An Investment Primer for Reforestation CARBON REMOVAL, ENVIRONMENTAL and SOCIAL IMPACTS, and FINANCIAL POTENTIAL
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1 An Investment Primer for Reforestation CARBON REMOVAL, ENVIRONMENTAL AND SOCIAL IMPACTS, AND FINANCIAL POTENTIAL JANUARY 2020 1 CONTENTS Contents About CREO 2 Terms 3 Executive Summary 4 Background Forestry for Climate 6 Reforestation Investment Potential 9 - Investment Avenues 9 - Costs and Returns 10 Carbon Markets Regulatory Compliance 14 Voluntary 15 Corporate Offsetting 15 Summary 16 Timber and Non-Timber Forest Products Timber 18 Agroforestry 19 Summary 20 Restoration and Conservation Initiatives Direct Revenue Creation 22 Blended Finance 23 Catalytic Capital 24 Summary 24 Moving Forward 25 Appendix A: CREO Modelling Assumptions 26 Appendix B: Carbon Markets 27 Citations 28 2 ABOUT CREO About CREO The CREO Syndicate (“CREO”) is a 501c3 public charity founded by wealth owners and family offices with a mission to address the most pressing environmental challenges of our time affecting communities across the globe—climate change and resource scarcity. By catalyzing private capital and scaling innovative solutions, CREO is contributing to protecting and preserving the environment and accelerating the transition to a sustainable economy for the benefit of the public. CREO works closely with a broad set of global stakeholders, including Members (wealth owners, family offices, and family-owned enterprises), Friends (aligned investors such as pension funds), and Partners (government, not-for-profit organizations and academia), who collaboratively develop and invest in solutions across sectors, asset classes and geographies. CREO’s primary activities include 1) knowledge building; 2) relationship building among like-minded, values-aligned, long-term investors; 3) conducting select research to support the advancement of its mission; and 4) deal origination. 3 TERMS Terms Afforestation (AF): Planting and/or deliberate seeding on land not forested over the last 50 years. The terms afforestation and reforestation in modern times are often interchanged. In the context of this primer, afforestation is included within the reforestation discussion, though not specifically called out. Agroforestry: Intentional integration of trees and shrubs into agriculture and animal farming with a purpose of creating environmental, economic, and social benefits. This term is different from the concept of tree cultivation in monoculture formats as agroforestry integrates trees into another agricultural system with positive impact goals. Avoided Forest Conversion (AC): Protection of existing forests and grasslands from additional losses, especially from timber harvesting. Improved Forest Management (IFM): A set of practices that reduce the negative environmental and social effects and net emissions from forestry activities, such as timber harvesting. This concept includes better harvesting practices, the protection of ecologically important areas, and, in some cases, practices that encourage growth or regeneration. Reforestation (AF): Re-establishment of forest areas through planting or deliberate seeding that have less than 10% canopy after a temporary (less than 10 years) condition due to human-induced or natural disturbances. 4 EXECUTIVE SUMMARY Executive Summary Reforestation requires patient capital due to large up-front capital requirements and comparatively long time horizons needed to grow trees. The goal of this primer is to help investors develop a reforestation investment strategy that incorporates carbon mitigation. This is done through comparisons to other types of forestry investment strategies and information about different investment opportunities that incorporate reforestation. Overall, impacts from reforestation on carbon, social, and environmental factors, as well as financial returns, will be regionally and ecologically specific. This primer is broken up into major revenue sources for an investment in reforestation with examples of projects from investors and companies. The following are discussed in this primer to highlight the current state of individual markets: • Carbon Markets: This section includes both compliance and voluntary markets. At current scale and demand, carbon markets do not incentivize reforestation in most geographies due to an unstable policy landscape and weak price signals. Some investors are optimistic that carbon prices will be more favorable in the future and there may be an early-mover advantage for beginning projects now. • Timber and Non-Timber Forest Products Markets: Currently, most reforestation projects involve some form of timber or product harvesting. This section also covers non-timber forest products, such as rubber or agroforestry. A reforestation and harvesting strategy with major carbon mitigation potential lies with harvesting timber and other products from reforestation instead of natural forests. • Restoration/Conservation Efforts: This section includes using tools, such as conservation easements that allow for landowners to set aside land for conservation, or blended finance models. The section also includes major regional and global initiatives that are catalyzing efforts for reforestation, such as the African Forest Landscape Restoration Initiative. These efforts highlight a mixed capital stack that is bringing in institutional and public resources to support scaling reforestation projects. Investors should expect a range of returns depending on the project’s revenue mix of carbon, timber and agriculture, additional sources, as well as forestry project factors, like species mix and growth rates, or varying costs for land and maintenance. Based on CREO’s comparative financial modeling, return expectations for a reforestation project with both timber and carbon revenues consisted of 8.1% unlevered IRR and 8.7% levered IRR over a 35-year project period. Other investors with combined reforestation projects mixed with timber or a portfolio that includes reforestation projects among other types of forestry find returns up to the mid-teens for 10-year to 20-year projects. 5 BACKGROUND Background With an increase in the importance of climate mitigation efforts over the past few years, so too came an increase in interest in carbon dioxide removal (CDR) within the CREO community. Intergovernmental Panel on Climate Change (IPCC) primers have pointed to the need for CDR as necessary to limit warming to 1.5°C above pre-industrial levels. In alignment with this growing investor and scientific focus, CREO engaged in research into CDR solutions around technology and natural capital solutions around forests and agricultural soils. In thinking about reforestation as an alternative forestry strategy, reforestation presents one of the lowest cost solutions to carbon removal at scale, including technological solutions, that is ready for large scale capital deployment (the other is with soil carbon sequestration in agriculture). Since opportunities for investment in improved forest management and avoided forest conversion are already well-known and discussed elsewhere, this primer focuses on the current and potential ways that investors can fund reforestation projects. Combined forestry and land management is one of the largest sources of greenhouse gas emissions on the planet along with transportation and energy. The IPCC estimates Agriculture, Forestry and Other Land Use (AFOLU) made up a third of emissions from 1750 to 2011 and 12% of emissions from 2000-2009. The wider carbon and general impact potential around reforestation, especially when compared to improved forest management and avoided forest conversion, must be noted. As with most land use projects, it is important to bear in mind the current state of the land, the potential of the land to support other uses, the impact and financial return priorities of an investor, and any potential climate feedbacks. A pool of carbon sequestering investment opportunities already exists in the forestry asset class. There are centuries of historical knowledge and improved investment models around this asset class. Ownership of forest lands in the US and Europe is generally an equal split between private and public landowners. Within the past couple of decades, though, high impact models for carbon sequestering forestry have emerged Many of the existing investments in the carbon sequestering space rely on existing carbon, timber, and conservation markets, which are currently skewed in favor of improved forest management and 6 BACKGROUND avoided forest conversion. This includes REDD+, a United Nations program to reduce emissions from deforestation and forest degradation, as well as fostering conservation, sustainable management of forests and the enhancement of forest carbon stocks. Within reforestation, an investor’s intended area of impact drives the type of reforestation project and therefore the ultimate source of revenue. Examples below highlight the different types of reforestation projects associated with the type of impact desired: IMPACT HABITAT AND CARBON WATER FOREST LOSS DESIRED BIODIVERSITY Planting focused on Commercial reforestation Restoring a native Reforesting riparian Reforestation biomass accumulation with the goal of timber or ecosystem to its natural areas across an entire project type with fast growing or high non-timber forest product condition watershed carbon storage systems harvesting that replaces the harvesting of natural ecosystems through: Conservation easements, Revenue Carbon offset credits, • Monoculture systems, hunting and fishing generation Carbon offset credits conservation easements, such as pine or licenses, biodiversity