In 2021, world leaders from countries that contain close to 85% of the world’s forests agreed to end net deforestation by 2030. Halting deforestation is critical to meeting the 2050 net zero targets because when forests are cut down, vast quantities of carbon are released, while the carbon sequestration potential is lost.
There is no pathway to limit global warming to 1.5°C without immediate action to halt deforestation. However, to be on course for 2030, deforestation rates needs to decline by 10% per year, every year.
Unfortunately, the value we currently place on tropical forests in particular, is far too low if we want to protect them from deforestation.
A recent report by the Energy Transitions Commission (ETC) suggests that payments to protect the frontier of tropical forests from being cleared and releasing carbon into the atmosphere, will need to rise by at least 50-fold per year compared with current funding arrangements. However, once you take full account of the opportunity cost of the land to those who would look to exploit it for commodities and other uses, payments will need to rise at least 400-fold per year.1
Commodities are the primary driver of deforestation in the tropical rainforests of Latin America and South East Asia. It typically involves the permanent conversion of forests to graze cattle or to grow oilseeds such as soy and palm oil. In contrast, shifting agriculture is the main cause of deforestation in West African tropical forests. This latter process involves the clearing of forest for agriculture, often by smallholder farming, before it is then temporarily abandoned.
Although some governments have succeeded in implementing measures protecting vulnerable parts of their tropical forest from economic development, via effective monitoring and enforcement of anti-deforestation laws, for the most part this has only been achieved to a very limited degree.
In the absence of adequate protection by the state, another way to deal with deforestation is to tackle the underlying incentives, enabling landowners and other agents to put a value on the forest and the embedded carbon. This means they can then make an informed decision as to the economic value of cutting down the forest to grow crops and graze cattle, versus the value of maintaining the forests in-situ.
The opportunity cost of not deforesting will vary significantly depending on the attractiveness of the local soil and climatic conditions, the input and supply chain costs required to extract the commodities and access to the end market (e.g. labour, transport, storage, regulatory enforcement), and finally, the type of commodities produced and the price they can be sold at.
The marginal cost of avoiding deforestation is ~$35 per tonne of CO2, according to estimates by Vertree. Their analysis is based on the cost of producing and selling deforestation linked commodities in over 50 tropical forest countries, including Brazil, Indonesia, Malaysia, and the Democratic Republic of Congo. This tallies with other research published in 2019 that calculated the average opportunity cost of avoided oil palm expansion in Indonesia at $27.74 per tonne of CO2 (see Nature-based carbon credit prices need to rise: High commodity prices increase the incentive to clear forests and plant crops).
Compensation to landowners to avoid deforestation is significantly less than $5 per tonne CO2 based on the Nature-Based Global Emissions Offset (N-GEO) futures contract price. Meanwhile, price assessments by Trove Research analysing both exchange and OTC trades suggest the weighted average REDD+ price was around $8 per tonne CO2 in late Q1 2023, down from $14 per tonne CO2 in early 2022.
Whichever way you price it, the economic case for deforestation is well in the money.
In theory at least, if the carbon price equals the marginal cost of avoiding deforestation then the landowner would be indifferent between deforesting to produce commodities, and keeping the forest standing and generating carbon credit payments. However, merely being indifferent to cutting down the forest or not is unlikely to be a sufficient condition to persuade farmers and ranchers to refrain from doing so.
There may be large sunk costs involved - managing a large herd of cattle, investments in farm equipment, providing employment to a local community - that means walking away is a much more difficult decision than simply deciding which option pays the most. In other areas property rights may be disputed or non-existent, providing people with very little incentive to preserve the forest for the long-term. Expectations matter too, and while they may be use to the inherent volatility in commodity markets, carbon credit markets are unlikely to be as familiar. What guarantees are there that demand for, and payments towards, the protection of the forest will still be forthcoming many years into the future? These are just some of the factors which suggest that payments to avoid deforestation need to be much higher than the marginal cost, and give landowners significantly greater long term certainty
However, the cost of compensating farmers and ranchers for not exploiting the forest could go much higher still. As more forested land is protected that means there is less land available to be used for growing crops and grazing cattle. All else being equal, more restrictions on the available supply of land is likely to mean higher prices for agricultural commodities - and so carbon credit prices will need to rise to compensate. But there’s no guarantee the market will find a stable equilibrium at this higher level. Further scarcity could result in even higher agricultural commodity prices, necessitating another jump in carbon credit prices. And we haven’t even mentioned rising demand yet. As the global population expands and incomes rise, demand for high protein diets tend to rise, increasing the pressure on the available land (see Natural capital markets: Putting a price on nature).
This assumes that the forested land covered by a REDD+ project is actually protected from deforestation. The more remote the location, the more corrupt the country in which the forest is located, and the wider the spread between the marginal cost of avoided deforestation and the carbon price, the higher the incentive there is to renege on protecting the forest. For example, say there is a change of government resulting in less environmental enforcement, coupled with a jump in the price of soy. Those are the ideal conditions for a landowner to chance their luck and clear the forest (The signal and the noise: Pricing the carbon credit risk curve).
There has been plenty of negative publicity recently towards REDD+ credits in particular. Despite some of the criticisms being levelled at forest protection credits being unwarranted, this analysis does suggest that without a much higher carbon price there will always be a risk that the project fails to deliver its objectives. A higher price will mean there are more funds that can be used to monitor and guard the protected area from damage.
How much is this all going to cost, and are we anywhere near providing enough finance to dissuade landowners from clearing the forest? An alternative to directly seeking to protect the entire forest is to focus on the frontier - the edge of the forest, close to roads and other transport links, and so more desirable from an economic perspective. If you protect the frontier then so the argument goes, the economics of exploiting the interior become much more difficult to stack up. The frontier is estimated to include around 20% of the remaining tropical forest, based on satellite imagery analysis undertaken by the Food and Land Use Coalition.
The ETC estimate that 215 Gt CO2 is stored within this frontier, and therefore at heightened risk of being released into the atmosphere should it be developed. If preventing 215 GtCO2 emissions costs a minimum of $35 per tonne CO2 (recall it could well be some way north of this in reality), this implies annual payments of $0.9-$1.0 trillion between now and 2030. To put that into context, in 2022, energy transition investment exceeded $1.1 trillion for the first time.2
How much are we paying right now? Financing via REDD+ credits in voluntary carbon markets was around $500m in 2022 according to Trove Research. Overall domestic and international mitigation finance for forests (which includes REDD+) is estimated to be $2.3 billion per year, according to the latest Forest Declaration Assessment.3
The ETC suggest that payments to protect forest from being cleared and releasing carbon into the atmosphere need to rise at least 50-fold per year, however that is based on a very conservative $5 per tonne CO2. In reality, payments will need to rise by at least 400 times current levels if they are going to persuade people not to exploit the forest.
In addition to the REDD+ carbon credits purchased by corporates looking to offset some of their carbon emissions, a number of countries have, or are in the process of developing, sovereign carbon credits linked to the protection of their forests - for example Guyana and Gabon (see Green and black AND The big sovereign carbon trade).
Another option that some governments are exploring is sustainability-linked bond issuance. For example, Uruguay issued $1.5 billion in bonds tied to a number of sustainability goals including deforestation. The bond includes a 0.15% percentage point coupon that makes its debt cheaper if the goals were achieved.4
Ultimately, whichever way it is packaged, it is very unlikely that carbon finance alone will be sufficient to protect the tropical forest frontier; even if it was politically viable to direct that much money, rely on it being deployed effectively in some of the remotest regions on Earth, and be safe in the knowledge that it doesn’t have any unintended consequences.
In order to really tackle deforestation we will also need a much more transparent supply chain, while also ensuring that those commodities that cause the most damage - beef demand accounts for 40% of deforestation in tropical forests - are priced to bear a much higher share of the negative externality.
Either way, the price we pay to protect tropical forests from deforestation must rise.
https://www.energy-transitions.org/wp-content/uploads/2023/04/ETC_FinancingtheTransition_DeforestationAnnex_vf.pdf
https://about.bnef.com/blog/energy-transitions-new-industrial-landscape/
https://forestdeclaration.org/wp-content/uploads/2022/10/2022ForestDeclarationAssessment.pdf
https://www.ft.com/content/d53e4de1-bf87-4424-a3cd-8ad03680bbdb