Before others, Merrill Lynch & Co. saw the forest for
the trees. In 2008 the US bank agreed to purchase
carbon credits, under an option agreement, in what was
billed the worlds first commercially financed
avoided-deforestation project. This effort
focused on preserving nearly 3,000 square miles of the Ulu
Masen rain forest on the Indonesian island of Sumatra, which
was losing 135 square miles annually to logging and clearing.
Behind the project were nongovernmental organization Fauna
& Flora International, carbon brokerage Carbon Conservation
and the government of the province of Aceh.
For its contribution, which was paid over four years and
helped reduce deforestation in the area, Merrill (now Bank of
America Merrill Lynch) won the right to buy future carbon
credits at $4 per ton of avoided emissions. Fauna & Flora
says the project is expected to prevent 100 million tons
of carbon emissions in the next three decades.
We approached it from the perspective of a typical
carbon market deal, says Abyd Karmali, global head of
carbon markets at BofA Merrill in London. But the deal
wasnt typical. Merrill was one of the first big financial
firms to invest in projects seeking to avoid deforestation,
partly so it could play a role in developing the emerging
forest carbon sector.
Experts champion this space as an immediate and
cost-effective way to forestall the release of carbon and other
greenhouse gases into the atmosphere. REDD (reducing emissions
from deforestation and forest degradation) is shorthand for
forest conservation activities, while REDD+ covers
reforestation and sustainable forest management as well. But so
far, the market hasnt done much to encourage private
investment in either.
With little public money to spare, the need for that
investment is urgent. Forests play a crucial role in
sequestering carbon and release vast amounts of it when they
vanish. Deforestation accounts for 17.4 percent of annual
global greenhouse-gas emissions more than the entire
transportation sector according to a 2008 independent
report commissioned by the U.K. government. In a 2004 Science
magazine article, Princeton University scientists Stephen
Pacala and Robert Socolow wrote that halting tropical
deforestation and planting new forests could do as much to slow
global warming as doubling the worlds nuclear energy
capacity or building 2 million new wind turbines.
But on official, regulated carbon markets, only credits
derived from the creation of new forests are tradable. This
relegates those earned through conservation and better
management to voluntary, over-the-counter exchanges. In the OTC
world, however, REDD and REDD+ credits have thrived. They
jumped from less than 2 percent of the voluntary forest carbon
market in 2006 to 71 percent in 2010. The expectation has
been that the REDD+ segment would represent the next phase of
the carbon market, says BofA Merrills Karmali.
In 2010, BofA Merrill began creating a new REDD+ product for
institutional investors. The so-called rain forest bond,
developed by the firms carbon markets and fixed-income
teams, will pay a return by investing in a range of ventures,
including ecotourism, sustainable timber cultivation and REDD+
From our earlier experience in Indonesia, we
recognized the market was slow to take off, and because of
constraints on the policy process, we began to look at
longer-term instruments, Karmali says. We began to
realize that rather than looking at deals in REDD+ from a pure
commodity perspective, we could come up with a product that
fits the need of institutional investors. He adds that
its too early to provide specifics on the new bond.
Leslie Durschinger, founder of San Franciscobased
Terra Global Capital, is also developing a product aimed at
getting REDD+ credits into the portfolios of institutional
investors: the Terra Bella Fund, a private equity vehicle that
provides early-stage financing to forestry projects in
developing countries. Its target projects, similar to Ulu
Masen, will yield credits that are tradable on voluntary
markets but should eventually cross over to regulated carbon
exchanges. The fund will close in mid-2012 and has a target
size of $100 million.
Although Durschinger is getting interest from some
institutional players, including two large pension funds that
she wont name, she says the market still presents too
much risk to be a serious option for most of their peers. One
major source of risk is the policy uncertainty around
international carbon markets.
When evaluating returns in the sector, assessing
demand is a critical question, Durschinger explains.
How will demand from end buyers increase, what are prices
going to be, and how will this grow over the next ten or 12
years of the funds life? The market will play out over
time, but anyone who is looking to earn a return in two or five
years, this is not the sector for them.
Still, developments in global carbon-trading schemes give
Durschinger and other proponents reason for optimism about the
future appetite for REDD+ credits. The European Union Emissions
Trading System, the worlds largest carbon market,
excludes forest-related carbon, but it will probably start
allowing REDD+ credits next year. And early drafts of a
framework for Californias new cap-and-trade system, which
will be the second-biggest carbon scheme when it launches in
November, specify the inclusion of REDD+.
Demand aside, REDD+ projects and investments raise plenty of
other questions. Do such deals protect indigenous groups
rights? Are there mechanisms to stop the theft of funds that
are meant to support conservation? Will developing countries
adequately monitor and report on the status of their forest
Durschinger says improvements in monitoring technology, such
as greater access to satellite imagery and local
communities use of mobile devices to gather data, have
eased the last worry for most investors. The other two are real
risks, she admits. But Durschinger warns that theres no
time to waste. If we are going to have any chance of
reducing emissions from deforestation in a meaningful way, we
have to attract private sector investment, she says.
If we wait until everything is perfect, there will not be
any forest left to protect.