The IPCC’s recent AR6 Synthesis Report, published in March 2023, caught our attention.
According to the study, of all the solutions available today to reduce net emissions by 2030, “reduced conversion of forests and other ecosystems” ranks second only to solar energy.
Combined with ecosystem restoration, afforestation & reforestation, and improved sustainable forest management, forest carbon can potentially remove almost eight gigatons of carbon dioxide per year (GtO2-eq) from the atmosphere.
At Pachama, we find this insight encouraging. According to the United States Environmental Protection Agency, land use change is the second leading source of carbon emissions after fossil fuels. With proper management, we can reverse the trend and convert forests into our most powerful carbon removal technology.
There is, however, a catch: to achieve planetary stabilization through forest carbon activities, we must price forest carbon credits correctly to incentivize conservation and reforestation as competitive land uses.
Specifically, according to the same IPCC report, credits must be priced between $50 and $200 per ton for forest carbon activities to achieve their environmental potential. In what follows, we’ll dive into why forest carbon must be priced higher than it is currently.
First, though, let’s look beyond the economics to consider why we should conserve and restore forests.
Why are Forests Our Most Effective Carbon Removal Technology?
When considering forests as a carbon removal solution, some may quickly conclude that trees, the main stake component of forests, are a flawed technology.
After all, while some trees can last thousands of years, the argument goes, most trees live up to 100 years before dying and releasing stored carbon back into the atmosphere. If we’re to create a permanent solution to climate change, aren’t trees a stopgap measure?
To answer this question, we need to, ahem, see the forest for the trees.
While trees may be temporary, forests are permanent; indeed, they have been extracting and storing carbon from the atmosphere for millennia because the regenerative nature of forest ecosystems allows carbon to be recycled through plant growth and development.
The Amazon rainforest, for example, is approximately 55 million years old. The Congo Basin is estimated to be around 100 million years old. Though their trees grow and die, the forest ecosystem, when left alone, continues to draw additional carbon out of the atmosphere.
Speaking to this point, the CEO of Terraformation, Yishan Wong eloquently states, “while trees alone don’t necessarily offer a durable carbon drawdown solution, forests do.”
As Wong notes, only a small portion of their carbon is released back into the atmosphere when trees die. Instead, carbon returns to the earth when their fallen trunks feed the soil and the microbial ecosystems that help make forests thrive. Their seeds give way to new trees, and their absence allows sunlight to breach the forest canopy and nurture saplings.
Though often portrayed as the benefactor of healthy forests, biodiversity, including wildlife, increases the forest’s ability to remove and store carbon.
As a recent study in the journal Nature Climate Change points out, when multiple species of animals thrive in an ecosystem and are allowed to forage, burrow, and trample, they increase the ecosystem’s ability to sequester carbon by 250%. By distributing seeds, decomposing, and ensuring the ecological balance of an ecosystem, biodiversity not only benefits from healthy forests; it also contributes to the forest’s ability to sequester carbon.
Unlike many of the other carbon removal solutions, forests are ready to scale today at a relatively low cost, and there are reasons to be optimistic that the conditions exist to harness their full potential.
Theoretically, the world can bring about massive reforestation without encroaching on agricultural land. A recent study calculated that almost a billion hectares of degraded land worldwide is unsuitable for agriculture that, if restored through tree planting, could remove over 200 gigatons of carbon. This is the equivalent of 2/3rds of carbon emissions released into the atmosphere since the Industrial Revolution.
What’s more, according to research undertaken by the United Nations, the planet may have achieved peak pasture, meaning the amount of land dedicated to animal grazing is decreasing, primarily due to productivity gains.
Even with these conditions, however, our potential to extract maximum impact from forest carbon activities is limited by the price buyers pay for credits since the correct price either inhibits or facilitates the growth of the conservation and reforestation industry. So how much should a forest carbon credit cost?
How Much Should a Forest Carbon Credit Cost?
Determining how much a carbon credit should cost is a complex question whose answer has significant ripple effects on the economy and the planet.
If prices for forest carbon credits are too low, project developers looking to bring new high-quality forest carbon projects to market will struggle to compete with other land uses, like agricultural or commercial development.
In a race-to-the-bottom pricing scenario, credits would ultimately be derived from a few specific geographical locations where economic conditions allow for low price points. In a world where funding flows to just a few select regions, we’d limit the secondary benefits that create well-paying jobs for rural communities and protect critical, endangered species.
On the other hand, if prices for forest carbon credits are too high, their impact may become more limited.
Without a suitable price point, many corporates will opt out of purchasing reforestation credits, and these critical projects won’t get the funding they need to get off the ground.
The right price point for carbon credits incentivizes high-quality carbon removal worldwide. To begin to analyze the right price point for forest carbon projects, we need to evaluate both opportunity and operational costs.
For example, as previously mentioned, forest carbon projects must compete with other land use cases; as such, carbon credits’ price must be competitive for reforestation to become an economically viable alternative to agriculture, residential and commercial development, etc.
Herein lies the challenge: competing with activities like agriculture can be complicated by government subsidies, which are ostensibly designed to keep food prices low and/or protect food security. For better or worse, agricultural subsidies distort the agricultural and land-use markets.
So what carbon price is required for forest carbon to compete with agriculture?
According to a report by Credit Suisse, at a price of USD $50 per ton, many US farmers can break even from forest carbon credit revenue in 2 to 3 years. For EU farmers, that break-even point increases to 6 to 7 years.
To provide farmers with a financial incentive to switch from farming to forestry carbon projects within a reasonable amount of time, carbon prices must increase.
After considering the opportunity cost, we must ask how much it costs to remove an equivalent metric ton of carbon dioxide from the atmosphere.
To understand the operational costs associated with active reforestation projects, we at Pachama sourced data from projects across the Americas.
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To inform our analysis, Pachama has gathered data across hundreds of projects from project developers primarily concentrated in North and South America. With data in hand, we were able to develop an understanding of what costs project developers incur and what percentage of the overall project budget each represents.
While many factors influence the cost required to produce a high-quality carbon credit from an active reforestation project, two of the most influential are: credit yield, or the carbon sequestered annually by the newly planted vegetation, and the form of land ownership.
Fluctuations in these two factors drive a wide range in costs, as illustrated in the table below:
In our analysis, we broke costs down into three key categories:
- Landowner relationship: The cost of purchasing land or paying landowners for land use may vary between geographies and depend on the potential credit yield, which in turn depends on factors such as forest type and tree survival rate. Either purchased land or repurposed land may also have to acquire a permanent easement to ensure the long-term durability of the project.
- Initial costs: Across geographies, project developers must invest in initial costs such as tree planting (purchasing quality seedlings from nurseries and planting the trees), data acquisition, registration, verification, and legal and marketing costs.
- Ongoing costs: Over the lifetime of a project, developers also have to maintain the project to mitigate risks, optimize tree survival rates, and pay for periodic verification. Ongoing costs include a few cost categories required to generate high-quality carbon credits:
- Technology costs: Includes LiDAR data, field plots, cloud computing costs, etc., required to build higher precision forest growth and sequestration models.
- Financing costs: Project developers may seek third-party financing because of the high upfront costs for land and/or implementation. These financiers often require a return on investment in the high single digits to low teens.
- Project developer overhead: Includes shared overhead costs required to pay project development staff and market projects. Project developer costs may vary, considering that some forest carbon projects are undertaken by non-profits or public-benefit corporations and others by for-profit entities.
Based on our findings, we’ve developed a sample cost structure for a 2,500-hectare active reforestation project.
In our sample cost structure model for an active reforestation project, the upfront land costs are significant: 33 – 49% of the total lifetime cost.
Combined with the initial costs required to initiate tree planting and qualify for registry issuance, the first five years of a project incur 67 – 75% of the project’s lifetime cost, yet issuance and revenue only activate after the first issuance event, which can occur 5-7 years after tree planting.
Geography, we should note, not only affects the cost structure through the cost of land acquisition as well as the cost of labor but also plays a role in tree survival rate and hence future credit yields.
In addition, different types of forests that are found in different altitudes and climates also generate different credit yields. Also, certain jurisdictions may require landowners to conserve a certain percentage of their land as natural forest, thus affecting the project’s overall additionality calculation.
Based on this bottom-up analysis of more than 150 project developer business plans across multiple geographies, we at Pachama believe that the average price for an active reforestation carbon credit from upcoming 2023 vintages should be between $50 and $82 tCO2e.
Why is now the time to invest?
With this data in hand, the IPCC’s cited price range of between $100-$200 tCO2e for forest carbon activities makes sense if we are to scale from the planet’s current capacity of 2.4 gigatons of carbon dioxide removal through forests to well over eight gigatons. Moreover, Pachama’s predicted price range of $50-$82 represents a bargain for those clients considering long-term procurement of credits as part of their net-zero strategy.
A higher price for forest carbon credits creates economic incentives by allowing forest carbon activities to compete with subsidized agriculture and makes the space more attractive to investors willing to help project developers cover their initial costs. It goes without saying that more investors entering the space results in more competitive financial conditions, a win-win that can provide a major boost for the industry.
Of course, price alone will not make forest carbon a thriving industry, as price must also reflect the integrity, openness, transparency, and durability of forest carbon projects.
The best way for leading companies to restore nature at scale is to support the creation of new high-quality projects, and consider innovative financial models, such as investing in Origination, to help put the wheels in motion. The time to act is now. The time to invest is now.
