Alternative Approaches to Addressing the Risk of Non-permanence in LULUCF Activities

1. Alternative Approaches to Addressing the Risk of Non-permanence in LULUCF Activities

2. Context The Subsidiary Body for Scientific and Technological Advice to initiate a work programme to consider and, as appropriate, develop and recommend modalities and procedures for alternative approaches to addressing the risk of non-permanence under the clean development mechanism with a view to forwarding a draft decision on this matter to the Conference of the Parties …; Decision 2/CMP.7 Land use, land-use change and forestry.

3. Analytical work • In response to the decision.2/CMP.7, BioCarbon Fund in September 2011 initiated analytical work on the topic in collaboration with Duke University, USA • Two expert workshops were organized in Washington DC during November 2011 and April 2012 to discuss the analytical work • Peer reviewed report was finalized in November 2012 • Print copies are available • Electronic version of the report is available at the website noted below https://wbcarbonfinance.org/Router.cfm?Page=BioAltAR

4. Alternative Approaches

5. Rationale for Alternative Approaches • Reversal risk profile that contributes to non-permanence can be assessed • Risk profile can be used to identify different approaches or their combinations • Risk pooling and risk management adequately address reversal risks • Sellers and buyers can choose from a menu of approaches to address reversal risks • Approaches to address reversal risk can be integrated into monitoring system • Environmental integrity and economic viability of land use mitigation activities can be balanced

6. Modeling Reversal Risk Fire event data in Chile from 1964-65 Unintentional Reversal • Risks: Natural disturbances - Fire and wind • Data: Data on fire events and area affected in Chile • Geographic: Comuna-level fire event data • Time period: Fire events from 1984-85 • Loss estimates: Field research data on fire effects • Model: LANDCARB Ecosystem simulation model Intentional Reversal • Risks: Conversion to agriculture; Project abandonment • Data : Yield (tonnes/ha/yr) and price ($/tonne) data of A/R and commodities of alternative land use; site productivity; other economic factors • Time period: Cost and revenue data annualized over a 40-year period

7. Tonne Year Approach • Credits are issued incrementally over time upon meeting permanence requirements • Features • Credits are issued for a portion of carbon pools that meet permanence requirements • Avoids the need to reclaim credits after they are issued and subsequently reversed • Project length and permanence influence the number of credits. • Translates into lower NPV relative to other approaches • No residual liability for credits, e.g. credits are not issued before permanence requirements are met • Implementation issues • What is the project length? • What is the permanence period? e.g. permanence period of 100 years result in issuance of 1% of permanent credits per year from cumulative carbon stored • Whether the approach is viable for implementation?

8. Variables Influencing Tonne Year Approach • Permanence period (N) in years; Permanence factor = (1/N) • Annual carbon storage (tonnes CO2) • Cumulative tonne years of carbon storage = [n*(n+1)]/2*Annual carbon stored • Permanent emission reductions = Cumulative tonne years * permanence factor Example : Tonne year with a permanence period, N = 100 years (permanence factor = 0.1)

9. Buffer Approach • Buffer set aside of a percentage of credits issued in a separate account to address risk of reversal • Features • Buffers are generally effective in addressing unintentional reversals. • Project length and withholding rates affect buffer integrity and financial return. • Buffer pool through aggregation can reduce the risk of buffer failure. • Buffer performance in relation to intentional reversal depends on replacement requirements • Implementation issues • What percent of buffer to set aside? • How to manage buffer to avoid being overdrawn? • What types of reversals are to be covered (unintentional, intentional, both) ? • What scales of activity are to be considered - project or program level? • How to replenish buffer if it runs low?

10. Variables Influencing Buffer Approach • Entities: Project/program implementing entities • Risk: Type and magnitude of reversal risk influence buffer size • Project stage : Risk of loss is low in early stages of forest growth translating in a small buffer size • Use: Can be used as stand alone or in combination with other approaches, e.g. Insurance, guarantee • Project period: Short duration projects may need small buffer amounts relative to projects of long duration • Withholding rate: Periodic risk screening/assessment needed to assess the adequacy of buffer withholding rate • Management: Project specific buffer vs. program or system wide buffer may have different management needs. Management of pooled buffer may be cost effective • Robustness: Buffer approach is effective against unintentional reversals. Measures to deal with the risk of intentional reversals need to be adopted to avoid run on buffer due to intentional reversals

11. Effectiveness of Buffer Approach to Intentional Reversals

12. Insurance Approach • Premiums are paid to an insuring entity that guarantees against reversal risk by replacing credits affected by reversal. • Features • Liability for loss transferred to a third-party • Covers one or more categories of unintentional risks and loss magnitudes • Unlikely to cover intentional reversal risks • Premiums linked to type of risk, deductible and loss limits • Implementation issues • What are the enabling factors for use of insurance ? • What characteristics of insurance products suit project/program contexts? • How to get insurers into the market? • What measures are needed if insurers withdraw from market, cancel policies?

13. Variables Influencing Insurance Approach • Entities: Third parties that collect premium to underwrite coverage • Coverage: Can be full value replacement, catastrophic loss limit; buffer insurance • Use: For use as stand alone or in combination with other approaches, e.g. buffer, guarantee • Project stage: Projects in early stage may have lower premium as magnitude of loss is low • Project period: Premiums increase with project period as risk of loss increases • Premium and deductible: Depend on multiple factors influencing risk • Policy length: Insurance policy is short - annual or periodic • Policy renewal: Premium and deductible are subject to review and revision at policy renewal

14. Host Country Guarantee • Host country acts as a fiduciary backstop to address reversals unresolved at the project or subnational levels. • Features • Host country or an authorized third party can guarantee or backstop project against reversal risks • Improves flow of credits to projects as risk is shared by host country or authorized entities • Can be combined with other approaches – buffer, insurance • Lowers reversal risk impacts on projects • Institutional failures or lack of funds can prevent a country from realizing its guarantee • Implementation Issues • What factors influence host country guarantee? • What are ways to promote host country capacity to support guarantee? • How to ensure the credibility of host country guarantee? • How can external guarantees complement host country guarantee – e.g. Partial risk guarantee?

15. Variables Influencing Host Country Guarantee • Entities: Host country or third parties that provide similar guarantee • Coverage: Losses beyond those covered under other approaches • Risk profile: Projects with diverse risk profile maximize the effectiveness of guarantee • Policy and legal: Existence of policies and legal measures to implement guarantee • Capacity: Institutional and financial capacities needed in support of guarantee • Monitoring: National accounting and monitoring systems needed to track performance of activities in order to trigger guarantee against reversal risk • Implementation: Terms and conditions that support implementation of guarantee

16. Exceptions to Low Risk Activities • Categorical exceptions for certain low risk activities result in issuance of permanent credits • Features • Risk analysis based on historical data to demonstrate low risk • Exceptions are defined based on a range of criteria - project type, risk profile, geographic variables etc. • Low risk of activities to be confirmed through risk screening tools and independent audit • Low monitoring burden for activities that are identified as having low risk • Implementation issues • What are the criteria for defining low risk activities? • What are the safeguards to minimize the impact in case risks materialize, e.g. management plans for addressing relevant risks? • How can national guarantee include provisions governing exceptions for low risk activities?

17. Prevailing Approaches to Address Non-permanence risk under UNFCCC : Case of Carbon Capture and Storage (CCS)

18. Comparison of Approaches

19. Approaches Adopted in Different Standards

20. Approaches for Addressing Reversal and Scale Project • Project • Buffer • Insurance • Tonne-year • Temporary credits Sub-national National • Sub-national & National • Pooled buffers • Insurance • Host govt. guarantee

21. Policy Insights • Location matters • Scale matters • Diversification matters • Type of risk matters

22. Extensions of Analysis • Improved data on risk profiles • Multiple scales of coverage • Risks from different disturbance types • Other LULUCF examples • REDD • Agriculture • Extension to multiple land uses • Landscape contexts – REDD, A/R, SFM, Agriculture

23. Thank you Rama Chandra Reddy Email: Rreddy1@worldbank.org For more information on the BioCArbon Fund, please contact: EllysarBaroudy Email: Ebaroudy@worldbank.org www.carbonfinance.org

24. Additional Slides: Examples

25. Example: Modeling Unintentional Reversal Ratio of reversals to credits issued in a 20,000 ha project implemented over 40 years without approaches to address reversal

26. Example: Buffer Approach Mean buffer balance as percent of credits earned in a 20,000 ha project of 40 year duration with 10% buffer Mean buffer balance as percent of credits earned in a 20,000 ha project with 10% buffer

27. Example: Insurance Insurance coverage of a 20,000 ha project of 40 years length – full value coverage, catastrophic loss limit, and buffer insurance