Where is the market headed in terms of the demand for forestry-based carbon offsets?

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The easiest way to answer this question is to break it into its three parts:

• Where's the GHG market headed generally?
• What’s the demand for forestry-based offsets?
• Will forestry offsets be competitive in the market?

Each of these questions poses challenging issues. Let’s take a look at each in turn.

First, there are multiple GHG markets, particularly when it comes to forestry. There are mandatory markets, such as Europe has initiated, and there are voluntary markets, which dominate in the U.S. Nobody really knows where either of these markets is headed. The biggest single variable is U.S. politics -- will the U.S. rejoin the international markets, or will it implement GHG market policies of its own (by creating a demand for reductions)? Some people are forecasting that the market-clearing price for GHG credits could go to $50 or $60/ton in the international markets, but personally I doubt those numbers, at least not without steps that would dramatically ratchet down the emissions cap under which industrialized countries are operating. In today’s market context, we’re much more likely to see international prices in the $10-$20/ton range in the next several years. The voluntary market price has tended to be closer to $5/ton. The higher the market price, the more room there is to bring almost any group of credits into the market, including from forestry projects, and vice versa.

Second, the demand for forestry-based offsets historically has been associated with voluntary markets. Forestry-based offsets sell well to local constituencies, and can be pitched as having a variety of ancillary benefits. We’ve seen this very recently in PG&E’s announcement of its proposed Climate Protection Tariff, which will use forestry-based offsets to help render participating ratepayers carbon neutral. But voluntary markets remain quite modest in size, with low market prices. When you get into mandatory markets, you get commoditization of the market. Most buyers simply don’t care very much about where the tons come from. In today’s international market under the Kyoto Protocol, the role of forestry is quite constrained; it’s basically limited to reforestation, and you can’t get credit for growth after 2012. There’s a lot of discussion about expanding the role of forestry in the next Kyoto commitment period (post-2012), but we don’t even know yet whether we’ll have a real second commitment period at all. So whether we’ll see much demand specifically for forestry-based offsets depends on a host of variables.

Third, forestry faces significant challenges in competing in the offsets market, particularly in mandatory markets. Forestry has been a competitive offset in the past primarily because in voluntary markets the practice has been to front-load as much as 100 years of growth, counting all of that growth as offsets against emissions today. That makes it easy for forestry to look as inexpensive as $1-2/ton. But there’s more and more pushback against counting reductions in the distant future as offsets against current emissions, even in voluntary markets. Accounting for when the carbon is actually delivered would make many forestry projects look much more expensive and render them much less competitive in the market. Another challenge facing forestry is the issue of the permanence of the offset. To render forestry-based offsets equivalent to other offsets, particularly in mandatory markets, you have to address the potential for reversibility (e.g., in reforestation, what if the trees burn down or are harvested?) . There are ways to account for this risk, but almost all methods used to date have the effect of discounting the market value of a forestry offset as compared to other offsets.

When you put all this together, it’s a hazy picture. If international market prices stabilize at the $10-15 range, most forestry projects will have a hard time competing. The voluntary market remains the best opportunity for forestry offsets right now, but voluntary market demand is pretty uncertain to predict. In the U.S., the politics of climate change may become a driving force behind forestry-based offsets. A common theme in the push for national climate change legislation is that forestry and agricultural soils offsets will bring big bucks to important political constituencies. If such legislation were to create a significant domestic market demand for offsets, and include specific incentives for forestry and agricultural projects, it could have a huge impact on the role of forestry-based offsets in the market. In the meantime, we’ll probably continue to see forestry projects benefiting from the GHG market, but in very limited numbers.

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Dr. Mark C. Trexler has more than 25 years of energy and environmental experience, and has focused on global climate change since joining the World Resources Institute in 1988. He is now president of Trexler Climate + Energy Services, which provides strategic, market, and project services to clients around the world.

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