Carbon is the New Black Gold

This week I’ve been working on a valuation for a project that aims to reduce emissions from deforestation and degradation (otherwise known by its acronym REDD). In modeling and analyzing cash flows in terms of their sensitivity to numerous variables (price of carbon, rate of deforestation, etc) , and working with local investors, I’ve gained an appreciation of the position of the project developer in the highly glamorous voluntary carbon market.

Two quick links on carbon finance – both are chock full of info and materials if you want to find out more about these new markets: http://www.newcarbonfinance.com/, http://www.cdmgoldstandard.org/

Back to Indonesia 1997

Indonesia is central to the deforestation story-- because of all of its natural treasures and because of their misuse. In that story, one of the saddest chapters has to be what happened here in 1997-1998. Ten million hectares (25 million acres – an area eleven times the size of Yellowstone National Park) of forest were lost to fires that ravaged the earth. In 1997, the world was experiencing El Nino, a climactic phenomenon caused by the interaction between the atmosphere and warm water in the East Pacific ocean off the coast of South America. El Nino hit particularly hard in Indonesia, causing drought.

The sad part is that looking back on the event, researchers theorized that many of the fires were not due to the drought-like conditions, but were set intentionally by timber and agribusiness companies intent on clearing land for cheap, and ignorant of controlled burning techniques (some of which, ironically, had been practiced by locals for years). El Nino was a convenient excuse.

According to “Trial By Fire: Forest Fires and Forestry Policy in Indonesia's Era of Crisis and Reform” by the World Resources Institute/Forest Frontiers Initiative, there were numerous disincentives for logging companies to operate more efficiently. The government charged tax on the timber exported not on the volume cut down, thereby offering no regulatory incentive for the timber companies to be any less wasteful. In addition, companies didn’t just cut the trees, but many also operated as processing companies and used the logs to subsidize their inefficient processing facilities. This encouraged companies to try and source logs (the processing facilities raw material) at the lowest possible price, even it meant logging illegally.

The story goes beyond 1997-- Indonesia lost 1.5 million hectares each year from 1986-1997 as a result of land use policies under former President Suharto, a total of 40 million hectares (Germany and Holland combined) since the 1960s, 30% of Indonesia's forest cover.

But, 1997 was particularly bad. If I remember right, 1997 was the year Indonesia became the third large source of carbon emissions in the world behind the US and China. The effects of the fires were physically felt by people in countries as far as Malaysia and Singapore; the smog causes asthma, bronchitis, respiratory infections, etc. I can begin, from experience, to imagine how it felt. I was in Moscow in the summer of 2002 when, because of high temperatures, the peat bogs under Moscow began to burn. There was a cloud of smog over Moscow and you couldn’t venture outside without coming home smelling a little like burnt hair. Firefighters had to dig moats around the fires and it took an inhuman effort to put them out.

The earth was literally boiling. I don’t know how much peat there is under Moscow, but there are roughly 27 million hectares of peatland in SE Asia (think British Isles-size). Peatlands are bogs, but they are also huge carbon sinks, created over thousands of years and storing thousands of metric tons of today’s black gold. In 1997 peatland destruction alone may have caused 15-40% of global CO2 emissions (3000-9000 Mt).

Markets for Conservation
The carbon markets have created an opportunity for people to earn money for protecting forests and peatland. It’s not easy – project developers have to be able to get concessions from the government, understand the true value in carbon $$$ of the land to which they have the rights, document that through their efforts additional deforestation is not taking place, protect and maintain the land, work with local communities, and offer investors liquidity at some point in the future. They have to do all this with an uncertain future price of carbon, with risk of expropriation, in an environment in which middle men are slowly but surely lining up to take their cut.

So, the business model is full of uncertainty (great for Crystal Ball), but as an alternative to palm oil and paper and pulp plantations, it’s the coolest thing ever!

Ceremonial Offerings Part of SG&A

CCIF has been around about three years. It has grown quite a bit in that time—set up an Indonesian affiliate, hired Indonesian and expat staff, moved offices, and started working on more than a handful of cool projects. This week I give you a virtual tour of the office I work in, but before I begin, let me tell you about the day I decided to take these photos.

Last Wednesday was a propitious day. I know because it was the day that was chosen for a special ceremony to anoint a small new wing of the office. It is also the day that Sarah, my office mate found out she had not only contracted typhoid fever, but amoebic dysentery. Don’t worry too much; she’s on a course of flagyl, a heavy-duty anti-biotic that should wipe both infections out, and I'm being very cautious about what I eat and drink, and washing my hands obsessively.

While Sarah was curled in a ball at home, at the office, we were giving offerings to the gods.

The ceremony began at the office park’s main temple (shown below). The official religion in Bali is Hinduism, but it is visibly different from Indian Hinduism. The Balinese fused Hinduism with the animistic traditions that they practiced before the religion got to the island. This is the largest of the three (or more) temples located at the office.

Saras who works for PhotoVoices (I’ll write more about them later) led the ceremony. She appeared to scoop water from a bowl with a flower and sprinkle it on the temple. Then, her lips moved in prayer as she moved her hand in a circular motion before the offering. Here's Saras in the new office extension lighting incense for the offerings, which also included fruit, flowers, various bread products, and arak, the local homebrew.

Daily offerings (pictured below) are less ornate, and usually include various flowers and a cracker.
The juxtaposition of ceremonial life and modern day Bali is sometimes surreal. I took this shot from right in front of our office. You can see offerings scattered on the ground to the right of the bikes.

Now for the rest of the tour. This is Building One, which is where I sit, and Building Two, which is where the principals sit removed from us plebs. We share the space with a non-profit called PhotoVoices, which gives people who aren’t usually able to participate in media, cameras and a voice. They are preparing (any day now) to launch their Indonesian site, and it promises to be really cool. Stay tuned for a link. For instant gratification, check out my friend Tommy’s website http://www.tommyschultz.com/– for great pics of SE Asia.

I’ve been crazy busy this week with financial analysis stuff and dealing with all the illness and internet problems, so didn’t have time to put more thought into the text of this week’s blog. Next week I’ll get back to conservation finance.

Internship in Paradise, Bali, Indonesia

This summer, in between my first and second year of Darden Business School, I'll be working as a summer associate at the Community and Conservation Investment Forum, a consulting group that works on behalf of private, corporate, and multilateral investors seeking direct and immediate conservation returns on their investments. CCIF specializes in applying the tools, strategies, and capital sources of the private sector to address urgent conservation issues worldwide. For my internship, I'll be going head deep into the world of conservation finance, but...

What is Conservation Finance?

The first time I heard the term was in the job description for the phone interview. I promptly adopted it to sum up to classmates what I would be doing over the summer – you know what conservation is, right? You know what finance is, right? Well, that’s what I’ll be doing this summer—conservation finance, QED.

After a couple weeks in Bali, Indonesia, practicing this ‘conservation finance’, I still struggle to understand what it really means. Today, I would define it broadly as understanding the economics that underlie a wetland or a forest or a coral reef and the resources required to protect it, but I hope that over the course of the next couple months and throughout the development of this blog, I will be able to explain it better.

‘Conservation finance’ seems like a relatively new catchphrase in the conservation world and totally unknown in most business circles. I imagine it is partly the result of new philanthropic foundations such as Moore, Packard, Gates and Walton demanding more tangible returns from their investments than those historically demanded by the US Government, partly the result of this HUGE SNAFU called global warming which is making people try to develop market-driven solutions to problems like deforestation.

It is an attempt to value natural resources (a damn hard thing to do which I will discuss in more detail later), and estimate and finance the cost of conservation based on a range of preservation scenarios—for example, status quo, what is currently being done; minimum, what needs to be done to achieve a minimum set of realizable conservation requirements (in the case of the Pacific Leatherback Turtle this encompassed things such as protection of direct take of eggs, increasing hatchling rate success, starting to provide communities with reasonable economic opportunities other than the collection of eggs and turtles); optimum, which is like a dreamland scenario where habitat is not destroyed, fisherman switch to more sustainable livelihoods, etc. There are not any three standard scenarios – but a range of different levels of conservation that need incrementally higher levels of financial resources to be achieved.

Most of the work I will do centers around developing cost and endowment models for two protected areas – Raja Ampat, Papua, Indonesia, and the Cardamom Mountains, Cambodia. These models use an approach similar to the Net Present Valuation method used in corporate valuation, and are very dependent on the quality of the inputs used. As they say, ‘garbage in, garbage out.’ It is therefore very important to understand the local context, such as (among other things) the capacity of the local government to contribute money for conservation, the difficulties involved in physical enforcement of laws in ~million-plus-hectare territories, and the impacts that will form the basis of evaluating the success or failure of conservation efforts.

One Focus of Conservation Finance

The Raja Ampat (“Four Kings”) archipelago is located just off of the Bird’s Head Peninsula in North Western Papua and has to be THE coolest place on the planet. From 100,000 feet the peninsula resembles an overweight goose in flight (thus the name); it is home to leatherback, green and hawksbill turtle rookeries, and migratory cetacean aggregations of sperm and Bryde’s whales, orcas and dolphins.

Raja Ampat itself is made up of four large islands--Waigeo, Batanta, Salawati, and Misool--plus hundreds of smaller islands. Raja’s 9.8 million hectares have possibly the richest variety of species in the world. In a 2002 survey researchers tallied 535 species of coral (75% of all known coral Species), and 1,071 different species of fish. The area’s massive coral colonies show that its reefs are resistant to threats like coral bleaching and disease—threats that have severely degraded corals in many other regions.

Map 1: The best map I could find that targets the Bird’s Head Seascape

To give you some comparison, the Hawaiian archipelago, to the best of my knowledge, has 700 species of fish and 62 species of coral.

I am trying to understand why such biodiversity exists in Raja Ampat? I’m no scientist, but I think it has something to do with the way that new species evolved (over thousands of years) when parts of the archipelago were isolated from one of the two surrounding oceans, the Pacific and Indian oceans, and the interchange of water and species between the two oceans. There are probably thousands of factors that cause the biodiversity experienced in Papua.

This area is the focus of conservation not only because of the mouthwatering volume of fish, but also because of the encroaching threats to this ecosystem, such as cyanide and dynamite fishing, turtle poaching, and unsustainable logging. It’s attractive for conservationists, divers, fisheries, oil and gas, mining and forestry products alike.

Right now a couple massive environmental NGOs are battling it out for control in the area – Conservation International, Nature Conservancy, WWF. The organization I work for, Community and Conservation Investment Forum, sees using an endowment mechanism to ensure a more reliable, stable in-flow of cash to core conservation activities as a priority. Having worked in the NGO world for four years this seems like a good strategy. The problem with grant/project money is that one day it’s here, the next it’s gone and the communities, who have come to depend on it, are left holding the bag, (which has no money in it).

In such an endowment, a pot of money is set aside and invested on which only the interest revenue (not the principle) from the investment is used for finance conservation activities. The size of the endowment can be thirty times the size of the annual need, or more. I don't want to make it sound easy because it's not. More on this and other things in the next blog, which should be up by next Monday. Until then, sampait chumpa (Bahasa Indonesian for goodbye!)