Main conclusions The carbon markets provide an opportunity of added income for the forestry sector. Since the EU does not accept emissions reductions from forestry projects in its trading scheme, and since the UN Clean Development Mechanism (CDM) has decided that forestry-based reductions should only be given temporary credits, the CDM market is not an obvious choice for additional funding for the forestry sector – it may be more cost-effective to focus on the voluntary markets, with less stringent requirements. The Reducing Emissions from Deforestation and Degradation (REDD) mechanism offers new opportunities, but is yet difficult to financially evaluate.

For most forestry projects, proving additionality and leakage will be major hurdles; the CDM requires it to be proven that the project would not happen without the additional funding, and that afforestation in one area will not lead to deforestation in another. Voluntary markets are less stringent, but will still require that the carbon revenue results in some tangible emissions reduction.

With the right buyer, a forestry project can expect a price of around €2-7 per tonne of CO2e emissions reductions if sold wholesale to a retailer, and about double if sold directly to the end customer.

Carbon markets: The UN approach In order to combat climate change, in December 1997 the world agreed to the United Nations Kyoto Protocol. The protocol's central feature is its requirement that signature countries limit their greenhouse gas emissions. To help the industrialized countries meet their emission targets, and to encourage the private sector and developing countries to contribute to emission reduction efforts, three market-based mechanisms are included – Emissions Trading, the CDM and Joint Implementation (JI). These mechanisms were formally established by the subsequent Marrakesh declaration in 2001, and entered into force in early 2005 when enough countries had signed and ratified the Kyoto protocol. Under the UNFCCC Framework Convention, the most developed countries have special obligations to reduce their carbon emissions. These countries, known as the Annex I Parties, are the members of the OECD in 1992, plus countries with economies in transition, including the Russian Federation, the Baltic States, and several Central and Eastern European States. The other countries, Non-Annex I Parties, are mostly developing countries with no obligations to reduce their own emissions, but with ability to receive climate investments and technology transfer under the Convention. The CDM allows for projects in Non-Annex I-countries that reduce emissions to earn certified emission reduction credits (CERs), each equivalent to one tonne of CO2. These CERs can be traded and sold, and used by Annex 1-countries to meet a part of their emission reduction targets under the Kyoto Protocol. Apart from helping Annex 1-countries comply with their emission reduction commitments, the project must assist developing countries in achieving sustainable development, in accordance with their own definition. To prevent industrialised countries from making unlimited use of CDM, and thus limit emissions reductions in their home markets, the Convention establishes that the use of CDM must be ‘supplemental’ to domestic actions to reduce emissions. The CDM is the main source of income for the UNFCCC Adaptation Fund, which was established to finance adaptation projects and programs in developing countries party to the Kyoto Protocol that are particularly vulnerable to the adverse effects of climate change. The Adaptation Fund is financed by a 2 % levy on CERs issued by the CDM.

Carbon markets: The voluntary approach As a response to the stringent requirements of the CDM, a Voluntary Carbon Market (VCM) has been developed. Regulations are less stringent than for the CDM, meaning that the cost of the procedure is lowered, the prospects of achieving project approval are higher, while the financial remuneration is lower. The voluntary market has developed independently of government targets and policies. Here, businesses and NGOs can create and sell/buy carbon credits, but these cannot be traded as CERs, on the EU ETS or on similar markets – they can only be sold to those who voluntarily off-set their emissions. Some credits in this market are verified according to certain standards, others do not meet any identifiable verification standards. There are a number of relevant voluntary standards:

� Verified Carbon Standard (VCS), developed by The Climate Group and the International Emissions Trading Association (IETA), with Verified Carbon Units (VCU)1.

� Plan Vivo, for projects in rural communities which promote sustainable livelihoods, managed by BioClimate Research and Development and contracting the Edinburgh Centre for Carbon Management (ECCM) to develop technical specifications for projects alongside the project developer and the host organisation2.

� Climate, Community and Biodiversity Standards (CBB), developed by the Climate, Community and Biodiversity Alliance, with three levels of validation: approved; silver; and gold, and 23 possible standards to meet of which 15 are compulsory for “approved”. An independent third party evaluates whether the project merits approval, and if so, at what level. The standard uses the methodologies of the Intergovernmental Panel on Climate Change Good Practice Guidance (IPCC GPG) but can also use approved CDM methodologies for calculating carbon reductions3.

In addition, there exists Carbon Reduction Tons (CRTs), Climate Reserve Tonnes (CRT), and other ”currencies” for trading VERs. Not all projects comply with these standards and for many projects it is unclear how the project baselines are calculated, how additionality is tested and how verification is carried out. For some projects, this is not done at all, which reflects the cheaper cost of some of these credits in the voluntary market. The buyer determines what standards he wants his credits to meet. The voluntary market is of relevance not only for projects with less verifiable carbon gains, but also for smaller projects, since the rules and regulations of the CDM are strict and often problematic for them. The voluntary market can also act as a testing and learning ground for new projects wanting to enter the compliance market, especially for some forestry and land-use change projects4. In between the UN CDM and the voluntary market, the Gold Standard Foundation (GS), with around 90 environmental organizations including the WWF and Greenpeace International, has set up special requirements that can be added onto any project dealing with renewable energy. The GS criteria aim to ensure particularly high levels of environmental integrity. GS is currently developing joint criteria with the FSC and Fairtrade, aiming to ensure sustainable forestry and livelihoods, with a “one stop shop” solution for project approval. The first projects should be launched in 2014.

1 http://www.v-c-s.org/ 2 http://www.planvivo.org/ 3 http://www.climate-standards.org/ 4 http://www.parliament.the-stationery-office.co.uk/pa/cm200607/cmselect/cmenvaud/331/331.pdf

Project approval In order to get a CDM project approved, it must be proven that it fulfils the basic CDM requirements, including:

� Additionality. It has to be proven that the project would not happen without the income from CDM – otherwise there is no real climate benefit. This can be proven for instance by providing information showing that the project has not been fully financed, that it has been rejected by banks, or that the return on investment is below the thresholds established by investors.

� A baseline must be established, estimating the future emissions in absence of the registered project, with the project climate gains being the difference between the baseline and the actual emissions after the project.

� Leakage. It has to be proven that there is no leakage; that the emissions reductions caused

by the project are not off-set by emissions increases elsewhere.

� Permanence. Emissions reductions have to be long-term rather than temporary, otherwise the benefit to the climate is not sufficient.

� Sustainable development. For CDM, a host country approval is needed, in which the

country where the project takes place must establish that the project is not only beneficial in carbon terms, but also leads to a sustainable development in a wider sense, as defined by the host country. What this means will vary from one country to another and even over time.

Every kind of project has one or several methodologies approved by the CDM Executive Board. These methodologies have been developed through the projects and are still being improved, and every project owner can decide to try and introduce a new or revised methodology, though the cost and the risk of rejection will normally increase. An approved third party agency, called a Designated Operational Entity (DOE), must ensure that the project meets all the general and specific requirements. This is done in a PDD (Project Design Document) that is submitted to the Excutive Board (EB) for approval, at which point it also becomes public on the UNFCCC web site. If a project is registered and implemented, the EB issues carbon credits, CERs – each unit equivalent to the reduction of one metric tonne of CO2 (or its equivalent) – to project participants based on the monitored and verified difference between the baseline and the actual emissions. For smaller projects, with different thresholds for different sectors, the process is simplified, using a small-scale methodology. To reduce transaction costs, projects can also be bundled into one project for registration, validation, and verification. The voluntary markets have similar procedures, though less stringent and costly.

Reducing Emissions from Deforestation and Degradation (REDD) Since the CDM system was not designed to cover the forestry sector, and since deforestation accounts for about one fifth of all carbon emissions, the UN has set up specific mechanisms to help protect and improve forests from a carbon perspective, REDD – Reducing Emissions from Deforestation and Degradation. After several years of deliberation, in early 2013 it is still not clear whether REDD is an aid mechanism for supporting carbon related forestry projects, or a financial mechanism for reducing emissions, a CDM for the forestry sector. The criteria for REDD are still under development, the main trend being to add more criteria to the point of several developing countries arguing that not all sustainability issues should be addressed by this single mechanism. Until now there are no recognized REDD permits or ”currency” equivalent to CERs, and the estimates on how much one will be paid for avoided emissions through REDD vary wildly. The World Bank and Norway have until now been the largest buyers of REDD emissions reductions, with projects mainly in Brazil and Indonesia (Norway, not being part of the EU, has chosen to off-set part of their emissions targets through REDD). Many REDD projects are underway in Africa, often supported by the World Bank or other institutional donors, through different “REDD readiness” programs. Some have already closed, and others are expected to do so shortly, following increased awareness on the difficulties in meeting the criteria, and increased uncertainties about actual demand.

Buyers The buyers of emission rights can be divided into the following segments: a) Compliance buyers. These buyers are forced to meet certain emissions targets, as established by the Kyoto protocol, the European Union, national legislation, or similar. They are typically states or large companies, within the EU trading sector. To meet their obligations they can either reduce their own emissions or buy CERs, as established by the Kyoto Protocol, but not through VERs. Typically, these buyers will focus mainly on reducing their emissions at the lowest possible price, but more and more buyers are starting to demand that the CERs they buy are from certain types of projects or countries. Since the emissions reductions are mandatory, the compliance buyers typically do not communicate their buying of emission reductions rights extensively. b) Voluntary buyers. These buyers have voluntarily decided to reduce their emissions, partially or fully through off-setting the emissions. They are typically smaller companies, organizations, and individuals, but also larger companies, even companies that are compliance buyers, which off-set carbon footprints for product lines or activities that are not covered by the trading schemes, e.g. air travel. Since it is voluntary, they are free to choose any type of emission reductions that they see fit, including VERs and financing programs within their own field of operations. While some will go for the lowest price, others are ready to pay a premium for projects they deem to be in line with the environmental and social profile of the company. Since the emissions reductions are voluntary, these buyers typically communicate their buying of emission reductions rights extensively. The UNEP Risoe (www.uneprisoe.org) has a global web bazaar where CDM project developers can find buyers, while the different voluntary markets are much less transparent in terms of buyers.

CDM to date Operational since the beginning of 2006, until April 2013, 6 100 CDM projects were registered and more than 1.2 billion CERs issued, each representing one tonne of CO2e emissions reductions. By scope, more than 60 % of the projects involve energy industries, around 20 % focus on waste handling and disposal, and 5 % relate to fugitive emissions from fuels. 75 % of all projects originate in Asia and the Pacific, mainly China and India, about 20 % in Latin America and the Caribbean, mainly Brazil and Mexico, while less than 5 % originate in Africa. By far the largest market for CERs is the EU Emissions Trading Scheme (ETS), which allows for European industries to offset part of their emissions target with CERs. In 2009 alone, this meant a market of around 85 million CERs, though since then the emissions reductions market has been reduced to next to nothing, and the prices for the emissions reductions (each equivalent to one CER) has been reduced to under €3, compared to the €30 initially deemed necessary to create any momentum for reducing emissions rather than simply buying the permits. With a price of only €3, it also becomes very hard to prove additionality; how can such a small revenue stream be a necessary component of any project? The ETS disqualifies reforestation/afforestation projects and nuclear power plants and puts special demands on large-scale dams. Since 2013, the ETS only allows CERs from LDCs, least developed countries, valid for projects registered from this date onwards, which would create an additional interest for investing in these countries if there was a substantial price paid for the emissions reductions caused5.

CDM in the forestry sector Afforestation and reforestation were included in the CDM rules in 2003, with 15 approved methodologies and 13 approved tools for demonstrating additionality etc. The sector represents less than 0.5 % of the CDM market, with around 20 approved projects. The small proportion is mainly due to three factors:

1. The long pay-back time, since forestry projects have very limited emissions reductions during several years after plantation;

2. EU’s refusal to accept CERs from forestry projects on the ETS market; and

3. CDM’s decision to only emit temporary CERs (tCER) for forestry projects

Forestry projects are either crediting a fixed 30-year period or a shorter period (up to 20 years) that can be renewed twice. The temporary CERs expire after 5 years. Afforestation and reforestation projects that generate less than 16 000 tCERs are considered small-scale, with simplified methodologies. Forestry projects can still qualify under normal CDM rules, and thus deliver full, non-temporary CERs if the producer has complete control of the use of the biomass, or part thereof, and this biomass replaces non-renewables (coal, oil) in well-defined, preferably large-scale, power plants.

5 The official UN list of LDCs is found at http://www.unohrlls.org/

Prices From a high point of over €25, currently CERs are traded at well below €0.5. Obviously, this means that very little investment is taking place in CDM projects, some CDM projects that have continuous costs may be dismantled, and several companies focusing on CDM have folded or gone into hibernation. For forestry projects, only temporary CERs (tCERs) are issued, and they have been traded at €2-3, though to date we have no records of any trading. The price is based on prepayment mainly from the World Bank BioCarbon Fund. The price for VERs depends on what type of VERs they are. Carbon Reduction Tons (CRTs), sell at between €3-6 on the Chicago Climate Futures Exchange, Voluntary Carbon Units (VCUs) in the €3-4-range. Gold Standard VERs fetch around €2 more. For the voluntary market (VERs and others), prices are even more difficult to forecast as they are largely a combination of CER-prices and public readiness to voluntarily off-set emissions, with higher prices for more sustainable projects, projects with a higher visibility and projects in countries/sectors that play well with the buyers. The development costs of a carbon project as well as the registration fees vary widely depending on the market (CER/VER/other). For the CDM market, specialist companies are usually developing the projects, in return for a part of the income; in practise they will offer a price for the CERs that includes them ensuring that the project is accepted. This would normally be 20-40 % of the expected income. The registration cost, including third party verifiers, is usually around €50,000 for a CDM project, €20,000 for a VER project, with an additional €5,000 to € 10 000 cost for the issuance, usually yearly (it is up to the project owner).

For REDD, there is currently no established price for a tonne of CO2e emissions reduction, and future price estimates are difficult to come by, as it is not even clear whether REDD will in fact be tradable. Generally, USD5-10 is estimated for a tonne of CO2e emissions reductions. This would currently put REDD at a price premium compared to CDM CERs, though it is not easy to understand how there can be a market for REDD if there is hardly any for the already existing mechanism.

The way forward After several years of UN negotiations, the Kyoto Protocol was finally prolonged at COP18 in Doha in December 2012, but with limited ambitions for reducing emissions and with virtually only the EU/EES as participating countries. The 20 % emissions reductions pledged by the EU is in effect only what the EU had previously pledged, and other partners commit to even lesser reductions. On a global scale, a long-term agreement for emissions reductions which includes all nations will not be in place before 2020, and it remains to be seen whether meaningful emissions reductions pledges can really be agreed on, the “shared but differentiated approach” being very difficult to implement in practice, given the UN principle of unanimous decision making. The absence of any meaningful emissions target means that the need for a trading mechanism for emissions reductions is limited. In combination with the economic recession that affects large parts of the world, few companies within the trading sector find it necessary to buy emissions reductions permits, and the price has collapsed.

On the voluntary market, the situation is more positive, in part as a result of the near collapse of the compliance market – several large companies have set strong emissions reduction targets for themselves as a reaction to the failure of governments and the UN to do so. Part of these emissions reductions targets are met by off-setting, and the market for products that are carbon off-set is growing, though this volume remains minimal compared to the compliance market. Price premiums are higher, but a surplus of CERs has led to lower prices and more difficulties in getting new projects off the ground. Since the voluntary market is often part of company profiling, demands for high quality projects are very high, and increasing. The light in the tunnel is mainly for national, regional or sub-regional carbon markets, where local carbon emissions standards may put pressure on industries to reduce emissions and to partially do so by purchasing CERs or other types of emissions reductions. The recently started Californian emissions trading market is the biggest, but regional Chinese markets are attracting a lot of interest, as is Australia’s decision to launch its own emissions trading market. The Californian market accepts certain types of forestry sourced VERs, and is scheduled to introduce REDD credits at a later stage.

CDM afforestation/reforestation The approved methodologies for afforestation/reforestation are:

� Afforestation and reforestation of degraded land, AR-ACM00016 � Restoration of degraded lands through afforestation/reforestation, AR-AM00027 � Reforestation or afforestation of land currently under agricultural use, AR-AM00048 � Afforestation/Reforestation with Trees Supported by Shrubs on Degraded Land, AR-

AM00069 � Afforestation and Reforestation of Land Currently Under Agricultural or Pastoral Use, AR-

AM000710 � Afforestation and reforestation project activities implemented on unmanaged grassland in

reserve/protected areas, AR-AM001011 These methodologies share some common traits. In order for a project to be eligible for CDM under the afforestation/reforestation methodology it must comply with several requirements, mainly:

� The project activity does not lead to a shift of pre-project activities outside the project boundary, i.e., the land under the proposed A/R CDM project activity can continue to provide at least the same amount of goods and services as in the absence of the project;

� Lands to be reforested are severely degraded and are still being degraded; and � Environmental conditions or anthropogenic pressures do not permit significant

encroachment of natural tree vegetation. The net greenhouse gases (GHG) gain is calculated using a baseline, based on a stratification of the area into major vegetation types. It can also be done using actual net GHG removals, based on the project planting/management plan and its actual implementation. 6 http://cdm.unfccc.int/UserManagement/FileStorage/R91NFM6OXC4GJBW5PY0D8Q2HKLVASU 7 http://cdm.unfccc.int/UserManagement/FileStorage/L1ZYHU4X5QRPFS2IVGDM8T90N3W6CJ 8 http://cdm.unfccc.int/UserManagement/FileStorage/KYBDLQFMI6R20X58OGH3Z71N9TSU4A 9 http://cdm.unfccc.int/UserManagement/FileStorage/T05CO1LWYIJ7EHD9GBVAKZPUSQ2N8X 10 http://cdm.unfccc.int/UserManagement/FileStorage/T913E6XG8P5QIYVFNUMDACJZ2B0SWR 11 http://cdm.unfccc.int/UserManagement/FileStorage/E7C9YIHB4JVX5UP63LANFZQSMG2DK1

The project owner needs to prove that the land would continue to be degraded in the absence of the project, by demonstrating a lack of: (a) On-site seed pool that may result in natural regeneration; (b) External seed sources that may result in natural regeneration; and (c) Possibility of seed sprouting and growth of young trees. Consequently, agricultural or pastoral activities must not be displaced from the project sites to other locations, and must not result in a reduction of reforestation activities or increase the deforestation activities outside of the project boundary. The methodology for determining changes in carbon stock is detailed and includes the total amount of biomass, not only the trees planted but also dead wood, litter, and soil organic carbon. Some pre-project afforestation is permitted, but will be deducted from the net gain that the CERs are based on. The baseline will be developed by proving the state of land use/cover from around 1990, or from 50 years before the start of the project, and from a most recent date before the start of a proposed A/R CDM project. The area should be monitored according to specific parameters every five years, with additional recordings to be done every 15-20 years. If the afforestation/reforestation is done with trees supported by shrubs on degraded land, a specific methodology is used. It allows for agricultural intercropping between planted tree rows, for nitrogen-fixing species to be planted or intercropped, on soil with an organic carbon pool that is subjected to decrease or low steady state in a long term. The project must comply with the following:

� Lands are severely degraded and still degrading or remaining in a low carbon steady state; � The project does not lead to displacement of production of goods or delivery of utilities; � The natural forest vegetation will not be encroached; � The lands will be afforested/reforested by direct planting or seeding, with trees/shrubs

complying with the minimum thresholds for the forest definition by the DNA; � Intercropping between rows of trees/shrubs is allowed and included in the monitoring; � Plantation may be harvested with either short or long rotation and will be regenerated either

by direct planting or natural sprouting; � Carbon stocks in litter and deadwood can be expected to decrease more or increase less in

the absence of the project activity, relative to the project scenario; and � Grazing will not occur within the project in both the project case and baseline scenario

There is a specific methodology for afforestation and reforestation (A/R) implemented on unmanaged grassland in reserves or protected areas. In order to comply with it, it must proven that the areas are not likely to be converted to any other land use except forestry, and that it has no potential to revert to forest without direct human intervention. This is to be proved by:

� Demonstrating that there is a lack of an on-site and external seed pools/sources that may result in natural regeneration with the project boundary; or

� Demonstrating that there are limited possibilities for seed germination and/or growth of seedlings or young trees within the project boundary because of natural climate/soil conditions, pest/disease impacts, or anthropogenic pressures;

� Generally: by demonstrating that similar lands in the vicinity are not, and are not planned to be, used for any alternative land use.

In the total CO2-balance, which is the basis for the CERs to be generated, the possible increase in emissions as a result of clearance of existing trees and shrubs during site preparation and/or from decay of un-cleared existing biomass must also be taken into account.

The project activity must not lead to a shift of pre-project activities to outside of the project boundary. The soil carbon pool within the project boundary is at steady state at project commencement; within the last 20 years the area has not been severely degraded or been used for agricultural cropping for more than three years. It must also be shown that applicable financial, legal, and regulatory/policy constraints/conditions/incentives during the last 20 years are not likely to have led to a significant increase in forest planting rates over time.

For afforestation and reforestation of land currently under agricultural or pastoral use, there is a specific methodology, applicable if the establishment of the project occurs after a period of decreasing intensity of agricultural and pastoral activities and it may be expected that the trend would be continued in the absence of the project activity. In particular:

� If the pre-project activity is agriculture then: ◦ Total production of crops collected from the planned project area has decreased by at

least 30 % during five years preceding the validation year; or ◦ Area cultivated within the planned project boundary has decreased by at least 30 %

during five years preceding the validation year.

� If the pre-project activity is pastoral activity then: ◦ The annual average number of animals present in the planned project area when

expressed using the common livestock unit used in the host country has decreased by at least 30 % during five years preceding the validation year.

The pre-project crown cover of trees within the project boundary must be less than 20 % of the threshold for crown cover reported to the EB by the host nation.

For small-scale afforestation and reforestation projects, there are UNFCCC-approved simplified methodologies12, established in order to reduce transaction costs associated to preparing and implementing the CDM project. The demands for the project design document are simplified, as are the methodologies for baseline determination and monitoring plans. It is also possible to bundle several small-scale afforestation or reforestation project activities, with just one overall monitoring plan and verification/certification.

Key issues for forestry seeking carbon funding

� Additionality. Often, forestry projects have a long planning process or are on-going. To prove additionality – that the project would not have happened without the CDM financing – thus becomes particularly difficult. With the current low CER prices, additionality is very hard to prove for any project.

� Leakage. For forestry, the leakage criteria means a requirement to show that trees protected

within the project area do not lead to increased deforestation elsewhere. Voluntary schemes do not have as strong requirements on leakage.

12 http://cdm.unfccc.int/methodologies/SSCmethodologies/SSCAR/approved.html

� Sustainable development. The host country approval needed may be particularly hard to

obtain in areas where many different actors are involved, which is typically the case for forestry projects.

� Soil requirements. The UNFCCC requires that plantations shall be done on “ lands that are

degraded or degrading at the start of the project activity” . The UNFCCC has a “Tool for the identification of degraded or degrading lands for consideration in implementing CDM A/R project activities” 13.

� Replacing fossil fuel. If the project can be designed as a tool for reducing the usage of coal,

kerosene, petrol or other non-renewable fuels, and if this replacement is done in a well-defined area (as opposed to sold to any car that happens to fill up at a petrol station), it may be much more beneficial to present the carbon project using these methodologies.

� Right buyer. Given the limited experience of forestry-based CDM, and the large number of

different possibilities on the voluntary market, any developer of forestry based carbon projects should “shop around” for buyers on both the CDM and the voluntary markets.

This paper was written by Mattias Goldmann, who has extensive experience from the renewable energy market, focusing on CDM in Eastern and Southern Africa. While it forms part of the ABBBA project, partially funded by SIDA and chaired by Global Challenge (Global Utmaning), the conclusions are the authors alone.

13 http://cdm.unfccc.int/methodologies/ARmethodologies/tools/ar-am-tool-13-v1.pdf