Who pays? Lessons from CDM forestry projects for REDD (Newsletter #1)

See Newsletter #1, November 2012

Forestry projects typically involve local communities and are challenging to implement. When farmers get involved with personal financial liabilities, the question of who bears the financial risk arises especially in cases where revenues from carbon credits do not materialise. A closer look at a CDM forestry project and the underlying rules reveals that if the forestry project does not generate tradable carbon credits, the financial risk lies solely on the marginal farmers.

According to the recent report “State of the Forest Carbon Markets 2012”, 451 individual forest carbon projects are currently recorded with several compliance and voluntary carbon markets. In total there are 72 forestry projects in the CDM pipeline. After the infamous Plantar project in Brazil was awarded 4 million carbon offsets earlier this year, a second project received carbon credits in October for restoring vegetation cover to degraded land in Ethiopia.

Yet forestry projects don’t come without controversy. Due to non-permanence of emission reductions and the high risk of leakage, forestry projects only receive temporary carbon credits (tCERs) which need to be replaced with “real” and permanent carbon credits at a later stage. Moreover, the establishment of crediting baselines and measurement of reductions is inherently difficult because of the volatile nature of forest carbon and the variety of carbon sinks present in forests. Financial constraints are also important. Even with upfront funding, the investments needed for these projects are typically higher than financial returns from the carbon credits. This is especially the case with credit prices at around 1 Euro each. As a result, only two out of 40 CDM forestry projects have received carbon credits even though they have been registered for many years. The administrative CDM process involves high financial costs and often local communities get involved with personal financial liabilities. Hence, if revenues from carbon credits do not materialize, the matter of who takes financial risk arises.

The World Bank’s BioCarbon Fund, which invests in around 20 forest and land-use schemes, has historically been the largest driver of forestry projects in the CDM, including the Plantar and the Humbo project in Ethiopia. The BioCarbon Fund is also financing the so called “JK Papermill project” located in India, in the state of Andhra Pradesh and Orissa. The project, which covers 1.600 ha of land and involves more than 1.500 farmers, was registered in February 2011. During the crediting period from 2004-2034   the annual reduction is estimated at less than 5.000 CERs per year. At a carbon price of 1 Euro each, this would amount to about 150.000 EUR over 30 years. Although the monitoring report for the period of June 2004 to August 2011 has been published, no issuance of credits has been requested to date.

According to the project design document “the farmers equity contribution is in the form of land and labour supplies in the establishment of tree crops. The resource poor farmers are also contributing their savings as investment in the plantation activity. Accordingly, the beneficiary farmers themselves out of their savings or through loans meet the plantation establishment cost.”

The project activity aims to raise tree plantations on farmland that are currently under subsistence culture. It also intends to secure supply of timber wood as raw material to JK Paper Ltd. (JKPL) for paper production. The participating farmers entered into an agreement to plant Eucalyptus and Casuarina in growing cycles of five years to sell the timber to JKPL at market rate and were promised to receive at least 80% of carbon revenues from the annual expected tCERs to supplement their incomes. However, consultations with individual farmers confirm that the financial situation of many have considerably worsened given that they have not been able to pay back loans that were provided to them to buy the seedlings and other supplies needed for the plantation. Reports from the farmers confirm that most who were involved in the project are indebted and are waiting for the promised carbon revenue. However, based on the agreement and current carbon market prices, the farmers would get about 2,4 EUR per year for their efforts, which is hardly enough to pay back the loans they entered to facilitate the project.

Trading off financial risks: The additionality analysis reveals that the methodology puts financial burden on poor farmers

The methodology applied under this project (AR-AM0004ver.3) requires application of the “Tool for demonstration and assessment of additionality for afforestation and reforestation CDM project activities”. The current version of this tool allows project participants to choose either the investment or the barrier analysis as a stand-alone analysis. Underlining the decision, the PDD barely states that “it is neither feasible nor appropriate to undertake investment analysis for this project situation” but does not explain why an investment analysis is not feasible and why it is not appropriate. Since the rules allow for this decision, the validating auditor did not further comment on this decision. The Designated Operational Entity (DOE) confirmed the additionality of the project based on the following barriers:

1.            Institutional barriers: It is argued that it was necessary to set up the organisation Veda Climate Change Solutions Ltd. to provide institutional support to the numerous farmers participating in this project without which the project would likely not have taken place. The DOE considered it a valid barrier.

2.            Investment barriers: It is argued that only by providing dedicated access to financing the numerous individual investments and by providing upfront payments in terms of CER revenues to bridge the 5 year span from tree planting to harvesting (after which tCERs could then be issued) such kinds of projects would only be attractive to small farmers. This barrier was accepted by the DOE too.

3.            High transaction costs of sourcing raw material from small and marginal farmers: The DOE did not consider this barrier as relevant because it is associated with JK Paper Ltd. and not the farmers investing in tree planting.

4.            Technological barriers: It is argued in the PDD that without technological support (for breeding, planting, harvesting activities) farmers would not invest into such projects. Technical support is anticipated to be provided by the paper mill having a key commercial interest in the project to secure timber wood supply. This barrier was also accepted by the DOE.

A closer look at this project and the underlying rules reveals that participating companies can easily shift the financial risk of a project to participating local communities and farmers. If the project does not generate tradable carbon credits, the financial risk lies solely on the farmers. Even if carbon credits materialise, the revenue would not stretch to cover the costs they have incurred. This is a serious issue regarding the responsibility of participating entities that put the livelihoods of marginal farmers at risk because of a risky CDM forestry project.

Negative experiences with the CDM have to be taken seriously. There are hundreds of REDD projects under development that are likely to adopt similar rules, templates for contracts and agreements. Strong safeguards are needed to ensure that local communities don’t have to shoulder the financial risk of forestry projects. If a project fails, financial sanctions and compensation measures are needed to get the poor ‘beneficiaries’ out of the indebted situations they then find themselves in. This is the minimum social and financial responsibility the public expects of project participants such as the World Bank’s BioCarbon Fund.