Case study: peatland protection and restoration in Kalimantan, Indonesia. Box 1 Profile and Key Conclusions ● This case study is based on an existing $42 million USD investment managed by a local project developer in Indonesia. The project seeks to protect and restore peatland ecosystems that are under threat from conversion to agriculture through partnership with local communities. The project has been accredited under the Verified Carbon Standard (VCS) and is able to sell Verified Carbon Units (VCUs) in the voluntary carbon market. ● The project area leases a government concession of an area of 306,000 hectares, of which 150,000 hectares are peatland, which store extensive volumes of CO2. The climate change mitigation impact of the project is 230 million tonnes of avoided CO2 emissions up until 2050 in the SS. Additional environmental benefits include protection of biodiversity benefits from conservation of forests are on the peatland (biodiversity benefits are not quantified in this case study). ● The case study has been considered under a range of future conditions and is modelled in two specific scenarios using the Model of Agricultural Production and its Impact on the Environment (MAgPIE): (1) Business as Usual (“BAU”), with an average carbon price in the voluntary market of $5 USD/tonne of CO2 for the 2020-2050 period; and (2) the Sustainability Scenario (“SS”), where significant global action to meet Net Zero goals is implemented and carbon prices rise meaningfully to an average of $40 USD/tonne of CO2 in the same period. ● The business case is compelling and robust across scenarios: for BAU, the investment is estimated to deliver a 16% unlevered real return to 2050, while in SS unlevered real returns approach 21%. ● Peatland degradations currently contributes about 10% of global greenhouse gas emission from the land use sector. Hence, the protection and restoration of peatlands are associated with significant carbon revenues. An economic modelling exercise identifies an investible universe of $120 billion USD with a similar profile in Southeast Asia and Pacific, illustrating the potential scope for projects of this nature. ● Challenges to overcome include: policy uncertainty, as the business model is based on the concession awarded by the government; cash flow duration because the project takes 10+ years to be set up and verified; uncertainty around the carbon price; and an increase in demand for oil palm and biofuels that will intensify land competition. 1. Investment Thesis Investment overview This archetype investment is inspired on the Katingan Mentaya project1 in Central Kalimantan. This is a comprehensive peatland forest protection and restoration project spanning climate change, biodiversity and community goals. The project area licensed under the ecosystem restoration concession encompasses 149,800 ha of land. Figure 1 Location of Katingan project Source: Katingan VCS project document Peatlands in Indonesia are being drained and burned to create nutritious soil for agriculture. This issue is especially prominent in Kalimantan, where unsustainable palm oil and acacia plantations are lucrative and expand significantly. It is important to highlight that there are sustainable palm oil and acacia plantations (e.g. FSC certified) in the region which are not contributing to the depletion of peatland. The project reverses this trend by undertaking the following activities and getting issuing Verified Carbon Units for sale to the voluntary carbon market: 1 https://katinganproject.com ● Avoid peatland degradation: avoid the deforestation, degradation and drainage of peat swamp forest by getting legal licence to protect the project area. ● Rewet the drained peatland in areas where drainage canals already exist while the conservation of undrained and partially drained peatlands in the rest of the project area. ● Agroforestry, fire break plantation and intensive reforestation. The involvement of communities is key for the success of the project. This project requires participatory planning and the deployment of micro-finance schemes, sustainable energy development and enhancement of public services (health, sanitation and education). Additionally, the project will restore degraded habitats and therefore needs to manage species and their interaction with communities. This case study focuses on the protection aspect of the project (as opposed to restoration and agroforestry)—leading to avoided CO2 emissions compared to a business-as-usual scenario—because most of the cost and revenues are associated with these types of activities. Additionally, carbon revenues associated with peatland restoration often materialize on a timescale beyond the scope of this analysis. Carbon Pricing Scenario Descriptions The government of Indonesia and the international community recognise that the high level of emissions associated with forest and land conversion in the region is a critical environmental issue, both from climate change and biodiversity perspectives. Public actors are putting in place a number of initiatives that aim at facilitating the development of carbon markets: ● The Environmental Fund Management Agency (Badan Pengelolaan Dana Lingkungan Hidup— BPDLH). Announced by the government of Indonesia in 2019. The BPDLH will streamline flows of national and international finance into sustainable land use projects through the voluntary market. ● The jurisdictional Reduced Emissions from Deforestation and Degradation (REDD+) programme developed in the East Kalimantan region and supported by the World Bank’s Forest Carbon Partnership Facility. ● The government of Indonesia is considering putting together a nationwide Emissions Trading Scheme that is expected to cover the land use sector. The future investment opportunity in peatland restoration via REDD+ projects is modelled using two scenarios: Business as usual (BAU) and Sustainable Scenario (SS). The main assumptions behind each scenario are described in Table 2. The future costs and revenues of the project are then estimated using an economic model that optimises land use at the global and regional scales (see technical annex for detailed information). Table 1 Scenario description Scenario Mitigation Carbon Annual Productivity Area Ruminant Policy price Bioenergy increase by protection meat Demand 2050 relative fadeout to 2020 Business as Currently Gradual 20 EJ by 37% 352 Mha No usual (BAU) implemented increase 2050 (IUCN fadeout policies only. from $2 Category Consistent with USD in I,II) a 3-4C global 2020 to $5 temperature USD from increase. 2025 onwards Sustainable Consistent with Gradual 60 EJ by 108% 352 Mha 25% scenario a below 2C increase 2050 (IUCN fadeout (SS) global from $2 Category by 2050 temperature USD in I,II increase. 2020 to 110 USD in 2050 Source: Vivid Economics Under BAU, the project is expected to sell its VCUs in the voluntary market with relatively low prices (like it has been doing since 2017). On the other hand, under the SS, compliance markets will develop in Indonesia and/or international trading will be supported by Article 6 of the Paris Agreement or other international mechanism, and the project will be able to sell its credits at a significantly higher price than in BAU. Land Use Dynamics The future land use dynamics in the area will determine the future of the Katingan project and other peatland protection projects. The difference in land use dynamics between the two scenarios are driven by two main factors: 1. A carbon price increase from $2 USD in 2020 to $110 USD in 2050 in the SS. This fiftyfold increase generates incentives to use more land as a carbon sink rather than agriculture. 2. An increase in agricultural productivity of 108% from 2020-2050 in the SS, meaning that less land is required to fulfil food demand. Figure 2 Peatland distribution in Kalimantan- comparison of Current, BAU and SS 3,5 3,0 2,5 2,0 (Mha) 1,5 1,0 0,5 Distribution of Peatland in Kalimantan 0,0 Agriculture on Peatland Peat Swamp Forest Other peatland Current BAU SS Note: Current data refers to circa 2018. Source: Vivid Economics using MAgPIE results and Miettinen et al, 2016 for baseline data. Figure 2 illustrates the land use dynamics that result in both BAU and SS scenarios, and compares them to current (c.2018) values. The results focus on peatland in Kalimantan. ● Current values: Kalimantan has a total area of 54 Mha, 5.7 Mha of which are categorised as peatland. Out of the total peatland area, 1.5 Mha are being used for agricultural plantations, both industrial and small scale, 2.4 Mha are still covered by peat swamp forest (although more than 80% presents some degree of degradation), and 1.8 Mha are open undeveloped areas that present some sort of secondary regrowth 2. ● BAU: Despite the Indonesian peatland moratorium of 2012 that forbids the issuance of new agricultural concessions on peatland, the increasing demand for bioenergy and palm oil has led to a widespread expansion of plantations onto peatland3. Drained peatland provides a suitable soil for oil palm, acacia and other commercial land uses that have high market values. Experts in the field of peatland protection4 predict that this phenomenon will continue to happen indefinitely unless stricter environmental regulation comes into play. Therefore, the economic model predicts a further increase in agricultural production on peat swamp forests of 320,000 ha by 2050. The increase is moderate, especially because a large extent of the peat swamp forest in Kalimantan is protected5, either by the moratorium,