa Rican Office on Joint Implementation (OCIC). These CTOs are credits of carbon fixation based on the amount of CO2 fixed in forests or emission reductions derived from their renewable energy plants. The first batch of CTOs (200,000 tons of carbon) was sold to a Norwegian consortium at US$10/ton C (US$2.70/t CO2), for a total of US$2,000,000. The Private Forestry Programme (PFP) encourages landowners to opt for forestry-related land uses by providing direct payment for environmental services. Environmental services include CO2 fixation, water quality, biodiversity, and landscape beauty. The monetary incentives aim at increasing the attractiveness of forestry compared to higher impact forms of land use. Incentives are paid to landowners over a period of 5 years following the signing of a contract to keep their land under a specified type of utilisation for a minimum period of 20 years. Farmers who receive these incentives assign the rights of to the environmental services of the government, who bundles them for potential sale. The resources for initiating the PFP programme were raised by a domestic 15 percent tax on fossil fuels, which is expected to raise US$21 million per year. It is hoped that future payments to farmers will be based upon successful sales of resultant CTOs. The value of PFP incentives varies. There are three main areas of interest: conservation of existing forests, selective harvesting for sustainable wood production, and reforestation or natural regeneration of degraded pasture or agricultural land. In the case of private forest conservation, farmers receive US$56 ha-1year-1 to a total of US$280 ha-1. They are also waived payment of land tax. Those opting for natural forest management receive US$47 ha-1 year-1, to a total of US$235 ha-1, in addition to the revenue derived from timber harvesting. In order to enforce compliance with low impact logging guidelines, the law requires that any harvesting operation must be supervised by a trained forester. Farmers who choose to reforest part of their agricultural land receive a series of payments related to the costs of plantation establishment, to a total of US$558 ha-1. The institution co-ordinating the administration of the private sector incentives is called Fonafifo (Forestry Financing Fund), an office created by the MINAE (Ministry of Energy and Environment). Fonafifo has the role of receiving and analysing applications, conducting field verifications, carrying out the payments, and monitoring field implementation of forestry projects. Costa Rica is also working on a second national level land use project, called Protected Areas Programme (PAP), with the objective of reducing deforestation rates by consolidation of its national parks network. The programme aims at consolidating 570,000 ha within 28 national parks, and claim the carbon savings derived from avoided deforestation, which historically has averaged 3% per year. Costa Rica expects to avoid the release of about 18 million tonnes of carbon (66 million tons CO2) through the implementation of the PAP. These savings have been independently verified by the international certification company (Moura-Costa et al. 1997) and CTOs will be issued accordingly. At a projected price of US$10 per tonne of carbon, Costa Rica expects to raise US$180 million through PAP. The sale of CTOs from the PAP has been done with the assistance of international environmental brokers. In conjunction with the Earth Council, who is providing some of the catalytic finance for the PAP, Costa Rica will use a portion of those proceeds to finance construction of the Earth Centre. This will be a research and demonstration project highlighting various aspects of sustainable development and environmental values. These Costa Rican programmes provide good examples of how carbon trading could be utilised by developing countries to attract international investment into national priorities. The whole programme has been entirely conceived by the Costa Rican government and, consequently, totally conforms to national priorities. While Costa Rica managed to secure catalytic funding for the initial phase of the PAP (provided by the Earth Council and the World Bank), all other costs will be borne by Costa Rica itself, who is also responsible for determining the sale price of CTOs. In this way Costa Rica maintains full control of the production costs and profits associated with the commercialisation of CTOs, which will be redirected into priority areas within the country.

4.4. The Kyoto protocol and its aftermath (post 1998)

In December 1997, 170 countries signed the Kyoto Protocol during the CoP 3 of the UNFCCC. The establishment of binding commitments has led to more demand for offsets. According to a study of the MIT/World Bank (Ellermann et al., 1998), if these targets were accomplished through greenhouse gas emissions trading, this would generate a demand for Emission Reduction Units (ERUs) in the order of US$20 billion a year. This is a substantial change from the previously voluntary phase.

The provisions in the Protocol, even if still far from certain, greatly increased the attractiveness and reduced the risks of investment in forestry-based offset projects, leading to an immediate response in the, still incipient, carbon market. The supply of offsets became more organised and offered more sophisticated financial instruments. The Costa Rican national programme, the first to produce carbon denominated securities (CTOs - Certified Tradable Offsets), was the first producer-led carbon offset initiative in the world, and the first one to utilise independent certification and insurance (Box 3). This project was followed in 1988 by the New South Wales State Forests, a state organisation, which sold the carbon sequestration services of some of its plantations in the form of CTOs to Australian and Japanese power companies. New South Wales State Forests is currently working with the Sydney Futures Exchange on the development of an Australasian market in forward contracts for forestry-based carbon credits. Other forestry companies also realised that they had the capacity to attract carbon funding, with important implications for the financing of their operations, as illustrated by the prospectus-based forestry investment funds in Australia (Box 4). At the same time, the World Bank launched its Prototype Carbon Fund, with an initial capitalisation of US$130 million, which intends to include some forestry projects.