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Abstract

Forest-based carbon markets could become an important source of income for countries 

prices

scenario, the value of the forest-based carbon credit market could increase from 

















structuring, monitoring, verification, and

surveillance. Countries need to promote actions in 

and 

as institutions to resolve several market failures, 







Forest-Based Carbon Markets

Pitfalls and Opportunities

MAURICIO CÁRDENAS · JUAN JOSÉ GUZMÁN AYALA

POLICY PAPER 313 • NOVEMBER 2023

The Center for Global Development works to reduce global

poverty and improve lives through innovative economic

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is encouraged; however, reproduced copies may not be used

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respective organizations.

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Center for Global Development. 2023.

Forest-Based Carbon Markets: Pitfalls and Opportunities

Mauricio Cárdenas

Columbia University (SIPA and CGEP) and Center for Global Development

Juan José Guzmán Ayala

Columbia University, Center on Global Energy Policy (CGEP)















3forest-

based-carbon-markets-pitfalls-and-opportunities

Contents

1. Introduction .......................................................................................................................................1

2. Understanding the role of forests and carbon markets ............................................... 3

Why are tropical forests relevant to mitigate greenhouse gas emissions? ......3

Additionality, permanence, leakage, and quantiﬁcation integrity ...................... 5

3. Carbon pricing instruments (CPIs) and forest carbon ﬁnance schemes .............. 7

Fundamentals of market and non-market mechanisms ......................................... 7

Project-based vs. Jurisdictional approaches ...............................................................8

Volume of forest carbon ﬁnance .....................................................................................10

4. Developing forest-based carbon markets .......................................................................14

Transaction costs for project-based crediting .......................................................... 16

Value chain ............................................................................................................................... 17

5. The interaction between land markets and carbon ....................................................19

Externalities .............................................................................................................................22

Implications for Latin America and Sub-Saharan Africa ......................................23

6. Productive development policies ........................................................................................ 25

Establishment of National Carbon Federations ....................................................... 26

7. Conclusions ................................................................................................................................... 29

Annex ..................................................................................................................................................... 31

References ......................................................................................................................................... 32

About the authors ........................................................................................................................... 36

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Forest-BasedCarbonMarketsPitfallsandOpportunitiesMAURICIOCÁRDENAS·JUANJOSÉGUZMÁNAYALAAbstractForest-basedcarbonmarketscouldbecomeanimportantsourceofincomeforcountriesinAfrica,LatinAmericaandAsia-Pacific.Estimatesindicatethatunderahighcarbonpricesscenario,thevalueoftheforest-basedcarboncreditmarketcouldincreasefromUS$1.3billionin2021toUS$25billionperyearby2030.Apartfromtheclimateandmonetarybenefits,forestbasedcarbonmarketsalsohavepitfallsthatmustbeavoided.Withouttherightinstitutionsinplace,atthenationalandlocallevel,forestprojectscangeneratenegativeexternalities,suchaspopulationdisplacement,increasesinfoodprices,andbiodiversitydegradation.Thevaluechainincarboncreditsinvolvesanumberofhighvalue-addedupstreamanddownstreamactivitiesthattendtotakeplaceoutsidethecountrieswheretheprojectsarelocated.Industrialpoliciesarerequiredforhostcountriestoreceiveahighershareoftherevenuestream,includinginareassuchasstructuring,monitoring,verification,andsurveillance.Countriesneedtopromoteactionsinlabortraining,researchanddevelopment,andaccesstolong-termcapital.ThepaperproposesthecreationNationalCarbonFederationsasinstitutionstoresolveseveralmarketfailures,whilepreventingconflict,ensuringadequatesavingsoftheadditionalincome,andstrengthendemocraticgovernance.Theseorganizationscanalsoprovidekeypublicgoods,sothatlocalcommunitiesbenefitfromthedevelopmentofcarboncreditsfromtropicalforests.POLICYPAPER313•NOVEMBER2023Forest-BasedCarbonMarkets:PitfallsandOpportunitiesMauricioCárdenasColumbiaUniversity(SIPAandCGEP)andCenterforGlobalDevelopmentJuanJoséGuzmánAyalaColumbiaUniversity,CenteronGlobalEnergyPolicy(CGEP)TheauthorswanttothankMartínPérez,JulianAndrade,andFrancesSeymour.Finally,theauthorsarealsoparticularlygratefultotheCenterforGlobalDevelopmentpublicationsteamfortheireditorialwork.ThispaperwasdevelopedwithfundingandsupportfromColumbiaUniversity’sCenteronGlobalEnergyPolicy(CGEP).Thisreportrepresentstheresearchandviewsoftheauthors.ItdoesnotnecessarilyrepresenttheviewsoftheCenteronGlobalEnergyPolicy.WewouldliketothanktheexcellentcommentsmadebyFrancesSeymourandananonymousrevieweronanearlierdraft.Allerrorsremainentirelyours.MauricioCárdenasandJuanJoséGuzmánAyala.2023.“Forest-BasedCarbonMarkets:PitfallsandOpportunities.”CGDPolicyPaper313.Washington,DC:CenterforGlobalDevelopment.https://www.cgdev.org/publication/forest-based-carbon-markets-pitfalls-and-opportunitiesCENTERFORGLOBALDEVELOPMENTTheCenterforGlobalDevelopmentworkstoreduceglobal2055LStreet,NWFifthFloorpovertyandimprovelivesthroughinnovativeeconomicWashington,DC20036researchthatdrivesbetterpolicyandpracticebytheworld’stopdecisionmakers.UseanddisseminationofthisPolicyPaper1AbbeyGardensisencouraged;however,reproducedcopiesmaynotbeusedGreatCollegeStreetforcommercialpurposes.FurtherusageispermittedunderthetermsoftheCreativeCommonsAttribution-NonCommercial4.0LondonInternationalLicense.SW1P3SETheviewsexpressedinCGDPolicyPapersarethoseofthewww.cgdev.orgauthorsandshouldnotbeattributedtotheboardofdirectors,fundersoftheCenterforGlobalDevelopment,ortheauthors’CenterforGlobalDevelopment.2023.respectiveorganizations.Contents1.Introduction........................................................................................................................................12.Understandingtheroleofforestsandcarbonmarkets................................................3Whyaretropicalforestsrelevanttomitigategreenhousegasemissions?.......3Additionality,permanence,leakage,andquantificationintegrity.......................53.Carbonpricinginstruments(CPIs)andforestcarbonfinanceschemes...............7Fundamentalsofmarketandnon-marketmechanisms..........................................7Project-basedvs.Jurisdictionalapproaches................................................................8Volumeofforestcarbonfinance......................................................................................104.Developingforest-basedcarbonmarkets........................................................................14Transactioncostsforproject-basedcrediting...........................................................16Valuechain................................................................................................................................175.Theinteractionbetweenlandmarketsandcarbon.....................................................19Externalities..............................................................................................................................22ImplicationsforLatinAmericaandSub-SaharanAfrica.......................................236.Productivedevelopmentpolicies.........................................................................................25EstablishmentofNationalCarbonFederations........................................................267.Conclusions....................................................................................................................................29Annex......................................................................................................................................................31References..........................................................................................................................................32Abouttheauthors............................................................................................................................36ListofFigures1.Annualnetemissionsfromlanduseandlandcoverchange(LULCC)globallyforthreelatitudinalbands(A)and10globalregions(B).............................................................42.Landscapeofforestcarbonfinancemarkets,non-marketpayments,andresults-basedfinance(A)andthethreephasesofREDD+(B)........................................83.Comparisonofworldcomplianceandvoluntarycarbonmarkets,marketvalue..................................................................................................................................................124.Forest-specificvoluntaryandcompliancecarbonmarkettransactions.............................135.Annualaveragepriceperton(localpricesconvertedtoEuros).............................................136.Forest-specificvoluntaryandcompliancecarbonmarkettransactionsandODAdisbursements...........................................................................................................................157.Locationofvalueadditionandproductionfactorspecificityintheforestcarbonvaluechain.....................................................................................................................................198.Globalforestcarbonreturn-on-investmentfromfinanciallyviablesites...........................219.Effectofcarbonpricingonthefinancialviabilityofforestcarbonsites.............................22A1.Compositionofcompliancemarket,byregion.............................................................................31ListofTable1.Qualityproblemsincarbonmarkets....................................................................................................61.IntroductionAccordingtotheIntergovernmentalPanelonClimateChange(IPCC),reductionsindeforestationandforestdegradationhavethepotentialtomitigateglobalgreenhousegas(GHG)emissionsby0.4–5.8GtCO2eperyear(IPCC,2022),contributingbetween1.2%and18%oftheemissionscutrequiredtomeetthe1.5°CwarminggoalsetoutbytheParisClimateAgreement(UNFCCC,2019).1Inadditiontotheclimateeffects,the“forestcarboneconomy”isalsoaneconomicopportunityforcountrieswithjurisdictionovertropicalforests,suchastheAmazonrainforest,ElChacoandtheMayabiosphereinSouthandCentralAmerica,theCongorainforestinCentralAfrica,theAustralasianrainforestinNewGuineaandnortheasternAustralia,SundalandinIndonesia,MalaysiaandBrunei,andthetropicalforestsoftheIndo-BurmaregioninSouthEastAsia(Butler,2020).AllofthemareuniquelypositionedtoreduceglobalGHGemissionsand,intheprocess,acceleratetheirowndevelopmentthroughproject-basedandjurisdictionalopportunitiesinvoluntaryandcompliancecarbonmarkets.2Nature-basedsolutionsincludingtheconservationandrestorationofcarbon-richecosystems,aswellasimprovedlandmanagement,notonlyhavealargeGHGmitigationpotentialbutcanalsobecomeanimportantsourceofincomeastheprotectionoftropicalforeststransitionsfromanaid-basedtoamarket-basedmodel.3However,notallcountriesareequallypositionedtobenefitfromthedevelopmentofforest-basedcarbonmarkets.Onlythoseabletoputinplacetherightinstitutionsandpoliciescouldbenefitfromtheexpectedincreaseincarboncreditdemand.Inotherwords,theabilityofcountriestoimplementnaturalclimatesolutionswilldependonthedevelopmentofadequategovernanceandregulatoryframeworks(Griscometal.,2020).Atthesametime,althoughtherearesignificantrevenueopportunities,forest-basedcarbonmarketsbringnewchallenges.Someoftherisksthatshouldnotbeoverlookedinclude:i.Theuncertaintyassociatedwiththeevolvingnatureofcomplianceandvoluntarycarbonmarkets(inotherwords,theuncertaintyregardingtheactualdemandforcarboncredits).ii.Thepotentialharmtovulnerablecommunitieswhocurrentlyinhabitand/ordependonforestsfortheirlivelihoodduetodeficientenforcementoflandownershiprights,1Agigaton(Gt)isequivalenttoabillionmetrictons.CO2eisCO2equivalent.2Project-basedcarboncreditissuanceprocessesinvolvestargetedeffortswithinlimitedforestareastoreduceemissionsandenhancecarbonsequestration.JurisdictionalREDD+isamorecomprehensiveapproachthatintegratesforestconservation,emissionreductions,andsustainabledevelopmentacrosslargerregions.Itaimstoalignvariousstakeholdersandpoliciesunderaunifiedframework,oftenledbypublicauthoritieswithparticipationfromprivateandcivilsocietyactors.Voluntarycarbonmarketsallowprivateentitiestobuycarboncreditsvoluntarily.Compliancecarbonmarketsareregulated,requiringentitiestocombineemissionsreductionsand/ortheacquisitionofcarboncreditstomeetlegalemissionreductionrequirements.3Protectreferstothepreventionoflossofnativeecosystems,restorereferstotheexpansionofnativecovertypes,managereferstoavoidanceofCO2emissionsorenhancecarbonsinksthoughimprovedmanagementpracticesthatdonotreduceagriculturalandlivestockproduction.FOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES1bureaucraticbarrierstolandtitlingforvulnerablecommunitiessuchasindigenouspeoples,andlandgrabbing.iii.Negativedownstreameffectsinagriculturalmarketsascarbonmarketsbegintocompetewithlandusedforagricultureandlivestockwhichcouldimpactfoodpricesandthedemandforrurallabor.iv.Theconcentrationofrevenuesonhighvalue-addedactivitiesinthecarbonmarketvaluechaininthehandsofexternalintermediarieslimitingtherevenueperceivedbyruralentitiesandcommunities.v.Negativeexternalitieswhenlargemonocroppingreforestationandafforestationprojectscausethelossofbiodiversityandecosystemdegradationandtransformation.4A“carbontunnelvision”couldresultinlossesofplant,fauna,andfungibioticdiversity,andassociatedecosystemservices.5Maximizingtheopportunitiesandminimizingtherisksassociatedwiththedevelopmentofcarboncreditmarkets—includingacarbonvaluechain—requiresstrengtheningstatecapacityatthenationalandlocallevel.Inparticular,itisnecessaryto:i.Enhancethecapacityoflocalgovernments,enterprises,andcommunitiestocaptureagreatershareoftherevenuesgeneratedbythecarbonvaluechain.ii.Developrobustsafeguardsandprocedurestomitigatethepotentialnegativesocialconsequencesofpoorlygovernedandexecutedcarboncredit-generatingprojects.iii.Avoidunintendedconsequencesthataffectthedelicatebalanceoflocalecosystems.Itisnecessarytoanticipatestrategiestopriceand/orprotectbiodiversityandecosystemserviceswithincarboncreditmarketmechanisms.Thepurposeofthisnoteistoprovideinputsforthedesignofgovernanceandregulatoryframeworkstopreemptivelyaddressthesechallenges.Thepaperofferssuggestionsastohowtheseissuescouldbeaddressedtoguaranteethegrowthofrobust,justandliquidcarbonmarkets,incorporatingsocialandnature-relatedsafeguards.4Forexample,anafforestationprojectthatusesexoticandwater-thirstyspeciessuchaseucalyptustreestoconvertalargeareaofanaturalgrasslandintoamonocroppedforestpotentiallyalteringecosystembiophysicaldynamics,functionality,andbiodiversity.5Theconceptofthecarbontunnelvision,developedbyJanKonietzkofromtheMaastrichtSustainabilityInstitute,referstothescenariowhere“wesolelystrivefor‘net’zeroemissionswhileignoringothersustainabledevelopmentgoals,”leadingtoapotentialdisregardofclimatepolicyasitrelatestobroaderdevelopmentalgoals(Achakulwisutetal.,2022).FOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES22.UnderstandingtheroleofforestsandcarbonmarketsForestsareessentialnotjustasGHGsinks.Theyalsoensurebioculturalconservation,provideecosystemservices,andhosttheworld’sbiodiversity.Whileaid-basedforestfinancingwasoriginallyintendedtoconservebiodiversityandprotectcommunitiesthatdependedontheseecosystems,theriseofcomplianceandvoluntarycarbonmarketshasmadeforestsanattractiveassetassourcesofcarboncredits.Thisnewtrendisshiftingthebalancebetweendevelopment-aidfinancingforforestmanagementandconservation,andthecarboncreditsectorwiththegoalofoptimizingcreditproduction.Anincreasingshareofforestfinancingisfallingintocommercialmarketdynamicsandawayfromaid-basedsystems.Inthepast,ministriesoftheenvironmenttypicallyinvestedpartoftheirlimitedbudgetsinprotectedareastoconservebiodiversityandkeyecosystemsincludingforests,grasslands,andwetlands,amongothers.Interestfromotherareasofthegovernmentwasverylimited,whileprivatesectorengagementwasalmostnon-existing.6Today,public(includingplanning,agriculture,andfinanceministries)andprivatesectoractors(includinglargecorporations),areincreasinglyinterestedinmarket-basedinstrumentsforforestfinancing,whichbringsbothrisksandopportunities.Whyaretropicalforestsrelevanttomitigategreenhousegasemissions?Jurisdictionsendowedwithcarbon-richbiomessuchwetlandsandtropicalforests,facinghighlevelsofdeforestationandlandusechangecouldparticularlybenefitfromdevelopingcarboncreditmarkets.Acarboncreditisanon-physicalfungiblegood,analogoustoacommodity.7ItcanbetradedorusedinexchangefortherighttoemitacertainamountofCO2einagivenperiodoftime.To“originate”acreditanactormustproveareductioninGHGemissions,eitherbydecreasingpositiveflowsofcarbontotheatmosphere(suchasthoseproducedfromtheburningoffossilfuels)orincreasingnegativeflows(suchascapturingatmosphericcarbonthroughtherestorationofacarbon-richbiome).ThekeytounderstandingthevalueandpotentialofcarboncreditsforforestsintropicalcountriesistorecognizethenetpositiveflowofGHGscomingfromthedepletionofcarbon6PublicpressureanddiplomaticnegotiationsonaddressingbiodiversitylossgaverisetotheConventiononBiologicalDiversity(CBD)in1992,amultilateraltreatyratifiedby196states,withthreemainobjectives:i.theconservationofbiologicaldiversity,ii.thesustainableuseofitscomponents,andiii.thefairandequitablesharingofbenefitsarisingfromgeneticresources(UN,2023).7Thedebateremainsonwhethercarboncreditsaretobecategorizedascommoditiesorasitsownassetclass.Whilecertainactorsalongcarbonvaluechainsdonotdistinguishbetweentheoriginandcharacteristicsofagivencarboncredit(treatingitlikeafungiblegood),othersplacedifferingvaluesontheunderlyingattributesofacredit(treatingitasitsownassetclass).Undermechanismsthataligncarboncreditprojects,suchastheUnitedNationsSustainableDevelopmentGoals(SDGs),theWarsawFrameworkforREDD+,andcorporate-specificgoalsthatmayincludefactorssuchasbiodiversityandsocialco-benefits,carboncreditscouldbedifferentiated.Suchanapproachwouldresultinsystemicandidiosyncraticrisksanddemand-sidepreferencesthatdifferfromcommoditydynamics.FOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES3stocksintropicalcountrybiomes,andthenetnegativeflowsofGHGsfromrestorationandforest/landmanagement.Netemissionsfromlanduseandlandcoverchange(LULCC)areoriginatedmostlyintropicalregionsasemissionsinthenorthernnon-tropicsrapidlydecreasedandturnednegativebythe1960s(HoughtonandNassikas,2017)(SeeFigure1).8GHGemissionsinSouthandSoutheastAsia,LatinAmericaandSub-SaharanAfricahaveincreasedsincethe1950sduetolandclearinganddeforestation,andtheharvestingofwoodforindustrialusesandfuel(HoughtonandNassikas,2017).WhileLULCCemissionsrateshavedecreasedsincethe2000sinpartduetofallingdeforestationrates,netcarbonflowsfromLULCCintropicalregionsremainshighataround1.3PgC/year.9Tropicaljurisdictionscansimultaneouslyconserveuniqueandbiodiversity-richecosystems,protectcommunitiesthatdependonthemfortheirlivelihoodsandculturalwellbeing,contributetowardstheglobalgoaloflimitingtheplanet’saveragetemperatureincreaseto1.5°Cabovepre-industriallevels,andprogresstowardsincreasedlevelsofhumanwellbeinganddevelopmentthroughtheuseofcarbonmarkets,ifdoneproperly.AninterestingcaseisthatofHighForestLowDeforestation(HFLD)areassuchasthoseunderindigenousterritories.Theirparticipationinforest-basedcarbonmarketsremainsinalimboasthereisadebatearoundwhethercreditsgeneratedfromthemmeettheprincipleofadditionality(Sebastian,2022).FurtherdevelopmentsareneededforHFDLjurisdictionstobeabletoaccesscarbonmarkets,likelyasaformofcompensationforprotectinglargenaturalcarbonreservoirs.FIGURE1.Annualnetemissionsfromlanduseandlandcoverchange(LULCC)globallyforthreelatitudinalbands(A)and10globalregions(B)Note:Negativeemissionsrepresentremovalsofcarbonfromtheatmosphere.Source:HoughtonandNassikas,2017.8NegativeemissionsrepresentnetremovalsofGHGsfromtheatmosphereduetoincreasesincarbonstocksinsoilandvegetation.9Apetagramofcarbon(PgC)isequaltoagigatonneofcarbon(GtC).FOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES4Additionality,permanence,leakage,andquantificationintegritySincethefirstcarboncreditsweretransactedundertheCleanDevelopmentMechanism(CDM),establishedbytheKyotoProtocolin1997,concernshaveemergedonthehighlytechnicalcomplexitiesofmeasuringandaccountingforGHGemissionsandremovals.Markettransactionshaveusedthird-partycertificationstoensureprojectsare“additional”andprovidepermanentreductionsinGHGstothegreatestextentpossible.Certifiersalsoneedtoassesstheriskforleakage(SeeTable1),andestimateunavoidableleakagetodeductthecorrespondingvolumefromthenumberofcreditsissued.Whilethird-partycertificationhasrapidlybecomethenormincarboncreditmarketstomitigatethereputationalrisksassociatedwithlowqualitycarboncredits,recentanalysesandpublicscandalshavecasteddoubtovertherealreductionsachievedbycertifiedprojectssuggestingtheyhavebeenoverstated(T.Westetal.,2020).AuthorssuchasT.Westetal.(2020),Guizar-Coutilñoetal.(2022)andT.Westetal.(2023)conductedextensiveanalysiscomparingcreditingbaselinesestablishedex-antebyprojectsinseveraljurisdictionsagainstex-postcounterfactualsbasedonobserveddeforestationincontrolsites.10Inoneinstance,theanalysisof12VoluntaryCarbonStandard-certifiedREDD+(VCS)11projectsinBrazilovertheperiodspanningfrom2008to2017,yieldednosignificantevidencethattheprojectshadmitigatedforestloss,andnosystematicevidencethatassociatedcreditsclaimedareadditionalreductions(T.Westetal.,2020).Abroaderanalysisfrom2023thatlookedat27projectsinsixcountriesinthreecontinentsfoundsimilarresults:mostprojectsdidnotreducedeforestation,andreductionsweresubstantiallylowerthanclaimed(T.Westetal.,2023).Alternatively,astudyfrom2022analyzing43VCS-certifiedprojectsfound30projectsachieveda47%reductionindeforestationandareductionindegradationinthefirstfiveyearsofeachproject’slifetimes(Guizar-Coutiñoetal.,2022).Thesedeviatingconclusionsarelikelytheresultofmethodologicaldifferencesconsideringthatcontrolareasmaynotalwaysbereliableduetotheirgeographiclocationbeingdistantfromtheprojectareaaswellasdifferencesinkeyfactorsthatdrivedeforestationsuchasforesttype,economicactivity,andneighboringagriculturalpractices,amongothers.Additionally,Guizar-Coutiñoetal.’s(2022)analysisfocusesondeforestationanddegradationratesonly,notspecificconversionstoemissionreductionswhichisanothersourceofcontroversy.Imperfectdatasetsandsite-specificfactorsmayalsocomplicatetheanalysisofcounterfactualscenarios.GovernmentshavearguedthatUNFCCC-specificguidelinesandstandardsshouldsufficetoguaranteethequalityofcarboncreditsassociatedwithbothforest-basedcarbonprojectsandjurisdictionalapproaches.Intheabsenceofrobustregulations,accompanyinglegislationand,validatedstandards,measurementsandverificationprocedures,actorsincarbonmarketvalue10REDD+isaframeworkcreatedbytheUNFCCCCOPto“guideactivitiesintheforestsectorthatreducesemissionsfromdeforestationandforestdegradation,aswellasthesustainablemanagementofforestsandtheconservationandenhancementofforestcarbonstocksindevelopingcountries”(UNFCCC,2023).SeebelowforadiscussionontheinteractionofREDD+mechanismswithbroaderforest-basedcarbonmarkets.11TheVCSprogramadministeredbycarboncertificationcompanyVerraistheworld’slargestcarboncreditingverificationprogramapplicableforbothindividualprojectsandjurisdictionalprograms(Donofrioetal.,2021).FOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES5chainsmayshifttheirpreferencesawayfromhighlycomplexforest-basedandopttooriginatecarboncreditswithlowerperceivedrisk(suchasthosefromrenewableenergyprojects).TABLE1.QualityproblemsincarbonmarketsQualityConcernsDescriptionAdditionalityAdditionalityreferstoGHGemissionsreductionsthatareadditionalPermanenceiftheywouldhavenotoccurredintheabsenceofacarboncreditgeneratingproject.IfaprojectorjurisdictionalapproachisnotLeakagedeemed“additional,”resultingcreditwouldnotreflectrealreductionsQuantificationintegrityinGHGemissions,andtheircompensatoryfunctionwouldbeinvalidated.PermanencereferstothechallengeofacarboncreditreflectingapermanentreductioninGHGemissions.Forlandandforest-relatedcarboncreditprojects,thereisapossibilitythatcarbonisstoredin“leaky”reservoirs,meaningaproject’spermanenceinstorageisdependentontheintegrityofthereservoir.Ifthesoil,forest,orlandinquestionweretobealtered,apartialorcompletereversalofGHGreductionorremovalwouldoccurinvalidatingtheissuedcredits.Leakageoccurswhencarbon-reductionprojectsdisplaceemission-causingactivitiesandproduceshigheremissionsoutsidetheprojectboundary.Calculationmethodologiesanddatausedtoestimatecarbonstocksandflowsfromcomplexecosystemssuchastropicalrainforestsarehighlydiverseandheterogenousintheiraccuracyandrobustness.Factorssuchassoilcomposition,inter-specieinteractions,speciemakeupandpopulations,aswellasgeochemicalflowsandbiophysicalvariationbetweenecosystemsandgeographiclocationsmakethequantificationofcarbonflowsachallengingprocessforwhichthereisnostandardandperfectanswer.Theintegrityofunderlyingcalculationsthatsupporttheissuanceofcarboncreditsremainsasasourceofidiosyncraticriskforcarboncredits.Source:McKinsey,2020andauthors.Concernshavegonebeyondthetechnicalitiesofadditionality,permanence,leakageandquantificationintegrity,andhavebeguntoinvolveissuesaroundproductionsocialandculturalsafeguards,aswellasconsistencywithgovernmentGHGemissionsreductionsregistriestoavoiddoublecounting,amongotherissues(TaskforceonScalingVoluntaryCarbonMarkets,2021).Insurance,monitoring,andregulatoryapprovalprocesseswillbecomeincreasinglystringentinthecarboncreditvaluechainasperceivedrisksbecomemoresalient,therewillbegreaterscrutinyonthequality(Pearsonetal.,2014).FOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES63.Carbonpricinginstruments(CPIs)andforestcarbonfinanceschemesFundamentalsofmarketandnon-marketmechanismsAtthecoreofthedevelopmentofamarketforcarboncreditsistheuseofcarbonpricinginstruments(CPIs).Puttingapriceoncarbon(atermusedheretorefertoGHGsingeneral)internalizesthesocialcostofanthropogenicclimatechangeandcreatestheconditionsformarketmechanismforcreditstoemerge.AsCPIsexpand,forest-financemechanismshavebenefitedfromcarbonmarkets.Carbonmarkets—wheredemandandsupplyforcesdeterminethepriceatwhichcarbonunitsaretraded—areoneoutcomeofCPIs.Therearetwotypesofcarbonmarkets:complianceandvoluntary.Compliancecarbonmarkets,commonlycalledemissiontradingschemes(ETS),followacap-and-trademodelwherebyregulated(compliance)actors,usuallycompanies,areassignedyearlyGHGemissionsrights(servingaslimits)andareallowedtochooseacombinationofi.directemissionsreductionsbyimplementingnewtechnologiesandprocessestoreducescope1andscope2emissions,12ii.buyingrightsforemissionstheyareunableorunwillingtoabatefromotherregulatedentities(referredtoasoffsetting),andiii.buycreditsfromnon-complianceentitieswhochoosetocontributetheiremissionreductionstothecompliancemarket.Incontrast,involuntarycarbonmarkets,privateactorschoosetosetemissioncaps/reductiontargetsinternallyandvoluntarily,andtradewithoneanothertoachievethem.Inthecaseofvoluntarycreditmarkets,“thereisnosuchthingasasingle‘marketplace,’butratheradiverseandgrowinglandscapeofexchangesandover-the-counter(i.e.,bilateral)transactions”(Donofrioetal.,2021).Bothcomplianceandvoluntaryforestcarbonmarketsfallunderthebroadcategoryofresults-basedfinancewherefinalcreditsaretransactedonthebasisofprovenandcertifiedemissionreductionsorremovals(SeeFigure2).Inadditiontomarketmechanisms,forestcarbonfinanceincludesnon-marketapproachesatbothprojectandjurisdictionallevelsundertheReducingEmissionsfromDeforestationandForestDegradationplusconservation(REDD+)frameworkcreatedbytheUNFCCC.TheprinciplesunderwhichREDD+projectsaregovernedwereagreedtoatCOP19inWarsawinDecember2013,resultingintheWarsawFrameworkforREDD+(WFR).TheWFRprovidesmethodologicalandfinancingguidancefortheimplementationofREDD+activities,includingthroughthedevelopmentofnationalstrategiesforREDD+,implementationofnationalpoliciesforcapacitybuilding,technologydevelopmentandresults-basedfunding,measurement,reportingandevaluationsystems(UNFCCC,2023).12Scope1emissionsrefertodirectGHGemissionsthatoccurfromassetsandprocessesdirectlycontrolledbyanorganization(e.g.,emissionsfromcompany-ownedinternalcombustionenginevehicles,steelmakinginafurnace,landclearingforcattleranching).Scope2emissionsrefertoindirectGHGemissionsfromelectricitypurchasedbyanorganizationfromathirdparty(e.g.,electricityboughtfromacoal-poweredplantoperator).Scope3emissionsrefertoallotherindirectemissionsfrompurchasedgoodsandservicesbytheorganization.Scope3emissionstendnottobeincludedwithinregulatedcap-and-tradeschemes,particularlyinlongsupplychains,duetothecomplexityinGHGaccountingandattribution.However,newervoluntaryschemessuchastheScience-basedTargetsinitiative(SBTi)isencouragingcompaniesthatcommittoemissionsreductiontargetstoincludeallthreeemissionsscopes.FOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES7REDD+activitiesproceedinthreemainphases,eachofwhichmaybeaccompaniedbyspecificnon-marketfinancialflows(Donofrioetal.,2021):i.Readiness:Includespaymentsandactivitiesassociatedwiththedevelopmentofnationalstrategies,plans,policiesandmeasures,andcapacity-building.ii.Implementation:Referringtotheimplementationofthestrategies,policies,plansandmeasures,capacity-buildingdemonstration,andtechnologydevelopment/transferactivitiesfollowingthereadinessphase.iii.Results-basedpayments:Financingflowscontingentonverifiedemissionsreductions,withmostresults-basedpaymentsunderREDD+comingfromdevelopedeconomiesandmultilateral/bilateraldevelopmentfinanceinstitutions(DFIs).Itisimportanttonotethatproject-basedREDD+creditscanalsobetransactedinvoluntarymarkets,andREDD+fundingfromtheprivatesectorhasbeenincreasingintherecentpast.FIGURE2.Landscapeofforestcarbonfinancemarkets,non-marketpayments,andresults-basedfinance(A)andthethreephasesofREDD+(B)AResults-basedfinanceJurisdictionalREDD+MarketsNon-marketpaymentsVoluntaryCompliancemarketsmarketsResults-basedImplementationReadinesspaymentsBPhase2:Phase3:ImplementationResultsPhase1:ReadinessMarketandnon-marketpaymentsFinance:grants,results-basedpayments,etc.OftencontingentonresultsSource:AdaptedfromDonofrioetal.(2021).Project-basedvs.JurisdictionalapproachesUnlikeproject-basedapproaches,jurisdictionalapproachestackledeforestationandforestdegradationatalargescalewithbaselinesbeingdefinedatanationalorsubnationallevel(i.e.,astateorprovince)insteadofadiscretepropertylevel.Implementationmeasuresgobeyondconservation,restorationandforestmanagement,andincludepolicydevelopmentandenforcement(includingaccesstocreditandtaxbenefits),landrightsprotectionandcoordinationamongstactorsintimber,FOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES8agricultureandlivestocksupplychainsleadingtoacomprehensivegovernanceofforestandlanduseacrossentirepoliticalterritories(CIFOR,2020;Donofrioetal.,2021;Seymour,2020).Paymentsaremadetonationalorsubnationaljurisdictions,usuallygovernments,butincreasinglytoprivatesectoractorscontrollingalargesupplychainsuchasthatofoilpalm,asaformofresults-basedpayments(Donofrioetal.,2021).Anotherimportantdistinctionisthatbetweenproject-basedandjurisdictionalapproachestoforestfinance.Project-basedforestcarbonfinanceapproachesareoftencriticizedfornotbeingfit-for-purposeastheymaybeunabletofullyaddressmanyoftheunderlyingobjectivesofREDD+includingavoidingleakage,creatinglarge-enoughincentivestosystemicallyreducedeforestationandforestdegradationataregionallevel,andensuringsocialandenvironmentalintegritystandards.Forthisreason,climatenegotiationsandprivatesupplychaininitiativesareconvergingonjurisdictional-scaleapproaches.Jurisdictionalapproachesbringseveraluniqueefficiency,measurementandgovernanceadvantageswhencomparedwithproject-levelapproachesthathavethepotentialofimprovingthereputationandqualityofassociatedfinancialflowsandcreditsissued:i.Byestablishingadeforestationanddegradationbaselineacrossanentirejurisdictionusingmethodologiesalignedwithinternationalreportingstandards,theriskofbaselinemanipulationandovercreditingisloweredwhencomparedwithproject-levelapproaches(Thompsonetal.,2022).ii.Monitoringacrossawholejurisdictionallowsforthedisplacementdeforestationanddegradationtobedetectedandaccountedfor(Thompsonetal.,2022).iii.Monitoring,reportingandverification(MRV)systemsareoftencostlyandtechnicallycomplex.ExpandingthescopeforMRVtoawholejurisdictionallowsforeconomiesofscaletoemergeasasinglesystemmaybeabletocoverwhatseveralproject-basedsystemswouldatalowercostandwithgreaterefficiency.iv.Sincejurisdictionalapproachesarelargelyadministeredbynationaland/orsubnationalgovernments,politicalactorsareincentivizedtousepolicy,regulation,andenforcementtoolstoachievereduceddeforestationanddegradationresults.Benefitsperceivedbygovernmentsincludenewrevenuesources,avoidanceofprotectionistmeasuresbyexternalbuyers(liketariffsonproductsfromareaswithhighdeforestation)andreputationalbenefits.Jurisdictionalapproachesthereforemodifythejurisdiction’spoliticalprocessbyaligningthemwithREDD+goalsbeyondthebenefitsofGHGemissionreductions(Seymour,2020).Thishasthepotentialoftriggeringlarge-scaleandsystemicchangesthatarehardertoensurewithproject-levelapproaches.Oneexampleisthepolicy-drivendecreasesindeforestationincountrieslikeBrazilintheearly2000s(Boucheretal.,2013).FOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES9v.Bydirectlyinvolvingthegovernmentapparatusandintroducingaccountabilityandsafeguardsystemsthatgobeyondcarbon-specificintegritystandards(suchastheequitablesharingofperceivedbenefitswithlocalcommunities,theconservationofajurisdiction’sbiodiversity,andtheenforcementoflandtenurerights),jurisdictionalapproachesdecreasetheriskoflowqualitycarboncreditsfrombeingissued(Seymour,2020).Whilejurisdictionalresults-basedpaymentshavebeenproposedsinceatleast2005whenPapuaNewGuineaandCostaRicaformallyintroducedthecreationofjurisdictionalfinanceunderREDD+duringCOP11inMontreal,specificmarketplaces,systems,andpaymentstoexecuteonthepromiseofjurisdictionalapproacheshavefaltereduntilrecently.In2021Mozambiquebecamethefirstandonlycountryintheworldtoreceivea$6.4milliondollarresults-basedpaymentfromtheWorldBank’sForestCarbonPartnershipFacilityforreducingemissionsfromajurisdictionalREDD+programinitsZambéziaprovince(Favasuli,2022).Recentadvancementsinsatellitesurveillance,methodologicalrobustness,andartificialintelligencehaveunlockedwhatusedtobeaninsurmountabletechnicalproblemofmeasurement,reportingandverification(MRV)forlargejurisdictions(SeymourandBusch,2016).Nonetheless,lackofacriticalmassofdemandandsupplyforjurisdictionalresults-basedREDD+paymentscontinuestolimititspotential(Favasuli,2022).NewinitiativessuchastheLEAFCoalitionpromisetobridgethisexecutiongapbyestablishingamechanismthatcrowds-inpublicandprivatefundingtofacilitatetransactionsandsecurealarge-enoughsupplytosatisfypublicandprivatedemandforjurisdictional-levelcarboncredits(Seymour,2020).WiththeinitialsupportofthegovernmentsoftheUS,UK,Norwayandninecorporateactors,theLEAFcoalition,anditsassociatedEmergentForestFinanceAccelerator,TREESstandard,andArchitectureforREDD+Transactions(ART)havesecureda$1billiondollarcommitmenttopayfor100MtCO2eataminimumpriceof$10dollarsperton,withthegoalofreaching1GtCO2einyearlyjurisdictionalcarboncredittransactionsby2025(Donofrioetal.,2021).Governmentfailures,lackofinterinstitutionalcoordination,unrealizeddemandandsupply,andgreatermaturityincarboncreditissuance,remainachallengeforthefutureexpansionofjurisdictionalapproachesdespiteitspromisingpotential.VolumeofforestcarbonfinanceCarbonmarketshavebeendevelopedmostlyinresponsetocompliancerequirements(23%ofglobalGHGemissionsarecoveredunderCPIs,thevastmajoritywhichfallundercompliancemechanisms(WorldBank,2022)).AsshowninFigures3and4,compliancemarketsaresignificantlylarger($968billionin2022)thanvoluntarycarbonmarkets(amere$1.7billionin2022).13Thisisnotsurprisinggiventhefactthatvoluntarycarbonmarketsareintheirinfancy,motivatedprimarilybytheneedtorespondtothepreferencesofconsumersand/orinvestors.13Notethevalueforworldvoluntarycarbonmarketsfor2022isaforecast(TroveResearch,2022).FOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES10Inthespecificcaseofforest-basedcarbonmarketsthenumbersaremuchsmallerandvoluntarymarketsoutweighcompliancemarkets:$799millionincompliancemarketsfor2019(latestavailabledata)and$1,328millioninvoluntarymarketsfor2021(Donofrioetal.,2022;Maguireetal.,2021).Despitewidespreadskepticismforvoluntaryforest-basedcarboncredits,markettransactionsincreasedbyafactorof8.3from2019to2021,indicatingasignificantriseindemand(Donofrioetal.,2022).Thefactthattropicalforest-basedcarbonmarketsrepresentonlyasmallshareofthetotalcarbonmarketsindicatesthattropicalcountrieshavenotbeenabletobenefitfromtheproductionofcarboncredits.Thisislikelyduetoregulatoryconcernsoverthedegreetowhichtheyrepresent“real”emissionsreductionsandprotectaffectedcommunitiesfromharm,comparedtoemissionsreductionsfromothersectors(Seymour,2020).Forvoluntaryforest-specificcarbonmarkets,REDD+remainedthemostdominantprojecttypetradedintheforestryandlandusecategoryin2021representing65%oftotaltransactions,continuingahistoricaltrend(Donofrioetal.,2022).Additionally,pricingtrendsindicatethatnotallcarboncreditsarecreatedequal,lendingcredencetotheideacarboncreditsareincreasinglyseennotascommoditiesbutasaseparateidiosyncraticassetclass,withcreditssoldfromprojectswithnon-carbonbenefits(e.g.supportinglocalcommunitiesandbiodiversityconservation)havingapricepremiumoverthe2021EcosystemMarketplaceGlobalCarbonPricebenchmarkof$4/tCO2e,andranginginpricesfrom$5.05to$9.34/tCO2e(Donofrioetal.,2022).Thissuggestssomeactorsareactivelypricingancillarydevelopmentandconservationbenefitsofcarboncreditsatapremium.Bothcomplianceandvoluntarycarbonmarketsareexpectedtogrowsignificantly.Compliancemarketscouldsurpassthetrillion-dollarmilestonein2023,andcontinuetheiracceleratedgrowthasexistingETSsexpandandmature,andnewETSsbecomeoperational.Infact,theexpansionofthebaseofregulatedentities,theprogressivedecreaseinemissioncaps,andtheincreaseinthemarginalcostofabatement(as“low-hangingfruit”forscope1and2emissionsreductionsarebeingexhausted)maketradingmoreattractive.Inthecaseofvoluntarymarkets,rapidchangeinconsumerandstakeholderpreferences(includinginvestors)isplacingsignificantpressureoncompaniestoreduceGHGemissions.However,globalvoluntarycarbonmarkettransactionsfromforestryandotherlanduse(FOLU)arestillrelativelysmall($1.3billionin2021)whencomparedtomulti-sectorcompliancemarketsmorebroadly(Donofrioetal.,2022;Refinitiv,2022).TheTaskforceonScalingVoluntaryCarbonMarkets(2021)estimatesthatdemandwillreach1–2GtCO2eperannumby2030,correspondingtoamarketsizebetweenUSD$5and$30billion,dependingondifferentpricescenarios.Althoughaspirational,thesenumbersprovideenoughmotivationtodevelopthisopportunity.FOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES11FIGURE3.Comparisonofworldcomplianceandvoluntarycarbonmarkets,marketvalueCompliancecarbonmarketvalue(USDbillion)9681,000Compliancemarkets850800600268322400208200201820192020202120220Voluntarycarbonmarketvalue(USDbillion)1.992.0Voluntarymarkets1.691.51.00.5200.50.300.32201820192020202120220.0Source:AuthorsbasedonavailabledatafromRefinitiv(2022)fortheperiod2018–2022forworldcompliancemarkets,Donofrioetal.(2022)fortheperiod2018–2021forworldvoluntarymarkets,andTroveResearch(2022)for2022forecastsinworldvoluntarymarkets.Anadditionalfactortoconsideristheexpectedevolutionofcarbonprices(seeFigure5)whicharestillrelativelylow(rangingfromEUR5intheChinaETSandashighasEUR65intheUKETS).Inthefuture,carbonpricescoulddramaticallyincreasebenefitingcountrieswithacomparativeadvantageintheproductionofcarboncredits.FOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES12FIGURE4.Forest-specificvoluntaryandcompliancecarbonmarkettransactionsTransactions(USDmillion)Voluntary11,3281,400Compliance21,3001,1591,2001731,1009581,0001599008006147006560098650054979931540020202019300Year2001002017201802021Notes:1.Referstovoluntarycarbonmarkettransactionvaluesintheforestryandlandusecategory.2.Thedataforforest-specificcompliancemarketsincludesvaluedatafortheNewZealandETS,theAustralianEmissionsReductionFund,theColombianCarbonTax,theKoreanETS,theCalifornia-QuebecETS,theAlbertaETS,theBritishETSandtheChinasub-nationalETSprograms.ItdoesnotincludeotheractiveETSandcompliancemechanisms,likelyresultinginanunderestimatefortotalglobalforest-basedcompliancetransactions.Nodataisavailablefor2020and2021.Source:Maguireetal.(2021)forcomplianceandvoluntaryforest-specificcarbonmarketsfortheperiod2017–2019andDonofrioetal.(2022)forvoluntaryforest-specificcarbonmarketsfortheperiod2020–2021.FIGURE5.Annualaveragepriceperton(localpricesconvertedtoEuros)Source:Refinitiv(2022).FOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES13Althoughthereisclearlyanupsideinthedevelopmentofcarbonmarkets,therearealsosomemountingobstaclesthatcouldderailtheseopportunities.Inparticular,i.Marketsareveryilliquid(causingvolatilityinprices)asthereareveryfewexchangeswithhightradevolumes.ii.Lackoftransparencytounderstandthepricingandunderlyingprojectdetails,especiallyinthecaseofover-the-countertransactionsbetweentwoparties.iii.Heterogenousbuyerpreferencesthatarenoteasilyvisibleandaggregatedintotradingprices.iv.Lackofstandardizationofdifferenttypesofcredits,makingitchallengingtoadequatelymeasure,compareandpriceancillarybenefitsofunderlyingprojectsandjurisdictionalapproaches.Compliancemarkets,duetotheirregulatednature,tendtobemoreliquidandhavehigherlevelsoftransparency.Voluntarymarketsarehighlydecentralizedandopaque,resultinginhighriskforprojectdevelopers(TSVCM,2021).Thereisalsotheproblemofgreen-andsocial-washingresultinginhighlevelsofskepticismandperceivedriskfromthebuy-side.Consolidatingarobustsupply-sidewithstrengthenedprojectpre-financing,regulation,scaling,andstandardswillbeindispensable.Thiswillbechallengingforforest-basedcredits.4.Developingforest-basedcarbonmarketsThecompositionoffinancialflowsgearedtowardsconservingandmanagingecosystemsischangingrapidly.AsshowninFigure6,between2017and2018market-basedmechanismssurpassedconventionalofficialdevelopmentassistance(ODA)astheleadingsourceofforestfinancing,withmarket-basedmechanismsrepresenting61.5%offorest-specificinternationalfundsreachingforestryprojectsin2018.Giventhesignificantriseintransactionsinvoluntarymarketsduring2021,thistrendislikelyaccentuating.NotethatwhileODAisgearedtowardsdevelopingcountries,voluntaryandcompliancemarkettransactionsincludefinancingforbothdevelopedanddevelopingeconomies.Thiscomparisonshouldbeobservedcarefullyasitdoesnotnecessarilyindicatemarket-basedmechanismsaresurpassingODAfinancialflowsindevelopingeconomies.Furtheranalysisisrequiredtounderstandwhetherthisbroadertrendisindicativeofmarket-basedmechanismstakingtheleadinfinancingfordevelopingeconomyeffortstohaltdeforestationandforestdegradation.Asdiscussedearlier,onepotentiallynegativeconsequenceofthistrendisthatthemainfocusofforest-specificprojectsistooptimizecarbon-relatedindicatorsattheriskofdisplacingmoreholisticecosystem-basedandjurisdictionalapproachestowardsforestmanagementinlinewiththeUNConventiononBiologicalDiversity(CBD)andREDD+standardsundertheUNFCCC.FOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES14In2022,attheCBD’sConferenceoftheParties(COP15),193governmentsfailedtodeliverstrongtargetsonbiodiversityandhumanhealthandclearindicatorsforbiodiversityconservation(Wyns,2023).ThisisparticularlyrelevantinthecontextoftheimplementationofArticle6oftheParisClimateAgreementwhichdealswiththegovernanceandrulesofcarbonmarkets.14Withoutclearbiodiversitygoalsandmeasurement,partiesnegotiatingthetermsofimplementationofArticle6(whichincludemarketstandardsetters,regulators,andenvironmentalauthorities)willnotbeabletoensurethatforest-basedcarboncreditinstrumentswillbebeneficialforecosystemsatlarge.Furtherdiscussionsaroundthenexusbetweencarbonmarketpolicyandbiodiversityconservationarewarrantedtoavoidthepotentialunintendedconsequencesassociatedwiththeone-dimensionalcarbontunnelvision.FIGURE6.Forest-specificvoluntaryandcompliancecarbonmarkettransactionsandODAdisbursementsTransactions/Disbursements(USDmillions)Voluntarycarbonmarkets12,4292,500Compliancemarkets2ODA(multilaterals)31,8852,000ODA(bilaterals)41731,5009861,6401,3281591,4951,4741,00065799315470549530597337182500175265629631389500202042261602018Year2019202120162017Notes:1.Dataisonlyavailablefor2017,2018and2019forforestcompliancecarbonmarkets.2.ThedataforcompliancemarketsincludesvaluedatafortheNewZealandETS,theAustralianEmissionsReductionFund,theColombianCarbonTax,theKoreanETS,theCalifornia-QuebecETS,theAlbertaETS,theBritishETSandtheChinasub-nationalETSprograms.ItdoesnotincludeotheractiveETSandcompliancemechanisms,likelyresultinginanunderestimatefortotalglobalforest-basedcompliancetransactions.3.ODAtotheforestrysectorincludesdisbursementsthatdonotexclusivelytargetforestprotection.4.BilateralforestryODAincludesconstantpricesdataforthe31membersoftheOECDDevelopmentAssistanceCommittee(DAC).Source:AuthorsbasedonvoluntaryandcompliancemarketdatafromMaguireetal.(2021)andDonofrioetal.(2022),andODAdatafromOECDCRS(2022).14Article6oftheParisClimateAgreementincludesthreeoperativeparagraphs(6.2,6.4,and6.8),twoofwhichrelatetothegovernanceandrulesofcarbonmarkets.CurrentdiscussionsattheclimateConferenceoftheParties(COP)undertheUnitedNationsFrameworkConventiononClimateChangehavesofarbeenunabletoreachanagreementintermsofthedetailsgoverningtherulesunderwhichArticle6willbeimplemented,limitingthepotentialfortheexpansionofinter-countrytradingofcarboncreditsandoffsets,includingthosederivedfromforest-basedprojects(Ferrato,2022).FOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES15ThisisespeciallyrelevantgiventheprojectionsmadebytheTaskforceonScalingVoluntaryCarbonMarkets(2021)whichplacetotalpotentialsupplyofcarboncreditsinthe8–12GtCO2e/yearrangeby2030.Thesupplyofcarboncreditsby2030isexpectedtocomefromfoursources:(i)technology-basedremoval;(ii)additionalavoided/reducedemissionsfromefficiencygainsandotheractivities;(iii)nature-basedsequestrationand(iv)avoidednatureloss.Nature-basedsequestration(afforestation,forest,andsoilmanagement)andavoidednatureloss(avoideddeforestationandecosystemdegradation)areexpectedtocontributewithmorethanhalfoftheexpectedsupply.Theestimatedvolumeofcreditscouldleadtoamarketsizebetween$5–$50billionby2030.Lower-endvaluescorrespondto“ascenariowherebuyerspurchasethehistoricalsurplusofcarboncreditsandthenacquirethelowest-costcreditsavailable”(McKinsey,2021).Thehigh-endestimate“representsascenarioinwhichmostbuyersopttopurchasecreditsfromlocalsuppliersonly,evenatapremium”(McKinsey,2021),likelyreflectinganabsenceofliquidityininternationalmarkets,thusforcingbuyerstopurchasecreditsinlocalmarketseveniftheyaresoldatsignificantmarkupsoverinternationalprices.Nature-basedsequestrationandavoidednaturelosswillroughlyrepresentbetween$2.5billionand$25billionby2030oftotalcarboncreditmarkettransactions.However,actualnumberscanbemuchsmalleraslagsbetweeninitialinvestmentandsaleofcreditslimittheforest-basedproject’sfinancialattractiveness.Also,inefficienciesincreditqualitycertificationcanfurtherreduceforest-basedcreditsupplyto1–5GtCO2e/yearby2030(McKinsey,2021).Inadditiontoconcernsrelatedtobiodiversityconservation,thedevelopmentofforest-basedcarbonmarketsrequiresactivepoliciestoensurethatanincreasingshareofcarbon-relatedrevenuesisreceivedbyhostcountriesandlocalcommunities.Thesearetheissuesdiscussedintheremainderofthissection.Transactioncostsforproject-basedcreditingHigh-qualitycarboncreditsproducedfromreductionandremovalprojectsincarbon-richlandjurisdictionsfacehightransactioncosts.Theseincludethecostsoftransactingandenforcingthecontractbetweenbuyersandsellers(Lileetal.,1998).AccordingtoDudek(1996)andMilne(2002),thesecostsinclude:i.Originationii.Designiii.Negotiationiv.Approvalv.Implementationvi.Insurancevii.Verificationviii.EnforcementFOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES16Projectoriginationcostsincludethesearchandidentificationofapotentialareasuitableforahigh-qualitycarboncreditissuance.Designcostsrefertothedevelopmentofaprojectimplementationplangivenanarea-specificbiophysicalandsocialcontext,aswellascorrespondingmonitoringandverificationprotocols.Negotiationincludescostsassociatedwithbrokeringatransactionbetweenbuyersandsellers.Approvalcostsencompassregulatory,legal,andcommunitycomplianceproceduresrequiredtoapproveacarboncreditproject.Implementationcostscoverexpensesforlabor,capacitybuilding,selectionoflocalcontractorsandsites,communitymeetings,technicalandmanagementplans,registrationoflandsandleases,distributionoffundstobeneficiaries,andthedistributionofplantingmaterialandassociatedinputs.Insurancecostsincludeprojectriskinsurance,andcostsofinsuringemissionreductions.Verificationandenforcementexpensesarerequiredtoprovetoinvestorsandregulatorstheestimatedlevelsofcarbonthathavebeenreducedorsequesteredfromtheatmosphere.AccordingtoGrafton(2021),estimatesoftransactioncostsarehighlyuncertainbecauseofdifferentaccountingpracticesandcanbeasubstantialproportionoftheoverallcostsofforest-basedsequestrationprojects.Pearsonetal.(2014)estimatethattransactioncostscanbeaslowas0.3%orashighas270%oftheanticipatedincomeofforest-basedprojects,suggestingsignificantvarianceinthisregard.Theyalsofindthatthethreelargestcostcategoriesare:i.insurance(41–89%oftotalcostsinvoluntarymarkets);ii.monitoring(3–42%)andiii.regulatoryapproval(8–50%).Asdiscussedearlier,jurisdictional-basedapproachesmaybeabletoresolvesomeoftheissuesstatedabove.Duetotheirlargescale,thepotentialmobilizationofpolicyandregulatorymechanismsandinter-actorcoordination,gainsfromefficienciesandeconomiesofscalemaysignificantlyreducetransactioncostsifnotoutweighedbytheaccompanyingincreaseinbureaucraticload.This,however,remainstobeprovedasjurisdictionalresults-basedpaymentsexpand.ValuechainTraditionalcarboncreditprojectstendtobefinancedthroughemissionreductionpurchaseagreements(ERPAs),“accordingtowhichaninvestorpurchasestherighttoowntheserialnumberoftheregisteredcarboncreditsandmakesfront-loadedpaymentstoprojectdevelopersandunderlyingfarmers/landowners”(Johnson,2015).Arelevantissueofconcernisthereforethedistributionofrevenueandprofitsfromcarboncreditproduction,verification,andtradingbetweenactorsalongthenascentcarbonvaluechain.Thisisanissuewiththepotentialtobeavoidedatleastinpartbyjurisdictional-scalecreditgenerationasstrongpolicyandregulatoryapproachesguaranteelocalgovernments,privatesectoractorsandcommunitiesperceiveahighershareofcarboncreditrevenues.Assumingthecontinuedgrowthofproject-basedcreditingapproaches,policymakersincarbon-creditproducingeconomieswillhavetodesignmechanismstobeabletocompetitivelycapturehighvalue-addedactivities.WithouteffectivepoliciesalimitedpercentageoftheexpectedFOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES17$2.5–$25billioncarboncreditmarketby2030willbeabsorbedbyproducingjurisdictions.Inordertoavoidthedynamicsofextractiveindustries,productivedevelopmentpolicies(seebelow)areneededtostrengthendomesticactivitiesandtheroleofdomesticplayers(suchasState-OwnedEnterprises)incarbonvaluechains,especiallyinthemidstreamstages.Thevaluechainofcarboncreditcanbesplitintothreebroadstages(Figure7):i.Landacquisition,projectnegotiationandmanagement(upstream);ii.Approval,measurement,andverification(midstream),andiii.Insuranceandbrokerage(downstream).Forest-basedcarboncreditsfrombothreductionandremovalprojectsnaturallyrequiretheuseofland,butsignificantcomponentsofthevaluechainareintensiveinskilledlaborandcapital.Theseisthecaseofupstreamanddownstreamactivities,wheremostofthecarboncredit’svalueisaccounted.Forexample,measurementandverificationarecapital-intensivegiventherelianceonequipmentsuchassatellitesandlandsurveyingtechnology.Incountrieswherelandfortropicalforest-basedprojectsisrelativelyabundant,andcapitalandskilledlaborarerelativelyscarce,capturingthebenefitsofcarboncreditscanbedifficult.Thisisspeciallythecasewhenupstreamanddownstreamsegmentstakeplaceinotherjurisdictions,andwherelandrepresentsonlyasmallpercentageofthetotalvalueofacarboncredit.Inthecaseofjurisdictionalapproaches,governmentsmayundertakeupstreamanddownstreamactivitiesandthusbeabletocaptureagreatershareofrevenuesfromhighvalue-addedactivities.Suchascenariowouldincreasegovernmentrevenues,potentiallyunlockinggreaterfinancingforpublic-ledconservationefforts,welfareprograms,andpolicyandregulationenforcement.This,however,assumesgovernmentshavethetechnicalcapacity(orappetiteandabilitytodevelopit)toconducthighlycomplexprocessesthatdemandcapitalandskilledlabor.Indevelopingeconomiesnationalandsubnationaljurisdictionswheretechnicalcapacity,humancapital,andbudgetsarelimited,thismayprovetobeasignificantchallenge.ReadinessandimplementationfinancingschemesunderREDD+wouldthereforeplayakeyroleinenablinggovernmentstoundertakethischallenge,astheywoulddirectlyengageincapacitybuildingforlocalpublicinstitutions.Alternatively,somegovernmentsmayopttooutsourceupstreamanddownstreamservicesprovisionstoincreaseefficiencyinjurisdictionalcarbonmarketservicedelivery(Poutvaara,2020).Todeterminewhetheroutsourcingissuitable,governmentswillneedtotacklethequestionofwhethertheyholdanaturalmonopolyoverupstreamanddownstreamservicesinjurisdictionalREDD+approaches.Ifanaturalmonopolyindeedexists,outsourcingmayprovetobelesssuitableasitmayresultinqualityproblems(Poutvaara,2020).Midstreamactivitieswilllikelybedevelopedthroughpublic-privatepartnerships,theimplementationandenforcementofpolicy,and/orprivate-levelandcommunityprojects.UnderFOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES18certainscenarios,midstreamactivitiescouldbecategorizedas“nestedREDD+”wheregovernmentsmaytransfertherighttogeneratecreditownershiptoprivateentitiesalignedwithjurisdictionalbaselinesanddeforestationmonitoring(Thompsonetal.,2022),yieldingahybridbetweenproject-basedandjurisdictionalapproaches.Nestingisstillinitsinfancywithnoestablisheddefinitionandapproach,likelyresultinginahighdegreeofvariationasjurisdictionalapproachesmatureintheirimplementationandgovernmentsdefinetheircorrespondingpreferences(Thompsonetal.,2022).FIGURE7.LocationofvalueadditionandproductionfactorspecificityintheforestcarbonvaluechainResearchandDevelopmentSecondarymarket(Bioengineering,basicbrokeringandinsurancescienceresearch)AddedeconomicvalueProjectoriginationBrokeringandmarketinganddesignProjectrightsnegotiation,Projectveriﬁcationandpurchasing/leasingofosetissuancelandandcontractingOn-the-groundprojectimplementationUpstreamMidstreamDownstreamIntangibleTangibleIntangibleValue-addingactivitiesbyvaluechainstageProductionfactorspeciﬁcityLabor-intensiveLand-intensiveCapital-intensiveSource:AuthorsadaptingfromtheSmileCurveconceptualframework(Mudambi,2008).5.TheinteractionbetweenlandmarketsandcarbonEvenifotherfactorsofproductiontakealargeshareofthevalueaddedincarbonmarkets,landisindispensableinforestandland-basedcarboncreditprojects.Theexpansionofcarbonmarketstomeetvoluntaryandregulatorycommitmentsandrequirementswillthereforeintroducenewpressuresonmarketsforlandinareaswheredeforestationandforestdegradationishigh.Themaindriverofdeforestationintropicalcountriesistheincreaseddemandforlandresultingfromtheexpansionoftheagriculturalfrontier.Producttypesdominatingtheuseofdeforestedlandintropicalcountriesarebeef,oilseeds(oilpalm,soy,sunflower,etc.)andforestryproducts(paperandwood)—mostlyexportproducts-,eachtyperesponsiblefor41%,18%and13%oftropicaldeforestation,respectively.Thetensionsbetweencarboncreditproductionandagriculturalexportsarethusapparent.FOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES19Forcarbonmarketstogrow,thevalueofthemarginalproductivityoflandusedfortheproductionofland-basedgoodsmustbelowerthanthatoflandusedforremovingGHGemissionsfromtheatmosphere.Inotherterms,therealrentoflandusedforcarboncreditproductionmustbeequaltoorhigherthantherealrentoflandusedforagriculture/forestry.Ifthenominalvalueofcarboncreditsand/orthemarginalproductivityoflandusedforcarbonreduction/removalistoolow,agriculture/forestryactivitiesmayoutcompeteanycarbonpricingmechanism.Dependingonlocalconditionssuchaslandabundanceandthespecificproductivityoflandinreducingand/orremovingcarbon(vs.productivityinagriculture),aswellasinternationalpricesforcarboncredits(vs.pricesofagriculturalgoods)incentivestoutilizelandforagricultural/forestryproductionmayrapidlychangetowardsconservationand/orreforestation/afforestation,andviceversa.This,however,doesnotfactor-inbroaderpublicservicesprovidedbyforestsintheformofecosystemserviceswhereavoidingdeforestationatalarge-enoughscalemaypreventtemperature,precipitation,humidityimbalancesatajurisdictionalscale.Currentagriculturalactivitiesdonotwidelymeasureordistinguishvaluegeneratedfromecosystemservices,thuspreventingthepricing-inofecosystemservicebenefitsinagriculturalmarkets.Buschetal.(2019)estimatemarginalabatementcost(MAC)curvesfortropicalreforestationandavoideddeforestationin90countries.15Accordingtotheirresults,thetoptencountriesthatcouldincreaseCO2removalsfromtropicalreforestationbetween2020and2050atapriceofUS$20pertonofCO2areBrazil,Indonesia,theDemocraticRepublicoftheCongo,Mexico,Angola,Colombia,India,Tanzania,MozambiqueandThailand.Thesecountriesrepresent55%ofthetotalremovals.Thetoptencountriesforreducingemissionsfromdeforestationbetween2020and2050atUS$20areBrazil,Indonesia,theDemocraticRepublicoftheCongo,Peru,Colombia,Bolivia,PapuaNewGuinea,RepublicofCongo,VenezuelaandMalaysia.LatinAmericarepresentsnearlyhalfoftheglobalreductioninemissionsfromdeforestationatthatprice.Itisalsotheregionwiththemostlow-costpotentialforbothremovalsfromreforestationandreducedemissionsfromdeforestation.Inthesamespirit,Kohetal.(2021)calculatethepricesatwhichcarbonprojectsbecomefinanciallyviableindifferentjurisdictions.Thestudyarguesthatasthenominalpriceofcarbonincreases,thepercentageoflanddevotedtoforestconservationincreasesatadecreasingrate(Figure8).Whatthismeansisthatthemarginalincreaseinthenominalcarbonpriceatlevelsroughlyabove$50/tCO2ewillnotnecessarilyrepresentsignificantgainsinnewlandthatbecomesfinanciallyviabletodedicatetowardsland-basedcarbonreduction/removal.Mostlandgainstomakecarbonpricingcompetitivevis-à-visotherlandusesoccurbetweenthe$0to$25pricerange.ThecalculationofinvestableforestcarbonreferstotheestimatedtotalvolumeofCO2associatedwiththreecarbonpoolsintropicalforests:abovegroundcarbon,belowgroundcarbon,andsoilorganiccarbon,whileapplyingVoluntaryCarbonStandard(VCS)criteriatoaccount15Estimatingcostsisharderforreforestationthandeforestationbecauseitisaslowerprocess.Also,CO2removalfromreforestationissubjecttoreversalsduetoharvestornaturalloss.FOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES20foradditionalityconcerns.Tocalculatethereturn-on-investmentofforestcarbon,theauthorsemployaseriesofsimplifyingassumptions,includingthecostofprojectestablishmentatanaverageof$25/ha,annualmaintenancecostsof$10/haandaconstantcarbonpriceof$5.8/tCO2eforthefirstfiveyears,withasubsequentincreaseof5%peryearovertheproject’slifetime(30years).16Theopportunitycostisgivenbytherentsassociatedwithalternativeland-usesfromagriculture(basedon18crops)andtimberextraction(Kohetal.,2021).AreaswheretheopportunitycostexceedstheprojectedNPVforinvestableforestcarbonarethereforeexcluded,resultinginasignificantdecreaseinclimatemitigationpotential.Thestudysuggeststhatatapriceof$5.8/tCO2e,thevastmajorityofcarbon-richtropicalforestsremainfinanciallyunviablefortheproductionofcarboncredits(Figure8).Figure9,alsofromKohetal.(2021),showsthenetpresentvaluesovera30-yeartimeframeforthefivecountrieswiththehighestpotential(andestimatesalsofortheregions).Theaccumulationofprofitsovertimeattheglobalandregionallevels,withshadingsaroundthelinesrepresentingstandarddeviationisalsoofinterest.FIGURE8.Globalforestcarbonreturn-on-investmentfromfinanciallyviablesitesSource:Kohetal.,2021.16AnalysessuchasthosebyKohetal.(2021)donottendtoprice-inpositiveexternalitiessuchasecosystemservicesandbiodiversityconservation,aswellashard-to-measureintangiblessuchastheculturalandintrinsicvalueofnature.Theyratherfocusoncalculatingopportunitycostbasedonmarketableprivategoodsandservices.Giventhedifferingscopeofjurisdictionalapproaches,publicgoodssuchasecosystemservices,andintangibleassetscouldbepriced-inwithinopportunitycostcalculationschangingtheoutcomeoftheanalysisabove.FOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES21FIGURE9.Effectofcarbonpricingonthefinancialviabilityofforestcarbonsites17Source:Kohetal.,2021.ExternalitiesThemonetizationofforestandland-basedcarboncreditshasthepotentialofgeneratingbothpositiveandnegativeexternalities.Otherthanbenefitsresultingfromtheregulationoftheglobalcarboncycle,forestsprovideecosystemsservicessuchregulatingclimatestabilizationthroughthebiophysicaleffectsofforestcover(decreasingtemperaturesandincreasinghumidity),thatbenefitareasbeyondthescopeofaspecificproject(orjurisdiction)withmorestableprecipitationpatternsanddecreasedtemperatures,bothofwhichbenefitagriculturalactivitiesandpublichealth(Seymouretal.,2022).Thesebiophysicalpositiveexternalitiesarenotcurrentlypricedundermostcarboncredittradingsystems,largelyinpartduetotheirpublicgoodsnature,thusundervaluingforest-specific(Seymouretal.,2022).Forest-basedcarboncreditingisalsoapotentialdriverofnegativeexternalities.Forexample,somereforestationprojectsarecharacterizedbytreemonocroppingaffectingenvironmentalservicessuchasthehydrologicalcycleandpollinatordiversity.Anotherdimensiontoconsideristheterritorialdisenfranchisementforlocalactors.Policiesneedtoensurethatarapidexpansionofcarbonmarketsdoesnotresultinnegativeeffectsonland,labor,andecosystemservicemarkets.17Graphindicatestheproportionofinvestibleforestcarbonthatarefinanciallyviableforcarbonfinance.Shadingsaroundthelinesrepresentconfidencebandsbasedonstandarddeviation.FOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES22Oneofthelessunderstoodeffectsisapotentialincreaseinlandcompetitionwithimpactsonlivestockandagriculturalmarkets,includingrurallabormarketdynamics.Whilecarboncreditmarketsrepresentasignificantopportunitytoattractforeigndirectinvestment(FDI),increaseexports,anddecreaseorevenreverseforest-lossandecosystemdegradation,thereareotherpotentiallynegativeimpactsthatneedtobeassessed.Thereisevidenceontheemergenceofa“GreenDutchDisease”resultingfromtothesuddeninfluxofforeignexchangeinundevelopedruralmarkets.Inbroadterms,theseeffectsincludeissuesrelatedtocorruption,landconsolidation,andlandgrabbing.Ifnotproperlydesignedandimplemented,projectscanresultinmassdisplacementofindigenouspeoples,farmersandotherhistoricalinhabitantsofthelandinquestion.Onamacroeconomiclevel,aboomincarboncreditscanappreciatethecurrency,reducingtheincentivestoproduceothertradablegoods.Thiscannegativelyimpactagriculturalproduction.Somepreventivemeasuresareneededtoavoida“GreenDutchDisease”fromsettlingincountrieswithexpandingcarboncreditprojects.Whilecentralauthoritiesmaybetemptedtofocusontheenablingenvironmentforcarboncreditprojectsonissuessuchasregulatorylicensingandnormativeprocedures,andtheenforcementofpropertyrights,suchimprovementsarenotsufficient.Muchlikeitoccurswithrentsderivedfromnaturalresourceextractionincertaincountries,governmentsmaybetemptedtoextractrentfromtheissuanceandtransactionofcarboncredits,furtherentrenchingrent-seekingpatterns.Arobustdomesticmarketforcarboncreditscouldresultinagreaterportionoftotalrentstoremaindenominatedinthelocalcurrency,mitigatingsomeoftheconsequencesoftheDutchDisease.ImplicationsforLatinAmericaandSub-SaharanAfricaAccordingtotheanalysisbyKohetal.(2021),initiallyminorincreasesinnominalcarbonpricingcouldresultinlargeareasbecomingfinanciallyviableforforest-basedcarboncreditremovalprojectsinSouthAmericaandSub-SaharanAfrica(SSA).ThequestionisthenhowwillagriculturalcommodityvaluechainsandlandtenurepatternschangeIfcarbonpricesreachhighenoughlevelsinthenearfuture.LandproductivityinagriculturehaslargelygrowninLatinAmericaandSSAduetoincreasesintheuseoffertilizer,betterpracticesandgeneticmaterial,andgrowthintheuseofcapitalthatexpandedcultivatedareaperworker(Andrianarimanana&Yongjian,2021;Nin-Pratt,2015).Improvedgeneticvarieties,growthintheuseoffeedandefficiencygainshavealsoledincreasesinproductivityintheanimalstock(Nin-Pratt,2015).Consideringthecompetitivenesspressuresofcarbonpriceincreases,agriculturalandlivestockactivitiesincarbon-richareaswilleitherbeslowedorfullyhaltedoncefullpricetransmissiontakesplace.Productivityinland-andforest-basedcarboncreditprojectshasalsochanged.ForreductioncreditsassociatedwithREDD+,thetwomaindeterminantsare(i.)therateatwhichdeforestationandFOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES23degradationareoccurringand(ii.)thecarboncontentofthespecificareaandecosysteminquestion.Bothfactorsareexogenoustotheplanningandimplementationphasesoftheproject,thereforelimitingtheimpactofpolicyinterventionsinreduction-basedprojectsapartfromtheestablishmentofmoreefficientenforcementmechanisms.Endogenousfactorsthatdeterminethecompetitivenessofagriculture/livestockexpansionversusreduction-basedcarboncreditingprojectsarethereforelimitedtotechnologicalinnovationontheagriculture/livestockendofthespectrum,andimprovementsintheefficiencyofconservation/areaprotectionenforcementforREDD+projects.18Adifferentscenariocouldbeexperiencedunderjurisdictionalapproacheswheregovernmentscoulddevelopfiscalincentivessuchasconcessionalcredit,taxbreaks,subsidiesandotherregulatoryincentivesthatcouldaidincounterbalancingthetrade-offsmentionedabove.Removal-basedcarboncreditprojectsdiffersignificantlyfromreductionprojectsintermsoftheirdeterminantsofproductivity.UnlikeREDD+projects,removalprojectsarebasedonactivereforestation/afforestationofdeforested/non-forestedareas,resultinginproductivitydynamicsverymuchalikethoseofforestryandtimberoperations.However,unliketimberoperationswherevolumeandqualityofwoodarethefactorsoptimized,forest-basedremovalcarboncreditprojectstargetthevolumeofcapturedcarbonasthemainfactortobeoptimizedovertheproject’slifetime.Theefficiencyatwhichaprojectdevelopercancaptureandstorethelargestamountofcarbonintheshortestamountoftimewiththefewestnumberofresourcesbecomescrucial.Muchlikeinthecaseofagricultureandlivestock,determinantsofproductivitythatareendogenoustoanareaarethereforetechnicalinnature.TomaximizetheyieldoftCO2e/ha/year,projectdeveloperscaninvestini.improvedgeneticmaterialthatrequireslesscare,isdroughtandexcessrainresistant,andloweramountsofinputs;ii.improvedsoilmanagementandtreeplantingmechanismstooptimizesoilandvegetationcarboncaptureandstorage,andiii.technologybywhichtheprojectismonitored,verifiedandenforced.Theconsequencesofsuchdynamicssuggestthatimprovementsinenforcementarehighlyeffectiveinareaswheredeforestationisrampant.Asignificantchallengefacedbyproject-basedapproachesliesinthelackofincentivesandresourcesforgovernmentstoimproveenforcementcapacity,particularlyinsparselypopulatedandremoteareaswheretheruleoflawmaybenon-existent.Underconventionalcarbonmarketapproaches,governmentenforcementcapacityandappetitemayremainlacking,makingjurisdictionalapproachesattractivetoalignenforcementandresource-allocationactionswithREDD+activities.Inareaswheredeforestationhasalreadyoccurred,maximizingcarbonyieldsmakereforestationmoreefficient.18AnexampleofpotentialimprovementsinproductivityofREDD+projects,istheintroductionofsatelliteimagingtechnologytoidentifythreatareaswheredeforestationisstartingtotakeplacetobeabletotackleitatanearlystagewithfewernumberofresources.FOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES246.ProductivedevelopmentpoliciesTheadoptionandscale-upofnewtechnologiesthatreducecarbonemissionsisanewkeydomainofthegreenindustrialpolicy,whichentailstheadditionalobjective–vis-à-vistraditionalindustrialpolicy—ofprocuringenvironmentalsustainability(Johnstone,Roggea,etal.,2021).Themultiplemarketfailuresthatcausedeforestationandforestdegradationandpreventreforestationprovideaclearrationaleforanactiveroleofgovernment.TheinabilityofthemarkettoadequatelypricethenegativeexternalitiesassociatedwithGHGemissionsinthesesectorsliesatthecoreoftheproblem.Inthespecificcaseofforest-basedcarbonmarketsthemaingoalofgovernmentinterventionsisensuringthatthebenefitsassociatedwithconservationandclimate-friendlylandmanagementareadequatelyinternalized.Anumberofmarketfailuresposesignificantchallengesforeffectivesolutionstotheclimatecrisis.AsmentionedbySternandStiglitz(2021),insufficientinvestmentinR&Dandinnovation,andlackofaccesstolongtermcapitalcreatesignificantimpedimentstothespecificprojectsthatareconsistentwithnet-zeroemissions.Othermarketfailuresincludetheinabilitytointernalizetheco-benefits(includingair,waterandsoilpollution)ofinvestmentsthatreduceGHGemissions.Anumber,butnotall,ofthesegovernmentinterventionscanbegroupedintowhatcanbecalled“productivedevelopmentpolicies.”Afteryearsintheshadows,industrialpolicyisbackonthesceneasaninstrumenttoaddressclimatechange.Althoughthetermcanbemisleading–inpartbecauseindustrialproductionisanimportantcauseoftheclimatecrisis—,“productivedevelopmentpolicies,”“structuraltransformationpolicies,”or“innovationpolicies”arecertainlyacentralcomponentinthepolicymenutodevelopadynamicforest-basedcarbonmarket.Privateactorsunderestimatepotentialreturnstonewclimate-friendlytechnologies,sounderinvestmenttendstooccurintheabsenceofboldgovernmentaction.Policyinstrumentsincludede-riskingprojects.Onewaytodothisisensuringinitialdemandforcarboncreditsthroughdomesticoff-takers(whichcouldbeSOEs).Taxdeductionsandcreditsonsponsorsofprojectscanbehelpful,aswellasspendingoneducationandjobtrainingintheskillsneededtodevelopthismarket.Directbudgetsupportforequityinvestmentsandlendingfromdomesticdevelopmentbankscanbecriticalbyprovidingpatientcapitaltosupport“mission-oriented”innovationandinvestment(MazzucatoandPenna,2016;Detter,Fölster,andRyan-Collins,2020).However,itisnecessarytobestowthesenewpolicyinstrumentswithframeworkstomonitorandassessfiscalrisks,aswellasthebestgovernancepracticesforstate-ledinnovationpolicy(AigingerandRodrik,2020;CherifandHasanov,2019;IMF,2021).Somespecificexamplesofwhatneedstobedoneinclude:i.Developthedomesticsupplyofcarbon-specificskilledworkers.ii.Improvetheefficiencyofmeasurement,verification,andenforcementmechanisms.FOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES25iii.Promoteprivateormixedownershipofenterprisesthatprovideservicestotheproduction,issuance,andtransactionofcarboncredits.iv.Encouragethedevelopmentofalocalmarketforcarboncredits,includingaroleforSOEsasinitialoff-takers(domesticbuyersofcarboncredits)forproject-levelapproaches,ornationaland/orsubnationalgovernmentsinthecaseofnestedapproaches.v.Encouragetheverticalintegrationandthenetworkeffectsbetweendifferentprovidersofservicesthatarepartofthevaluechainincarboncredits,whetherthroughproject-basedmechanisms,jurisdictionalapproaches,ornestedmechanisms.vi.Provideincomesecurityandpreventthedisplacementofjobsforgroupsofthepopulationthatcouldbeimpactedbythetransformationofagriculture/livestockactivitiesintoland-intensivecarboncreditprojects.TheneedofeffectivePDPsshouldnotminimizetheimportanceofgoodgovernanceforaneffectivedeploymentofclimatemitigationactivities.Griscometal.(2020)considertherelevanceofWorldwideGovernanceIndicatorstoconcludethatahandfulofcountries(i.e.,Indonesia,Brazil,India,Malaysia,Mexico,andColombia)thathavehighergovernanceindicators(amongcountrieswithtropicalforests),andstrongtointermediatefinancialcapacity(costofimplementationofnaturalclimatesolutionsasashareofGDPislower)andwherethereisalsopoliticalwill(reflectedinambitiousNationallyDeterminedContributions)areinanuniquepositiontolead(withinternationalco-financing)intheimplementationofnaturalclimatesolutions.EstablishmentofNationalCarbonFederationsThecontinuousindustrializationofforest-basedcarbonmarketsislikelytoamplifythevolumeanddepthoftheemergingsocio-economicandenvironmentalchallengesdescribedabove.19Thesechallengeswhilenewinoriginarenotnewinscopeandresemblethoseofindustrializedagri-foodsystems.Challengessharedbyagri-foodandforest-basedcarbonvaluechainsinclude:i.Producerstakingtheshortendofthestick:Opportunisticbehaviorinverticalmarketrelationshipswherehighvalue-addedactivitiesonbothendsofthevaluechain(R&Dintheupstreamandretailandmarketinginthedownstream)resultinaninequitabledistributionofincomeandprofits.ii.Landandcommunitygovernancesystemsnotalignedwithmarketincentives:Farmersandsmall-scaleforest-basedcarbon“producers”(indigenouscommunities,peasants,andSMEs)oftengovernlandanditsusesthroughparticipatory,collective,andhighlydecentralizedprocessesthatpreventtheutilizationofeconomiesofscaletorapidlyimprovethequantity19Industrializationinthiscontextcanbedefinedasa“particularwayoforganizingproductionassumingthereisaconstantprocessoftechnicalandsocialchangewhichcontinuallyincreasessociety’scapacitytoproduceawiderangeofgoods[andservices]”(Hewitt&Wield,1992).FOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES26and/orqualityofthecommoditybeingproduced(agri-commoditiesorcarboncredits)makingthemlesscompetitive.Thiscouldresultintheirdisplacementinfavoroflargescaleandconsolidatedprivateoperationsthatcanactmoreexpeditiouslytomeetdemandatlowercosts.iii.Exploitationofinformationalasymmetries:Muchlikeinthecaseofspecialtyagri-foodcommodities(e.g.,coffeeandcacao),farm-gatebuyersandofftakersmayexploitaproducer’sabsenceoftechnicalexpertiseonthequalityand/orimplicationsofadealtounfairlynegotiatethetermsofatransaction.Acoffeefarmermaynotknowtheyholdhighqualitycoffeeandthussellatbelowmarket-pricelevelsmuchlikeanindigenouscommunitymaynotknowthefullextentofthevalueoftheiractivitiesinaREDD+project.Lackingregulationandgovernmentoversightincontractnegotiationandenforcementmayalsoopenthedoorforfraud.iv.Inequitabledistributionofrisk:Highpricevolatilityandrapidlyevolvingregulatoryenvironments(e.g.,newrequirementsbytheEuropeanUnionfordeforestation-freecoffeeproduction(Regulation(EU)2023/1115,2023);evolvingETSregulationworldwide),resultsinproducersfacinghighprice,financialandregulatoryrisk.Thebusinesscharacteristicsofprojectintermediariessuchashightradingvolumes,wideaccesstodiversemarketsandaccesstofinancingprovidethemwithriskhedgingandmanagementmechanismsthatremainunavailableforhighlydisaggregatedproducers.v.Socialandenvironmentalprotectionleakage:Socialandenvironmentalsafeguardstandardsarehighlyheterogenousinscopedependingonthespecificcertificationbeingusedtomarketagri-foodcommoditiesandcarboncredits(e.g.,RainforestAllianceversusSmithsonianBirdFriendlyforcoffeeandVCSversusTREESforcarboncredits).Thisheterogeneityisfurthercomplicatedbynon-specializedmarketsthatdonotdemandhighqualitycommoditiesandcredits.Differingmarketpreferencesandabsentordeficientregulatorystandardsinbothvoluntaryandcompliancecarbonmarkets,muchlikeinagri-foodcommoditymarkets,mayresultin“socialandenvironmentalprotection”leakageasaportionofproducedcreditsdonotmeetstrictsocialcriteria(e.g.,priorconsultationandequitablebenefitsharing)andenvironmentalcriteria(e.g.conservationofbiodiversity).Agriculturalcooperativesemergedinthelate1800sasaformofverticalintegrationto,amongotherthings,internalizethecostsofopportunisticbehaviorinverticalrelationships(FultonandGiannakas,2013).Toachievethis,agriculturalcooperativesformuser-ownedandmanagedbusinessestoprovideservicessuchasmarketaccess,cropprocessingandproductionsupplyandservicesprocurement,includingcreditandfinancialservicesinthecaseoffinancialcooperatives.Thismodel,whileimperfect,hascontributedtoaddressbargainingpowerimbalancesbetweenbuyersandfarmers,accesstofinance,technicalassistanceprovision,educationandaccesstomarketandweatherinformation.Thismodelmayserveasinspirationtotacklethechallengesfacedbytropicalforestcountriesinneedofforest-carbonindustrialpolicy.FOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES27ThecreationofCarbonFederationsasnational-levelcooperativesaggregatingsmall-scale“forestcarbon”producerssuchasindigenouscommunities,peasantorganizations,ruralandsmall-scalemunicipalitiescouldserveasamechanismtounlockthebenefitsof“industrialized”carbonmarketsforcommunitiesandstakeholderswhoarelikelytobeoverlookedbybroaderpolicyprocessesgearedatcreatingmoreliquid,efficientandtransparentcarbonmarkets.CarbonFederationscouldbeinchargeof:i.Providingcontext-basedtechnicalassistance:Scalingthedeliveryoftechnicalassistanceprovisionformemberstooptimizecarbonandnature-basedprocessesintheirareaofinfluencewhileaddressingpotentialcompetinginterests(e.g.,agricultureandinfrastructuredevelopment).Federationscouldcomprehensivelyassessanareaanddeveloplandmanagementplanswithmembersthatgobeyondtheoptimizationofcarboncreditproductionandaddressthecomplexitiesofmanagingdiverselandscapesfromanecologicalandsocio-economicperspective.Additionally,technicalassistanceprovisionandadvicecouldprovideeconomyofscalesavingsformembersthatmayotherwisebeprohibitivelyexpensiveifprocuredonapiecemealbasis.ii.Meetingregulatoryandvoluntarystandardsatscale:Intermediarieswhodevelopcarbonprojectsareofteninchargeofprocuringqualityverificationprocesseswhilemeetingtheirunderlyingrequirements.AFederationcouldreplacetheroleofexternalintermediariesandmakethisprocessendogenoustotheultimatebeneficiariesofcarbontransactions.Duetotheirpotentiallylargescale,Federationscoulddevelopthenecessarytechnicalcapacityandverificationdemandvolumethatwouldplacethemasactorsabletoengageinthesehighlycomplexprocesses.iii.Improvingbargainingpower:Byaggregatingsupplyfromcarbon“producers,”Federationscouldaccessbothprimaryandsecondarycarbonmarketsatscale,eliminatingtheneedforintermediariesbringingproducersclosertolocalandinternationalmarketsoftenfoundfurtherdownstream.ThescaleofFederationsandthevolumeofcreditstheygenerateandtransactwouldprovidethemwithimprovedbargainingpowerinnegotiatingover-the-countertransactionswithlocalandinternationalcounterparts,whilepoliticallyitwouldgive“voice”totheconcernsandinterestsofproducersindevelopingregulationbydefininglegitimateinterlocutorsthatrepresentwidemembershipbases.iv.Providingriskmanagementfacilitiesforproducers:Theestablishmentofpricestabilizationfunds,factoringtoaddressliquidityconcernsofcarbontransactions,theacquisitionofexchangerateriskmanagementproducts,andprovidingintelligencesurroundingupcomingregulatorychangescouldallbemechanismsusedbyFederationstoextendriskmanagementsupportformembers.v.Channelingincentivesandaccesstofinanceatscale:Thedevelopmentofcarbonmarketsisincreasinglycallingforthearticulationoffiscalincentives(e.g.,taxcreditsfororganizationsmitigatingemissions)withthescaling-upofcreditandfinancialservicesprovision.FOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES28Federationscouldserveasthecentralentitytochannelthoseincentivestomembersandbuildapipelineandportfoliosofbankableprojectsthatwouldotherwisebedeemed“tosmall”forfinancialinstitutionstoconsider.Inessence,CarbonFederationswouldallowsmall-scalecarbon“producers”toaccessthemarketopportunitiesandbenefitscurrentlyonlyavailableforlarge-scaleandsophisticatedintermediaries,allowingacertainlevelofverticalintegrationthatwouldpromotebothsocialandeconomicequitybybringingproducersclosertomarketsandpolicy-makingprocesses.CarbonFederationcanalsodealwithissuesofcoordinationfailures,pervasiveinthedevelopmentofnewmarkets.Efficient,transparent,anddemocraticgovernanceschemeswillbefundamentalforCarbonFederationstoachievetheabovewhilegainingandmaintaininglegitimacyforitsmembers.Learningfromthefailuresofmorethan150yearsofagriculturalcooperativeswillbekeytodevelopsystemsoftrustthattranslateintoconcretesocio-economicandecologicalbenefitsforthecommunitiesCarbonFederationswouldrepresent.CarbonFederationscouldserveaspartofimplementingentitiesofnestedandjurisdictionalREDD+approacheswhendealingwithhighlyrural,disaggregated,anddiverselandscapes.TheestablishmentofCarbonFederationsoffersaviablemechanismforaddressingtheinherentchallengesinindustrializedforest-basedcarbonmarkets,drawinginspirationfromthesuccessesandlessonsofagriculturalcooperatives.Throughstrategicverticalintegration,thesefederationscoulddemocratizemarketaccess,enhancebargainingpower,andimplementriskmanagementforsmall-scaleproducers,therebyfosteringsocialandeconomicequity.7.ConclusionsThedevelopmentofforest-basedcarbonmarketsisincreasinglyseenasasignificantopportunityfordevelopingcountries.Thisisspeciallythecaseofcountrieswheretheworld’stropicalforestsarelocatedinAfrica,LatinAmericaandtheAsia-Pacific.Estimatesindicatethatunderahighcarbonpricesscenario,thevalueoftheforest-basedcarboncreditmarketcouldincreasefromUS$1.3billionin2021(Donofrioetal.,2022)toUS$25billionperyearby2030(McKinsey,2021).Thesearenotsmallnumbers,comparedtoothersourcesofexportrevenue.However,toachievethisoutcomeamoreliquid,deep,andtransparentmarketforcarboncreditsmustbedeveloped,andanumberofbarriersthatgeneratesignificanttransactioncostsmustbeovercome.Governmentsinterestedinexploitingtheseopportunitiesneedtoactivelyengageinindustrialpoliciesinordertodevelopthevariouscomponentsofacomplexvaluechain,thatrequireslabortraining,technologicaldevelopments,accesstolongtermcapital,someofwhichmaybeachievedthroughtheestablishmentofNationalCarbonFederations.LargeSOEs(andespeciallyFOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES29NationalOilCompanies)needtobeengagedintheseactivities,includingasoff-takersofthecarboncreditsfortheirowncarbonemissionsreductiontargets.Forestbasedcarbonmarketsalsohavepitfallsthatmustbeavoided.Withouttherightinstitutionsinplace,atthenationalandlocallevel,forestprojectstoavoidorabateemissionscangeneratenegativeexternalities,suchaspopulationdisplacement,increasesinfoodprices,theerosionofbiodiversity,andpotentiallynegativeeffectsonindigenousandriverinecommunities.Also,otherresourcecurseeffects,suchascorruptionandthenegativeimpactontheproductionofothertradeablegoods,mustbeavoided.Similartooilandmining,carboncreditscouldfloodtheeconomywithcash.ToavoidaDutch-diseaseeffect,inadditiontoindustrialpoliciesitwillbenecessarytoinvestininstitutionssuchasCarbonFederationsthatpreventconflict,ensureadequatesavingsoftheadditionalincome,enforceruleoflaw,andstrengthendemocraticgovernance.Thismeansanactiveroleforpublic-privatepartnerships,includingadequateformsoftaxationfromthisincomeinordertoprovidekeypublicgoods,indispensableforthesuccessfuldevelopmentofcarbonmarkets.FOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES30AnnexFIGUREA1.Compositionofcompliancemarket,byregionCompliancecarbonmarketvalue(USDbillion)1,000China,SKandNZ1Compliance850968950NorthAmerica(WCIandRGGI)2carbonmarkets54900UKETS355708503222652800EUETS292750Worldwide47648417002916502082682020202120226002018252Year55050024245040020193503000Notes:1.SKandNZrefertotheSouthKoreaandNewZealandETSs.2.WCIreferstotheWesternClimateInitiativeanon-profitcorporationwhichadministersthesharedemissionstradingmarketbetweentheAmericanstateofCaliforniaandtheCanadianprovinceofQuebecaswellasseparatelyadministeringtheindividualemissionstradingsystemsintheCanadianprovinceofNovaScotiaandAmericanstateofWashington.RGGIreferstotheRegionalGreenhouseGasInitiative,apower-sectorETScomprising12statesintheUnitedStates.3.TheUKETSbeganoperatingin2021.4.Thereisnodisaggregateddatabymarketsegmentfortheyear2018.Source:AuthorsbasedonavailabledatafromRefinitiv(2022)fortheperiod2018–2022forworldcompliancemarkets,Donofrioetal.(2022)fortheperiod2018–2021forworldvoluntarymarkets,andTroveResearch(2022)for2022forecastsinworldvoluntarymarkets.Maguireetal.(2021)forcomplianceandvoluntaryforest-specificcarbonmarketsfortheperiod2017–2019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tyofInternationalandPublicAffairsatColumbiaUniversity,andDirectoroftheMPAinGlobalLeadership.HeisalsoGlobalSeniorResearchFellowatColumbia’sCenteronGlobalEnergyPolicywhereheconductsresearchonenergyandclimatepolicy.DuringtheadministrationofJuanManuelSantos,Dr.CárdenaswasColombia’senergyminister2011–2012andfinanceminister2012–2018.HewaschosenbyEuromoneyasfinanceministeroftheyearin2015.Heservedinthreeothercabinetpositionsinpreviousgovernments(EconomicDevelopment,Transport,andPlanning).HehasbeentwiceexecutivedirectorofFedesarrollo,Colombia’sleadingpolicyresearchcenter,andSeniorFellowandDirectoroftheLatinAmericaInitiativeattheBrookingsInstitution.HeisalsoaDistinguishedFellowattheCenterforGlobalDevelopmentinWashingtonD.C.HewasamemberoftheWHOIndependentPanelforPandemicPreparednessandResponse(2020–2021),co-chairoftheTaskforceonCarbonPricingandNetZero(2021),andChairofthe‘DoingBusiness’ExternalReviewPanel(2021).HeholdsaPh.D.inEconomicsfromtheUniversityofCalifornia,Berkeley.HeisalsoaformerpresidentoftheBoardofGovernorsoftheIMFandtheWorldBank(2016)andoftheLatinAmericanandCaribbeanEconomicAssociation(LACEA).Heregularlywritesop-edsinElTiempo,ProjectSyndicateandAmericasQuarterly.JuanJoséGuzmánAyalaiscurrentlypolicyandfinanceadvisorattheAtlanticCouncil’sAdrienneArsht-RockefellerFoundationResilienceCenterinWashingtonD.C.,whereheleadsthedevelopmentofinnovativefinancialstructurestoforwardadaptationeffortsanddeliverresiliencyforvulnerablepeoplestofacetheclimatecrisis.ForthepastsixyearsJuanJoséhasbeenworkingattheintersectionofhumanwellbeing,economicpolicy,andclimatefinancewithafocusonGlobalSouthcountries.Afterashortstintininvestmentbanking,hejoinedISFAdvisors,wherehesupportedthedevelopmentofinnovativeblendedfinancestructuresforagricommoditiesbenefittingsmallholderfarmersandSMEsinlow-andmiddle-incomeeconomies.AtTransforma,aColombia-basedthinktank,heco-ledthedevelopmentofthecountry’sfirstclimate-relatedfinancialriskdisclosureinitiative,aswellastheLatinAmericadeskoftheInternationalClimatePoliticsHubwhereheworkedonissuessuchastheBridgetownInitiative,forest-basedcarbonmarkets,andjustenergytransitionpolicy.Hehassincesupportedvariousgovernments,NGOs,financialinstitutions,indigenousandpeasantorganizations,andprivatecorporationsonthedevelopmentoffinancialclimate-andnature-basedriskanalyses,andESGfinanceandclimatediplomacystrategies,inColombiaandtheUnitedStates.FOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES36JuanJoséholdsaB.A.inEconomicsandSustainableDevelopmentfromColumbiaUniversityandiscurrentlycompletingadualmaster’sinpublicadministration,andpublichealth,atthesameuniversity,wherehealsoservesasaPlanetaryHealthAmbassadorforthePlanetaryHealthAlliance.FOREST-BASEDCARBONMARKETS:PITFALLSANDOPPORTUNITIES37

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