Forestry as a climate solutions asset class

Tuesday 21 September 2021

Forestry

Author: Radha Kuppalli

There is no credible pathway to net zero without an investment transformation in forestry and land use, says Radha Kuppalli, Managing Director, Impact & Advocacy, at New Forests

The latest report by the Intergovernmental Panel on Climate Change (IPCC), published in August, left no doubt that rapid and deep reductions in greenhouse gas emissions are required in the coming decade to avoid catastrophic impacts. The risk of climate change is driving strategic asset allocation decisions of the world’s largest investors, an increasing number of whom are committing to net zero emissions by mid-century. In fact, the members of the Net Zero Asset Owners Alliance and Net Zero Asset Managers Initiative now collectively represent $50 trillion in assets under management. As these investors search for opportunities to invest in climate solutions and decarbonise portfolios, they will invariably look for technological transformations in energy, industry, and transport. But what is less understood by investors is that there is no credible pathway to net zero without an investment transformation in forestry and land use.

All climatic modelling that limits global warming to under 2°C requires improvements in land use, with some models showing a requirement of over 1 billion hectares of reforestation by 2050 relative to 2010 to remove carbon from the atmosphere. This is a staggering figure—particularly when we imagine a world where we need to meet the food, feed, fuel, timber, and energy needs of 10 billion people. This transformation in land use will require the mobilisation of hundreds of billions of dollars of investment in Natural Climate Solutions—the protection of threatened forests, improved management of productive forests and agriculture, and reforestation of landscapes. Investment must be channelled into strategies and companies that protect and restore ecosystems and improve working lands as a part of their investment thesis and long-term value creation approach.

 

New forests

Source: New Forests

 

 

The Transition of Forestry to a Climate Solutions Asset Class

Forestry today is an approximately $200 billion asset class—but what will it look like in a net zero world? Over the past 30 years, forestry has been an attractive asset class for institutional investors due to favourable portfolio attributes including low correlation to other asset classes, natural inflation hedging, and low volatility of returns. Institutional investors often acquire forests as productive timberland to generate returns from a combination of harvest income and long-term capital appreciation through the biological growth of the forest assets. Most investors gain exposure to timberland through their real assets allocation or through publicly traded REITs in their equities portfolio. Third-party sustainability certification and good land stewardship practices by professional timberland investment managers have also aligned forestry with institutional investors’ ESG objectives. But looking to the future, the carbon value—and the central importance of forests and sustainable land use to a net zero future—has the potential to transform forestry into a climate solutions asset class.

The monetisation of carbon would create an economic incentive to establish sustainable timber plantations and expand the investible universe of forestry to include forest conservation, ecosystem restoration and reforestation. Climate regulation in various parts of the world already value carbon sequestration from forests. The California carbon market, operating since 2012, has created value for conservation of mature forests and for the delay of harvest and extension of timber rotations in forests across the US. In certain US forestry investments optimising management of the asset for both timber and carbon has the potential to add on average 200 to 400 basis points of return compared to a timber-only management scenario. Forestry is central to the New Zealand Emissions Trading System, and in Australia, ecosystem restoration, improved forest management, soil carbon enhancement and practices to reduce wildfire have comprised the majority of carbon credit projects in the country’s Emissions Reductions Fund. Investment experience in the US, Australia, and New Zealand shows that modest carbon pricing (for example, $15 per tonne of CO2) creates meaningful incentives for incremental management changes to increase carbon sequestration like extended rotations, and slightly higher prices (such as $30 per tonne) creates incentives for investment in reforestation with native species and in new plantation development. Analysis by McKinsey forecasts the voluntary carbon market to rise to $50 billion per annum in 2030 in alignment with corporate net zero commitments—a carbon market of this size would need significant tropical forest conservation and reforestation across landscapes in Asia, Latin America, and Africa.

Furthermore, the ability to store carbon in a variety of forest products and materials will also be a critical element of addressing climate change. The emerging circular bioeconomy will provide new products and materials in a variety of industries from construction to packaging to textiles. Today, buildings account for 40% of global greenhouse gas emissions globally, associated both with the energy required for heating and cooling and with construction materials. To reduce the climate cost of the built environment, sustainable forest products will substitute for high embodied energy materials like cement and steel. The World Business Council on Sustainable Development estimates that the market for biomass-based construction and building materials alone will triple to nearly $1 trillion by 2030.

Importantly, not only can the forestry asset class deliver climate solutions, but it can also generate impact for people and nature. New markets and business models centred around sustainable production and climate change mitigation can diversify rural incomes and create new opportunities in regional economies. Examples from New Forests’ portfolio range from outgrower programs in Laos, where sustainable timber plantations are grown on farmers’ lands, to partnering with Native American tribes on carbon projects across the US, to creating jobs by building a new Cross Laminated Timber production facility in rural Australia. Climate finance can also drive ecosystem conservation and restoration, delivering private finance at scale to protect and enhance biodiversity and build resilience to climate change.

 

Enabling the Transformation of the Forestry Asset Class

Not unlike the clean energy transition, the transition to sustainable land use will require wholesale shifts in consumption, production, technology, and policy; investors, corporations, civil society, government, and consumers will all need to act. The transformation of forestry into a climate solutions asset class in particular will require:

  • Stronger policy settings to ensure a robust carbon price. Countries with significant agricultural production and degraded landscapes will need to prioritise forest conservation and reforestation through strong regulation and carbon pricing. An international framework to trade carbon credits—to be discussed during the COP26 negotiations in Glasgow in November—is critical to ensure public and private sector finance can flow to Natural Climate Solutions and support Paris Agreement climate targets.
  • Alignment of institutional investment portfolios with Natural Climate Solutions. Leading asset owners increasingly recognise Natural Climate Solutions as critical to a sustainable future but need to better understand the business case and how to allocate capital and resources, including risks associated with carbon markets and investing in emerging markets, where much of the new investment in the forest sector and Natural Climate Solutions is required. Action from investors will require innovation, learning by doing, and analysis to understand the opportunity associated with Natural Climate Solutions.
  • Transparency and impact reporting to ensure progress and accountability. Disclosure and data are critical for investors to understand the climate change and biodiversity impacts of their investments. The business case for investment in Natural Climate Solutions requires a common way of benchmarking and comparing assets and investment managers. Accounting frameworks and impact reporting will be critical in supporting investors’ Net Zero ambitions.

 

Towards a Trillion-Dollar Asset Class?

A world in which the carbon price reaches $100 per tonne of CO2 is imaginable—and is in fact necessary to reach net zero emissions by 2050. In this not-too-distant future, carbon asset value in land use could be trillions of dollars in 2030 and beyond, which would be capitalized into land and forest values. Substantial areas of forests and land would be valued primarily for their conservation. Some forecasts show forestry shifting into a trillion dollar asset class—greater than the market capitalisation of the oil and gas majors today. The emerging investment opportunity is clear—to invest in forests for the benefit of climate, people and nature. 

 

Radha Kuppalli is Managing Director, Impact & Advocacy, at New Forests

Radha Kuppalli

 

 

 

 

 

 

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