A VIRGIN FOREST MARKET?

Investors, companies and environmentalists hedge against global warming with tree options.

JAY PRUETT LAST YEAR SPENT us$5.4 MILLION OF HIS COMPANY'S money to plant a forest in Brazil. He's not planning to cut timber or build a resort. But he means to put those trees to work.

Pruett, environmental services director for Central & South West Corporation, a large Dallas-based utility company, is counting on the trees to do what comes naturally: absorb carbon dioxide produced by animals, factories and cars, and emit oxygen into the atmosphere. He's tapping into an emerging market spanning from San Jose, Costa Rica, to Sydney, Australia, that seeks to assign a price per ton of carbon dioxide processed by trees.

Driving the creative trade is concern over climate changes caused by the uncontrolled burning of fossil fuels, like gas and oil, which release heat-trapping carbon dioxide and other "greenhouse gases."

Business leaders, especially at power firms that emit large amounts of CO2, are anticipating laws that set limits on their companies' emissions--while allowing credits for the reduction of emissions elsewhere. These "offsets" may include measures such as improvements in another firm's efficiency or investments in forests. Interest in the effort, according to one consultant, has "gone from 25 mph to 100 mph" in the past 18 months, with some executives already scrambling to cut deals with forest owners.

"It's not altruism," Pruett says of his firm's investment, made in March 1999. "We're interested in the offsets and, by acting early, we figured we could get one of the best possible projects at the cheapest price."

To be sure, there's also the benefit of positive publicity, amid growing awareness of the risks of global warming. A consensus of mainstream scientists predict that business-as-usual practices could lead to rising sea levels, severe storms and mosquito-spread epidemics within the next few decades.

The new interest in forests as an anti-warming weapon heralds a potential boon for Latin America, home to 40% of the world's remaining woodlands, at a time when some 105 million acres of trees are lost each year. Yet the move to make photosynthesis a commodity is controversial. Leading environmental groups are split as to whether it will ultimately help or hurt the planet, despite the unprecedented prospect of billions of dollars of new investments for forests.

Investors out on a limb. Over the past several years, large U.S., European, Canadian and Japanese power firms have invested at least $75 million to plant or preserve trees they know they can't cut down, says Mark Trexler, a climate strategy consultant who tracks the deals. More than half have been brokered by non-profit The Nature Conservancy based in Virginia.

Meanwhile, a variety of plans are proceeding to trade carbon credits on global exchanges or over the Internet. Analysts say the market could grow to as much as $100 billion in the next few years. Remarkably, deals are being made without any guarantee of a concrete return on investments.

Take Pruett's South American venture. Concerned by increasing talk of strict measures to counter climate change, he began investigating carbon offsets three years ago. The Nature Conservancy gave him a list of 15 forestry projects, from which he chose a plan to buy about 17,000 acres of former Atlantic forest converted to buffalo ranch land in Brazil's southern state of Parana. He opted for the Brazil project because Central & South West Corporation has offices there, the project looked well organized and he was impressed by the ecosystem. "In the areas where the forest is still untouched, it's so rich and lush. It's incredibly beautiful," he says.

Pruett also liked The Nature Conservancy's estimate that the project will absorb about 1 million tons of carbon from the atmosphere. That puts the price per ton of carbon at $5.40, at a time when some analysts predict it may end up at several times that amount.

It's all still a matter of guesswork, but Pruett hopes some institution will eventually dole out credits to his Dallas-based utility for all that processed carbon dioxide. He made the investment slightly more than a year after leaders of 84 nations met in Kyoto, Japan, and signed a historic agreement on climate change. The Kyoto Protocol sets targets and timetables for reductions in greenhouse gas emissions by industrialized nations: the United States' target by the year 2008, for instance, is to slash emissions 7% from 1990 levels.

Under the Protocol, industrialized nations may get credits for offsets that would include tree planting, as in the Brazil project, or for conserving forests that otherwise would have been cut down. Deforestation currently accounts for a quarter of greenhouse gas emissions each year.

Kyoto's elusive targets. Other proposals include carbon credits for farm operations that switch to no-till practices that minimize soil disturbance, but there's no agreement about which undertakings should be credited. That could come in a key meeting of parties to the Protocol in the Netherlands in November--or it could take more time. And even if agreement is reached, there's no certainty the Kyoto Protocol will be ratified. The treaty faces opposition, especially in the United States, owing to the fact that the pact does not bind developing countries to their carbon targets.

"I actually don't think the Kyoto Protocol will ever be implemented--there are just too many political difficulties--but I do think something will be implemented and that carbon credits will be part of it," says utility executive Pruett. Other U.S. firms apparently concur: BP Amoco has pledged to reduce its emissions by 10% of 1990 levels by 2010, and E.I. du Pont de Nemours & Co. has announced plans to cut its own by a whopping 65%.

Debate over the use of forests to obtain the credits has split environmental and science entities. Organizations including the Sierra Club, Greenpeace and the World Wildlife Fund worry that relying on forests is a dangerous appeasement. "Carbon-trading can't be an excuse for business as usual," says Randy Hayes, president of the Rainforest Action Network in San Francisco. "We've got to cut fossil fuel emissions at the source-- that's the quickest and best and the only well-established way to stop turning the blue sky into a toxic furnace."

Conservation International, the Union of Concerned Scientists and the Environmental Defense, on the other hand, argue that such credits would underscore the financial value of ecosystems such as forests. "Environmentalists have been talking for years about solving this problem, and I think here we finally have an answer," says Mike Coda, vice president of The Nature Conservancy's Climate Change Program.

Discounted dioxides? While environmentalists argue over the value of carbon credits, financiers are hurrying to trade them. Their model is the successful barter of two other pollutants that has gone on for the past several years at the Chicago Board of Trade. There, U.S. power firms and speculators can buy and sell the legal rights to emit one ton of sulfur dioxide or nitrous oxide as if they were pork bellies. Under what is known as a "cap and trade" program, they use them to comply with emission limits set by the Clean Air Act or sell them for profit to other plants. The market has grown to more than $1.7 billion in annual volume.

The anticipation of a much greater volume in carbon credit trades has attracted recent interest around the world. In the boldest venture to date, the Sydney Futures Exchange intends to launch "carbon-trading" by November of this year. Australia has a particular interest in the development of carbon rights, since more than 50% of the country's forests have been razed over the past several decades. With a lot of available failing farmland, reforestation could be a booming business.

In the United States, meanwhile, veteran financial innovator Richard Sandor, at Northwestern University in Chicago, has begun to design a voluntary carbon trading market. Sandor is head of Environmental Financial Products, which has been active in the sulfur dioxide trade. An economist known for having invented interest rate derivatives, he has long been fascinated by the notion of "commoditizing the environment."

"We've been advocating carbon trading for a decade now," says Sandor, who delivered a paper on the topic at the Earth Summit in Rio de Janeiro in 1992. His project is being backed by the $1 billion Joyce Foundation, which is based in Chicago and focuses on public policy in the Great Lakes region.

"Nobody quite knows what a carbon credit is," Sandor says. "Our job is to invent it. We invent the market and the participants and let the game begin."

That doesn't mean he won't face competition. The World Bank has already set up a Prototype Carbon Fund, and other financial companies, such as Natsource and Cantor Fitzgerald, both based in New York. have made a few over-the-counter deals while preparing for market trading.

High school credits. As of June, there had been no significant trades of carbon from forests on stock exchanges or over the Internet. However, in one intriguing development, Natsource in June launched an Environmental Action Desk. a Web-based purveyor of emissions-reduction credits to individuals or nonprofit groups. Its first sale was to a group of students at Los Altos High School in California, who paid $3 a ton to "retire" 100 tons of carbon dioxide, via a reforestation project in Panama. The forest's performance is monitored by Centro Cientifico de los Tropicos, in San Jose, Costa Rica.

Big corporations, meanwhile, plod ahead with cumbersome private deals, each governed by an idiosyncratic set of rules. The corporate officials nonetheless wax enthusiastic over the new investment opportunities.

"We're a growing energy company, and we're investing over 20- to 30-year time frames where the risk of climate change is real to us," explains Gordon Lambert, corporate director for sustainable development for Canadian company Suncor Energy, based in Calgary.

Suncor is one of several corporate investors in The Nature Conservancy project in Belize that recently rescued a 14,400-acre parcel of forest. The land would otherwise have been sold to Mennonite farmers who already had chopped thousands of acres of trees to plant soybeans, according to Joy Grant, director of the Programme for Belize, a local partner of The Nature Conservancy. The investors' money helped Grant match the Mennonites' offer of $100 an acre.

"This is part of a number of strategies we've adopted in our climate change policy," says Lambert, adding that Suncor is investing in a $3.5 million reforestation project in Australia plus has paid for emissions reductions by Niagara Mohawk Power in New York and is retrofitting a dozen or two schools in Canada to improve their energy efficiency.

The Belize project attracted Lambert for a number of reasons, including its importance as home to the world's last remaining habitats for jaguars. Coda, at The Nature Conservancy, says increasing numbers of executives, including heads of manufacturing companies and airlines, are consulting him for counseling as they seek to hedge their bets before regulations set in.

Pruett and other executives argue, carbon credits or not, they'll still have to work hard to reduce emissions. Just to get back to 1990 levels, Dallas-based CSW, which emits about 50 million tons of carbon dioxide every year, must reduce that level to about 35 million tons.

"Our project in Brazil is only worth a million tons," Pruett notes. "There aren't enough forest projects available for what we'll need to do."

A MATTER OF SIZE

Brazil has a land mass of 2.1 billion acres, compared to 1.4 billion acres for Europe, but the South American country has three times more forest than the Old World.

EUROPE: 420 million acres of forest (30% of its total land area)

BRAZIL: 1.4 billion acres of forest (65% of its total land area)

SOURCES: World Resources Institute; Warburg Dillon Read; LATIN TRADE

GREENING THE GLOBE

The developing world has a high percentage of forest for each country's total land area, while Brazil, Canada and Russia account for around 45% of the world's forests. Forests account for only 23% of the United States' total land area, but they represent 524 million acres--far more than Guyana's 45 million acres, 95% of its territory.

SOURCES: World Resources Institute, LATIN TRADE

GREENHOUSE GAS PRICES

COSTA RICA, HOME TO SOME OF THE WORLD'S LUSHEST RAINFORESTS, IS pioneering their preservation through carbon-trading schemes.

Since 1997, the government has paid landholders to preserve standing forests and plant new ones. It then bundles these environmental benefits into Certified Tradeable Offsets, or CTOs, guaranteed by the Societe Generale de Surveillance of Geneva. CTOS have been sold to the Norwegian government, Norwegian firms and the Chicago-based Environmental Financial Products. Eventually, they may be traded globally.

Other Latin American nations have benefited from new interest in their forests. The region hosts three major investments brokered by The Nature Conservancy, the nonprofit veteran in forestry carbon offset strategies. An additional US$80 million worth of projects are awaiting sponsorship.

In Bolivia's Noel Kempff Mercado National Park, a partnership including American Electric Power, PacifiCorp, British Petroleum, The Nature Conservancy, the government of Bolivia and Bolivian non-governmental organization Fundacion Amigos de la Naturaleza, launched a $9.6 million project that retired logging rights on 1.56 million acres. The Nature Conservancy estimates the project may avert as much as 14 million tons of carbon emissions over 30 years.

In Belize, a consortium including Wisconsin Electric Power, Detroit Edison, Suncor and Pacificorp raised $5.6 million to conserve more than 146,000 acres of lowland forest. And in Brazil, Dallas-based Central & Southwest Utilities has invested $5.4 million to restore, protect and manage about 17,000 acres of Atlantic rainforest that had been cut down for buffalo grazing, and to promote local sustainable development.

While Brazil backs projects that plant forests, however, it strongly opposes credits to preserve trees.

"It's very hard to prove that an area would have been deforested if some action weren't taken, so what it ends up being is a license to pollute, with no countervailing benefit," says Flavio Goldman, a Brazil Foreign Ministry spokesman.

Weighty as the argument seems, it may not fully explain Brazil's opposition. Strong political interests in the country want to develop the Amazon forest region and resent what they see as outsiders' interest in turning it into a "park."